Neil Birrell, Premier Miton’s Chief Investment Officer and manager of the Premier Miton Diversified Fund range, looks back at 2023 and ahead to 2024 in the hope of working out what it might bring.
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
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Here we go again
It’s hard to believe we are at that point of year already when I look in the rear-view mirror and dust off the crystal ball. But here we are, it’s time to review 2023 and preview 2024.
As with all years, it is not possible to just compartmentalise them, they are dynamic and merge seamlessly. Forgive me, therefore, for taking a step further back. I was struck by a comment from our global smaller companies fund manager, Alan Rowsell, at the start of November. We were talking about how difficult stock markets had been and he noted that we had been in a bear market for 2 years. A bear market is often defined as one that has fallen 20%, although it is a term used colloquially to describe markets that have fallen sharply or fallen over a period of time. A post COVID hangover of sorts.
The past; has it really been that bad?
Looking across different asset classes, such as bonds, company shares and gold over the last 24 months or so is interesting. Firstly, what was happening in November 2021? The world economy was recovering rapidly from COVID as society reopened, however, there were supply chain shortages appearing, particularly in energy, the threat of inflation was looming and fears of interest rate increases were growing. That all came to pass and then Russia invaded Ukraine to accentuate all the issues. As we have gone through the period, we have been looking for signs of inflation abating and interest rates peaking. Until very recently, those signs have been fleeting.
It should therefore be unsurprising to report that financial markets have been through a difficult time. Bond markets, in particular, have fallen a long way; as interest rates rise, cash deposits become more attractive relative to the income provided by bonds which are riskier, meaning bond prices fall. Stock (or equity) markets have also fallen; the impact of inflation, the rising cost of living and interest rates have the effect of slowing economic activity and growth, so can lead to recession, which can lead to weaker corporate profitability and company share prices.
Major stock markets around the world have fallen. Alan’s point was a good one. The MSCI World Smaller Companies Index, which measures the share prices of a group of such companies, was down roughly 25% in the 2 years to the end of November 2023. Several other stock markets did not fall as far and have recovered some of their losses.
Gold is often considered to be a haven for investors in difficult times and also a good investment when inflation is higher; unsurprisingly, the price of gold has been reasonably strong.
Overall, a difficult 2 years to navigate and it is unsurprising that the attraction of the deposit rate in the bank has proven too hard to resist for many investors; something to take to relieve the post COVID hangover.
The present; has it got any better?
I think it is worth looking at two items here; the economy and financial markets, which are closely linked.
Firstly, the economy. Simply, no, it has not got any better, however that is good news. Economic growth is slowing and is expected to slow further as the impact of the interest rate increases kick in. It does also depend on which region we are looking at. The US is the largest and most important economy in the world. At present, it does appear to be slowing nicely; the consumer sector is still holding up, the jobs market remains supportive and the signs are good for inflation. The European economy has been struggling a little, but inflation has been abating.
It is less good news in the, albeit quite different, UK and China. China is the world’s second largest economy and therefore very important. It came out of COVID lockdowns much later than everywhere else, at quite a rate of knots, but that dissipated as the global economy slowed and their own property sector came under stress. It has slowed to such an extent that deflation (the opposite of inflation) has arrived, which is bad news for economic growth. In the UK there are fears that the economy is being damaged by the high interest rates already and recession is looming; inflation is still too high, wages are rising, unemployment is up, the housing market is showing signs of stress and the overall picture is not good.
As far as financial markets are concerned, bad news is not always bad news, sometimes bad news can be taken as good news! Let me explain. Because inflation is moderating and economic growth is slowing, even recession is a distinct possibility. The central banks that set interest rate policy will be making decisions based on future expectations, just as investors do. Therefore, they will aim to stop the increases ahead of any significant economic slowdown, a bit like steering a super tanker, which is exactly what investors are waiting for, as it signals a turn in the cycle and a more optimistic outlook; lower interest rates and a reversal of what we have been through.
The present; yes, it might be getting better!
That is exactly what happened in early November. It is not just the actions of the US Federal Reserve (Fed), the Bank of England (BoE) and the European Central Bank (ECB) that have been the focus, more the words and phrasing they have used in the accompanying statements and press conferences.
On 1st November the Fed left interest rates on hold as anticipated and their statement mentioned that they expected the prevailing policy measures to lead to a slowing of the economy and that they would be ready to act further if necessary to dampen inflation. All of that was to be expected, as was their cautioning against the perils of high inflation.
However, Jerome Powell, the Chair of the Fed, also hinted that we are close to, maybe even at, the end of the interest rate increases, which is exactly what investors have been craving. He would not allow himself to make that statement, but it was a suggestion.
