When can investors expect inflation to fall and central banks to ease the pressure on interest rates? This was the question that dominated stock markets in the US, UK and eurozone in 2023.
After the US Federal Reserve raised rates to tackle soaring inflation, investors agonised over whether the Fed had done enough to tame rising prices. Or had it, in fact, overdone its approach, risking a painful recession?
At the end of 2023, it appears markets have drawn their own conclusions, by and large shrugging off worries of a “hard landing” in which high rates pitch economies into a downturn. Inflation went into decline in many regions, while data points to a strengthening US economy and labour market. The S&P 500 is up around 23 per cent over the year — the tech-heavy Nasdaq up 41 per cent.
That is the background to this year’s FT Money annual investment lunch — a debate including FT specialists and finance experts on the outlook for investors in 2024. Chris Giles, FT economics commentator, and Katie Martin, the FT’s markets editor, join Caroline Shaw, a multi-asset portfolio manager at Fidelity International; Sue Noffke, head of UK equities at Schroders; and Simon Edelsten, a former fund manager, over lunch at the FT’s offices in the City of London.
Aside from inflation, the questions focusing the minds of our panellists include the impact of gyrations in the oil price, the outlook for the UK’s unloved equity markets, ESG’s annus horribilis and ever-present concerns over “geopolitical risks”. The US stand-off with China remain a key fault line for the global economy. Closer to home, the ramifications of elections in the US and UK will be inescapable for investors and savers.
Have central banks won the battle against inflation?
Most investors believe the worst of the high inflation seen in 2022 and this year is over, after price rises eased across many economies. The market is justified in thinking the outlook is significantly better, says Giles. But that still leaves plenty of room for surprises — as the Federal Reserve demonstrated on December 13. It unleashed a global market rally after it gave a strong signal that it planned to start cutting interest rates soon.
“There are a lot of uncertainties about how fast central banks will cut, partly because they are going to be incredibly wary about making a second mistake and letting inflation persist for any longer,” says Giles. “So I think markets might be a little bit disappointed in 2024 about how quickly interest rates fall.”
Noffke of Schroders agrees, adding that it wouldn’t be the first time the market had been wrongfooted on rates and inflation. “Markets like to look ahead. They are just so eager to move to the next thing. But there are a lot of lags in the pass-through of interest rates. The tightening we’ve seen has not yet had full effect.”
Central banks are always at pains to avoid accusations of political influence in their rate-setting, but next year’s US election complicates the timing of any Fed decisions. Giles says: “The US election will completely dominate everything next year. So it might be that the Fed goes a bit early [on rates] and then stops because it’s got a big political risk. Were there to be a Trump government and there were accusations that the Fed was helping the Democrats, that would be very problematic.”
In the eurozone, the rates outlook is strongly influenced by another factor: the oil price, which recently dropped to a six-month low. Edelsten says: “If I were the European Central Bank, I’d worry about the very low headline inflation rate, a big chunk of which Mr Putin has a finger on. I wouldn’t want to bet that I could cut rates and be safe, given that it could quite easily go up from here.” Of course, he adds, canny investors can hedge this scenario by including oil stocks in their portfolio.
Talk of a 2024 recession in the US, with its serious ramifications for other economies, is fading as inflation comes off the boil. But it remains a plausible scenario, says Martin. “Some of the portfolio managers and chief investment officers I speak to think everyone is kidding themselves and there’s definitely a hard landing coming next year. If this year has taught us anything, it’s to be really humble with forecasts. The markets did not behave themselves at all.”
She warns that a paradox lies at the heart of the current optimistic consensus among investors. “The market is saying both that the Fed has pulled off a soft landing but is going to cut by 120 basis points next year. These things can’t both be right at the same time. So I think next year is going to be quite jerky in terms of trying to figure out where yields should be. And everything else is pivoting around benchmark yields.”
Central bank policy dominates discussions of triggers for recession. But the “mechanical” effect of monetary tightening is only one element of this story, says Giles. “There’s the animal spirit aspect of how consumers and businesses feel about the world. If people feel the world is turning into a bad place to invest — which could happen for many geopolitical reasons — then you could easily get a recession. It’s not coming directly from monetary policy, although that can exacerbate it.”
Can US tech continue to drive growth in 2024?
The so-called “Magnificent Seven” — Apple, Meta, Microsoft, Alphabet, Amazon, Nvidia and Tesla — played a huge role in 2023 in fuelling stock market growth, dominating US and global indices.
Investors believe developments in artificial intelligence will drive the next wave of growth in many of these companies. Panellists can see the attractions, but risks are lurking.
“We’ve seen an AI frenzy, the retail bandwagon getting going and an expansion of valuations around the potential of those hyperscalers in the US,” says Noffke. “The US market is as concentrated as it’s ever been. After a period of concentration you usually get a broadening. This looks to be quite an unusual phenomenon. But they’re great companies, and it’s difficult to knock them.”
