Year in review: Dodging a downturn

We entered 2023 with talk of most major economies at or near recession and there seemed to be little cause for celebration. But as 2023 came to a close a more optimistic outlook for investors emerged as forecasters who had predicted more gloom, following 2022’s successive rate hikes, were proven wrong. However, it took a few twists and turns to get to this point.

A tug of war between inflation and interest rates played out across continents. Inflationary pressures started to build as economies reopened after the pandemic and supply couldn’t keep up with demand. Many central banks had the delicate task of curbing inflation without it stifling the economy.

The UK grappled with sticky inflation, and this posed some challenges to both consumers and policymakers. At the start of the year inflation hit a record 10.7% (Consumer Price Inflation) and Prime Minister Rishi Sunak made it one of his election pledges to halve it.[1] This was achieved in October when it declined from 6.7% to 4.6%,[2] but it’s still higher than the US (3.2%) and the eurozone’s (2.9%).

Meanwhile, the US saw CPI inflation easing this year from soaring over 9% in the middle of 2022. While the Fed initially downplayed the possibility of interest rate cuts, it changed its stance in December 2023 with the announcement that the Federal Funds target rate would stay between 5.25% and 5.5% and signalled that it expects to cut interest rates in 2024.[4] Fed officials believe core inflation will fall to 2.4% in 2024 and 2.2% in 2025, reaching the 2% target in 2026.[5]

United Kingdom (UK)

The UK stock market had a weak start to the year thanks to commodity prices falling and the banking sector being hit by the collapse of Silicon Valley Bank (SVB) followed by struggles at Credit Suisse.

The UK was also negatively impacted by the US tech stock resurgence and resulted in investors swapping value for growth stocks. The main UK index, which has a bias toward energy and mining stocks, was hit by lower energy and commodity prices.

Some areas fared better than others. Larger, more internationally focused companies with less exposure to the health of the domestic economy did better than medium sized and smaller businesses .

As recessionary fears for the US started to ebb towards the end of the year, so too did concerns that the UK would endure the same fate. Like the US, the UK economy remained more resilient than expected thanks to a strong labour market and consumer spending.

Overall, ‘smart borrowing’, where households and businesses locked in cheaper loans when interest rates were low during the pandemic and pre-pandemic era, also played a big part in keeping the economy ticking over.

United States (US)

The US stock market performance has been mixed this year as not all sectors enjoyed success. In March, the SVB collapse sent shockwaves through the financial sector and there were concerns of contagion. But this was stopped by the Fed’s intervention with the provision of emergency loans for the financial institutions that were in distress.

Despite the rocky start, US stock markets has been one of the better performers overall. However, the S&P 500 has been mainly buoyed by the performance of a group of companies known colloquially as the ‘Magnificent 7’, which include technology giants Alphabet, Microsoft and Nvidia. These tech stocks captured the interest of investors following rapid progress in Artificial Intelligence (AI).

AI will be an area to watch in 2024, especially given the potential for the technology to deliver economic and productivity growth. However, with recent strong performance, investors could be vulnerable to a correction should sentiment around AI stocks sour.

But the longer the US economy defies pessimistic forecasts there is a good chance there will be a broader lift in performance outside of the ‘Magnificent 7’ . This broadening out is already occurring as the US is seeing a resurgence in small caps and this could be the light at the end of the tunnel that investors have been hoping for.

Overall, the US economy surprised on the upside in 2023, particularly as there was talk among economists of a potential downturn. However, this didn’t happen mainly due to a strong labour market, robust consumer spending and elevated company earnings.

Europe

European markets had a stronger period at the start of the year than the US thanks to avoiding the worst of the energy crisis and was further supported by better company earnings and economic data. They also benefited from the belief of a China resurgence out of the pandemic, which is an important export market for Spain and Germany. However, European stocks have been overshadowed by US equity performance, particularly tech giants, and as sentiment around China grew weaker as its expected comeback didn’t materialise.

Asia

China’s economy reopened in October 2022 and there were great hopes that it would lead to further global economic growth, but this soon fizzled out due to weaker consumer consumption, which had not returned to pre-pandemic levels.

As disenchantment with China continued investors turned their attention on other emerging markets such as India and Mexico and Asian developed markets including Japan.[6]

The price of gold has appreciated through concerns over geopolitical instability and the risk that the conflict in the Middle East will spread.

Sanctions against Russia are likely another contributing factor to influence the rise in the gold price as emerging market central banks and sovereign wealth funds have been snapping up the precious metal over concerns that they may suffer the same fate. Holding bars in vaults makes it difficult for foreign entities to seize.

Gold has always been a good hedge in times of uncertainty and when stock markets or the US dollar perform poorly. However, even during the recent stock market rally in October and November, gold has performed well, and this is due to optimism that US interest rates are at a peak.

Bonds are generally viewed as relatively safe, but 2022 was the worst year on record for this asset class as the Fed’s aggressive rate hikes impacted on them negatively, with long-term bonds being the hardest hit.

However, 2023 was a better year for bonds. They became more attractive as yields soared to 15-year highs prompting UK investors to return to UK government bonds as their risk/return profile became more attractive.

Meanwhile in the US, restrictive monetary policy and increasing government borrowing drove US Treasury yields (inflation adjusted) up to levels not seen in over a decade. Yields could stay elevated due to high US public debt and an unwillingness by Congress to curb government spending. Bonds also became more attractive when it became more likely that inflation in America had peaked and the Fed wouldn’t raise interest rates further.

With interest rates having potentially peaked and some cuts forecast in the US in 2024 the fixed income momentum has remained strong.

In the UK, changing working patterns due to the pandemic have had a major impact on the real estate industry. With fewer staff returning to the office and changing working patterns – due to many corporates adopting a work from home or hybrid working model - occupancy rates have dropped and demand for office space in the major cities with it.

According to the latest research, office occupancy levels in the UK settled at 37.1% in early November 2023.[7]  It means that investors in the office market space need to consider the current and future impact of any potential surge in vacancy rates.

Ongoing wars in the Middle East and Ukraine are likely to have an impact on markets. With no end in sight to the conflicts, defence budgets globally are likely to increase, which usually bodes well for companies operating in the aerospace and defence sector.

There’s still the potential for an economic downturn which, coupled with 40 national elections and more than half the world’s population going to the polls, could result in further uncertainty.

Potential interest rate cuts in 2024 could bode well for fixed income and equity investors. If US interest rates are cut in the first half of the year, as expected, this could release more liquidity out of money market products and into equities. Equities could also continue to benefit from strong company profits and global growth could be spurred a strong labour market, which makes the case for remaining invested a strong one.

[1] Investors dumping China load up on other emerging markets | Reuters

[2] Eurozone inflation hits record high of 10.7%; UK mortgage approvals, credit card borrowing fall – as it happened | Business | The Guardian

[4] Dow closes at record high after Fed signals it will cut interest rates in 2024 | Federal Reserve | The Guardian

[5] Fed interest rate decision December 2023: Fed holds rates steady, indicates 3 cuts coming in 2024 (cnbc.com)

[6] Investors dumping China load up on other emerging markets | Reuters

[7] UK Office Occupancy Dips Due to Train Strikes (costar.com)