MARKET INSIGHT – December 2023

MARKET INSIGHT

Prime Partners’ monthly analysis of global economic and financial market news.

A breathtaking November!

After three straight months of declining equity markets and the onset of fall in Europe, investors were undoubtedly beginning to feel a bit gloomy. 2023 was starting to look like a wasted effort, and the performance of balanced allocations was losing altitude. This was without counting on an unexpectedly strong rebound in November, on both equity and fixed-income markets, with monthly performances in some cases breaking decades-old records, particularly for US bonds.

The latest economic releases were particularly encouraging, especially in the United States. Inflation, consumer spending and growth data all suggest that the Fed is on course to achieve a soft landing. In other words, for the time being, Jerome Powell and his team are succeeding in fighting inflation without inflicting too much damage on the country’s economic activity and consumers. That was all it took for financial markets to launch a major rally and become much more optimistic about the ability of economies to overcome post-Covid inflation.

2023 is a powerful reminder of a key principle of long-term investing: stay invested. Indeed, this year, it was the months of January and November that were not to be missed, or else one would have failed to capture a substantial part of the rise in equity indices. Their recent surge also had the merit of initiating a “rebalancing” between the major US technology stocks, now dubbed the “Mag 7”, and the rest of the market. The performance gap between these tech giants, perceived by traders as immediate winners from the advent of artificial intelligence, and most other sectors remains considerable, but renewed optimism about the economic environment over the next few quarters and, of course, the future attitude of central bankers, enabled a slightly wider participation in the bull market during November.

A number of lessons can be drawn from the latest US data: inflation, as calculated by the CPI index, has fallen considerably in 2023, as has its core component, which is closely watched by the Fed. Simultaneously, the US economy is proving even more resilient than expected, with GDP growth measured at 5.2% in the 3rd quarter. Last but not least, the American consumer, the true pillar of the economy, continues to spend money. Their purchasing power is intact, or even better than before the pandemic, thanks in particular to the wage increases received in recent quarters and to the easing of consumer prices in the past few months.

There is no doubt that the expansionary fiscal policy pursued across the Atlantic goes some way towards explaining the strength of the US economy. More generally, we do not wish to be caught up in the current euphoria, where a certain exuberance on the part of market participants is never far away.

The geopolitical situation has barely changed and remains deeply unfavorable. True, a conflagration in the Middle East following the Hamas attack in early October and the subsequent Israeli military response does not appear to be on the agenda. But neither does a peaceful solution in the region, where despite the recent truce and the exchange of hostages for prisoners, an end to Israel’s offensive does not seem imminent.

Nor is there any sign of improvement on the Russian-Ukrainian front, where the conflict seems set to drag on without any real diplomatic solution or major military victory for either side.

There is no doubt that the expansionary fiscal policy pursued across the Atlantic goes some way towards explaining the strength of the US economy

Beyond geopolitics, we are not losing sight of the economic and financial challenges facing us in 2024, of which there are many. Assuming, of course, that November’s good news is confirmed in the coming months, with inflation under control and robust economic growth, companies will start to be confronted with a “refinancing wall” whose volume of maturities over the next four years is extremely high. For many of them, this will mean dealing with a significantly different reality in terms of the cost of capital than in the pre-Covid period.

In this far less accommodating environment than before, the evolution of margins and the economic performance of companies will come under scrutiny, especially those with fragile balance sheets.

And let us not forget the problems experienced by American banks this year, as well as the unrealized losses to date by some major financial institutions on their bond portfolios, following the rise in interest rates and their subsequent persistence at high levels. Here again, caution is called for, because even if a certain normalization of the situation appears to be a logical consequence of the economic developments of recent months, history shows us that “accidents” happen all too quickly, and can easily rock the banking system.

2024 will also be a very busy electoral year, culminating in the election of the future American president. History shows that this type of event is generally favorable for US equities, and many of the campaign pledges will certainly give rise to a degree of optimism. However, we shall have to keep a close eye on the course of the upcoming electoral race, and on a potential resurgence of the rift between “Trumpists” and Democrats in the United States, where the assault on the Capitol in early 2021 remains a worrying memory.

Finally, as for the European Union, apart from the structural lack of agility in terms of common economic policy and beyond the future trajectory of inflation and growth on the old continent (which we believe to be similar to that of the US), over the coming quarters equity markets are likely to monitor closely the pursuit of greater energy independence, as well as the narrowing of the gap with the United States in the technology race.

November sent strong positive economic signals to investors, who were quick to react.

Against this backdrop, our portfolio allocations benefited greatly from these developments, with both equities and bonds rising.

We are still taking a cautious approach, and are maintaining our underweight in equities for the remainder of the year, compared with the neutral weighting of our benchmarks. This defensive stance has not penalized us in any way this year, thanks to the excellent performance of our selection of active managers and certain thematic strategies, such as those focused on technology.

Furthermore, our investments in convertible bonds and in a long/short equity fund further strengthen the actual exposure to stocks in our allocations.

November sent strong positive economic signals to investors, who were quick to react

On the fixed-income side of our portfolios, our “core/satellite” approach paid off handsomely over the past month, but more generally throughout the year.

Active managers selected in niche segments (high yield, senior loans or long/short bonds) had a very good November, helping our results to be less dependent on the behavior of equities in 2023.

Finally, we would be remiss not to mention gold’s continued strong rebound last month, against a background of falling interest rates favorable to the yellow metal.

We finish the year by adding a line of 20-year US Treasury bonds to our allocations, with the expectation that in 2024, in line with our central scenario, interest rates will fall and this instrument will reap the full benefits.

As we enter the month of December, whose holiday season will cut into volumes during the last two weeks, we look ahead to 2024, maintaining the same cautious approach that has enabled us to navigate this year so well.

Our priority for the coming quarters will continue to be the pursuit of performance across the various asset classes in our allocations. We remain fully aware, however, that a soft landing for the economies after 2022’s peak in inflation is by no means guaranteed next year, even if it looks increasingly likely.

A final word on the recent death of Charlie Munger, co-founder of Berkshire Hathaway and Warren Buffet’s right-hand man: his relentless common sense when it came to investments ( complemented by a healthy dose of humor in many of his statements) once again highlights the vital importance of investing with composure and for the long term.