The concentration risk should worry index investors, says Edelsten. “The Magnificent Seven is now 26 per cent of all global equities. And they’re correlated. Financial advisers often say the index is a low risk, worth investing in. It isn’t when the index itself is very wobbly. Back in 1987 the global index was 50 per cent in Japan — another point when it clearly wasn’t very balanced.”
AI’s intellectual advances have been astonishing. But how do these companies make serious profits out of it? One example, says Shaw of Fidelity, is Microsoft. It has been able to raise its licensing prices above inflation by selling the benefits of “impactful” AI-driven improvements in productivity. “Not everybody using Microsoft Office at home is going to benefit. It’s the corporates with software developers, who will be paying more for licences in order to reduce their labour costs. That, to me, sounds like something that’s going to be credible.”
The intensity of investors’ interest in the AI theme, however, has unintended consequences. Martin says: “These are proper companies that make proper money. But everyone’s latched on to the AI theme. Not only is it an index play, but if you take a stockpicking approach, you end up running the same equity risk as everyone else.”
Bonds are back. What does it mean for investors?
Higher interest rates have triggered a rejuvenation of the bond market, with returns attracting a wave of new investors. But retail and professional investors alike have been burnt by volatility in the market over this year.
As a result, for individual investors who need immediate access to their money, “it doesn’t look fantastic”, says Martin. But though they may be having “a horrible time” on paper, they should remember the bigger picture: “They have locked their money up for a certain period and they’re getting a juicy yield from it.”
The renewed interest in bonds raises the question of whether private investors will return to the tradition of a 60/40 split between equity and bond holdings in their portfolios. Martin warns: “If there is one certainty it’s that bond yields will continue to be volatile.” For those adding these conventionally “safe” assets, “that does introduce a little bit of spice that is not necessarily welcome in that part of your portfolio.”
Shaw agrees. “The equity bond correlation has been all over the place. I think we need to see that relationship stabilise again for people to really believe that they can do 60/40 or a similar split of bonds and equities.”
When inflation rises, US pensioners managing their own retirement funds have been among the buyers, says Edelsten. “That’s a symptom of the fact that most American pensioners since the financial crisis 15 years ago never saw a point at which they could buy a bond that they could afford. They’ve been overweight equities because they had to be in equities. And equities went up a lot. So the amount of money that’s got to rebalance bonds and equities just through ageing is massive.”
Panellists raised the related issue of cash, which investors built up during the pandemic, returning to it when interest rates went up. US savers typically put it into money market funds; in Europe and the UK, in savings on deposit. When meeting independent financial advisers this week, Shaw said there was one key question they were getting from their clients: “Why should I do anything other than cash?”
Martin says there has recently been more interest in long-term fixed income products, where attractive rates can be locked down. But large reserves of cash remain, which investors will seek to put to better use. “Everyone’s talking about this ‘dry powder’. Where is this money going to go? Into financial markets? Are people just going to spend it in the pub? I don’t know. But potentially for investors that’s an exciting new prospect for next year.”
Will we see investors return to UK equities?
UK stocks have been an unloved asset class for years, though for value investors the London stock market has much to recommend it: prices are low, and many companies produce reliable returns, in the form of profits, dividends, or both. So why have investors been taking their money elsewhere?
Noffke says: “People can see that there’s value but they look in the rear-view mirror in terms of returns and think ‘Oh, I’ll just have a bit more global’.”
Valuations are compelling for patient investors, she says: “The price to pay is such a high determinant of future returns. And particularly when you look at share buybacks, if no one else is buying, at least the companies are.” Throwing in share buybacks and dividends, she adds, total shareholder return is about 6 per cent. “That’s pretty good.”
Next year, UK investors will be keenly assessing the market-related fallout from the general election. Giles says a potential Labour government will impose strong party discipline — as long as it wins a reasonable majority at the ballot box. “If you get that, I think it’s good on broad stability grounds. Do they have a lot of money? No. Are they going to spend some money? Almost certainly.”
Some of that could find its way into the UK’s construction and industrials sectors, which are closely watched by Shaw. “Some of the housing data in the UK is a lot better than it is in Europe. So maybe we’re seeing a slight uptick and analyst upgrades on that side of things — that’s industrials, materials, specifically stocks that are leaning into the housing market. We’re at a low base. But we’re ticking up.”
In a different property play, Edelsten likes Land Securities. Its fully let estate in Victoria and low gearing translate into a 6 per cent yield, he says. “The thing about a company like Land Securities is that if you get inflation shocks, you wait long enough and you can put your rent up. Because as long as no one gives up using offices, you’ll be able to rent out ahead of inflation.”
Edelsten adds that he has had “very low” UK weightings for the last 12 years. “I certainly have more now, in ‘chugging along’ companies which are solid and reliable,” he adds. “That’s where I think there is an extraordinary amount of value.”
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