The next day, the Bank of England also left interest rates unchanged and also cautioned that they may need to rise again. However, the outlook is rather bleak in the UK and this could well be the peak in interest rates or else there is a risk of tipping the economy into recession.
Anyway, for good or for bad, for better or for worse, investors took the contrasting reasons (a gently slowing US economy and a stressed UK economy) for the perceived interest rate peak as good news. We saw an immediate and sizable reaction in US government bonds, which rose and a big move upwards in UK companies that had suffered as interest rates had risen.
To keep the short-term timeline going, the US inflation data released on 14th November provided more evidence that the economy is behaving well. When writing notes such as these, it is not that wise to reference very short term moves in financial markets, as they may well have reversed by the time you read it. However, the immediate reaction was for markets to move to a position where they expect interest rates to start falling in the US in the first half of 2024. That may be a little optimistic, but it does show how quickly and how far prices can move to reflect potential changes in the outlook.
As I write this, it is reasonable to say that the present financial market conditions are an improvement on the past (the last 2 years anyway).
The future; time for those predictions!
As far as investing goes, the future is more important than the past, however, it is not a science, so, let’s get the caveats out of the way. When it comes to forecasting what the future holds, I could be wrong and, very importantly, the economic outlook remains very uncertain. It is possible to paint a rather dire outlook as well as a positive one.
However, I am going to focus on investing in different types of assets (such as bonds and equities) and refer to the economic outlook as I think it will impact those asset classes.
I started this note by discussing what a difficult period we have been through in financial markets and that is certainly what I hear from the fund managers at Premier Miton when I discuss their funds with them, it’s all very downbeat. When we discuss the outlook, their tone is similar; it’s tough out there. But we are active investors, which means we select the specific bonds and companies in which to invest to build portfolios we think will produce good long-term returns. When I ask them about the outlook for the individual investments and the funds, they become quite animated, in a positive way!
What we have experienced is that the difficult macro-economic conditions (inflation, interest rates, economic growth, house prices, unemployment etc) have had a negative effect on the prices of companies, for example, whose business have continued to do well. This means that their shares have fallen to levels that make them look good value relative to the profits they are producing and their prospects. Similar features have occurred in property companies, which as a group in the UK, have rarely in history reached such low valuations. The same has taken place in other asset classes such as energy storage, renewable energy, specialist lending and shipping.
Bond markets have fallen a long way as interest rates have risen, to levels where parts of the bond market are now providing much higher returns for considerably less risk than they were 2 years ago. As it is very important to have your investment portfolio diversified across different types of assets, it seems to me that a high quality, lower risk selection of bonds is a good place to start. They provide, what I consider to be, attractive returns now and as we have seen very recently, if interest rates peak, let alone start falling, the returns could be even better. Of course, it could get worse before it gets better, but trying to perfectly time buying and selling investments is very, very difficult.
There are areas of the stock market at such attractive levels, I struggle to think of a time in my career that matches it. As with the economic backdrop and bonds, I could be wrong and prices could fall further, but for the long-term investors, to me, the opportunity is clear.
Further diversification through property companies and other asset classes, builds a portfolio of investments that can provide an attractive way of generating returns to tackle inflation and provide an alternative to the interest rate on cash deposits, which is likely to be coming down anyway, probably starting next year. Furthermore, the long-term potential returns are appealing in my view, starting from levels lower, in some cases considerably lower, than 2 years ago.
The future; what might produce less good returns
Cash has been increasingly the flavour of the month with investors for the last 2 years. It’s not surprising, it has been providing improving, effectively risk-free returns over that period, and has been a credible option for investors for the first time since before the global financial crisis in 2008. Furthermore, riskier assets such as bonds and equities have been doing the opposite for the last 2 years. However, as inflation falls and economic growth slows, maybe even recession arrives, the returns from cash should be expected to fall, certainly not back to near zero, but enough to make a difference. That’s exactly when bonds should be doing well.
Financial markets are very broad and diverse themselves and just as I said I have rarely seen such good opportunities, I have also rarely seen such disparity within markets, the stock market especially. I mentioned that there are parts of the stock market that I think are markedly attractive, which includes small and medium sized UK companies. There are also parts I think are looking expensive relative to the rest of the market, which includes some, but not all, of the very large US technology and communications companies. These and similar companies have driven the US stock market through 2023.
I think it is going to be very important to be selective in investment decision making. That’s been the case for some time and is likely to be even more so over the next year or two.
The future; the end!
This note turned out to be a lot longer than I anticipated, but there was a lot to say.
If you have got this far, to summarise; we have had a difficult period for economies and financial markets, where the returns have been poor as the returns from cash have risen. I cannot tell you when that will reverse, but it will, it is a cycle and the signs are it’s getting closer. But it could get worse before it gets better.