Q4 2023 Review; 2024

Q4 & 2023 Review; 2024 Outlook

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Market & Macro Review for Q4 2023 and 2023 Overall

The table below sets out performance for 2023 and Q4, by various asset classes and styles. The performance contrast is quite stark showing how, being univested, would have cost an investor substantial returns as a result of missing out on Q4 performance.

The close-out to the year was characterised by three factors:

1. Repeated talk of rate cuts. The Fed itself indicated as many as 3 during the course of 2024 while some market players suggested as many as 6.
2. Declining inflation at both headline (sensitive to energy and food) and core (sensitive to consumer components) levels. A fall in oil prices was a big contributor despite attempts by OPEC and OPEC+ to cut production.
3. A perceived decline in geopolitical risk, especially in the Middle East, where there was a temporary ceasefire as hostage negotiations took place and peace-brokering involvement from external countries (US, EU, Oman) and entities (UN).

Growth finished the year top performer (+37%) with a strong contribution during Q4 (+13%). Other rate sensitive sectors such as Global REITs went from negative to positive boosted by a +15.6% performance in Q4. The chart below gives a further breakdown:

The above shows the impact of falling energy prices (CRB Index, Brent and US WTI Oil) over the quarter while elsewhere (with some exceptions), performance post 27th October received a massive boost from Q4.

Also worth noting is the impact of NASDAQ type names on equities. There has been considerable mention of the Top Tech names and their performance, for example, NVIDIA +238.9%, AMD +127.6%, Palo Alto +111.3, Broadcom +99.6%, Salesforce +98.5%, Intel +90.1% - to name a few.

By stock market (local terms), Japan’s TOPIX was the star performer delivering over +28% with the S&P 500 close behind on over +26%.

In the world of fixed income, High Yield (HY) finished up strongly between +10.5% and +13.5% across EM, Europe and US. Sovereign bonds also delivered strong returns north of +4% reflecting a persevering risk-off appetite for many investors looking for safe haven investments.

So, in a nutshell, Q4 was boosted by declines in energy prices, perceived moderation in labour markets, falling inflation and therefore euphoria aroundrate cuts for the coming year. Markets priced this in and rewarded equities and corporate bonds.

Outlook for 2024

2024 will be characterised by the following factors:

1. What will be the next evolution in the Israeli-Gaza conflict and its impact on wider geopolitical tensions? This will directly impact Risk Premium i.e. the amount investors expect to earn to compensate them for elevated risk they perceive to exist in.
2. What will happen to inflation? This directly influence Central bank thinking when it comes to interest rates. Not all inflation will result in higher rates – key is whether it is demand driven or geopolitically driven (e.g. energy prices).
3. How will the election calendar playout with a lineup of over 60 national elections up for grabs. The Government voted in will determine policy which, in turn, affects and accentuates the above two factors.

Israel-Gaza: some 3 months after fighting began, we have witnessed the following:

• Civilians have borne the brunt of deaths (over 22,000 Palestinians and 1,200 Israelis).
• Some 130 Israeli hostages are still being held captive and their families continue to put pressure on Tel Aviv for their release.
• Hamas continues, via its tunnel network, to fire rockets albeit fewer in number (27 since the start of the year vs 3,000 in just the first few hours of the conflict on 7th Oct).
• A deputy Hamas leader (Saleh al-Arouri) was killed in Beirut on 2nd January though Israel has not formally claimed responsibility. Israel’s two key targets – political leader, Yahya Sinwar and military leader, Mohammed Deif – still remain elusive and at large.
• News flow has been controlled by the IDF (Israeli Defence Forces). However, numbers of Israeli deaths/wounded/disabled have been high. A leading Israeli daily, Yedioth Ahronoth, published information obtained from the Defence Ministry’s rehabilitation department stating over 2,000 IDF soldiers had been registered as disabled. The Times of Israel has reported the number of injured IDF soldiers, Israeli Police and other security forces at 6,125.
• Meanwhile, Israel’s stance and tone remains unaccommodating. Recently, two Cabinet Ministers called for a solution to encourage Palestinians to emigrate from Gaza while Israeli settlers return to the strip.
• Israel claims to have killed/captured up to 10,000 Hamas fighters (considered to be an exaggeration) out of a total of up to 45,000. Despite this, Hamas is a long way from being defeated. Support for Hamas has risen from 12% to 44% in the West Bank and from 38% to 42% in Gaza.
• The US is becoming increasingly frustrated at Israel as the latter refuses to heed US warnings. Meanwhile, the Houthi rebels are giving warships and global cargo shipping absolute hell – so much so they are forcing ships to take the long way round the Cape instead of via Suez and the Straits. US & UK forces have struck Houthi positions in Yemen in what is a first, clear sign this is no longer an isolated/confined conflict. It is spreading beyond Israeli borders.
• The Houthis have pledged retaliation. Meanwhile, what will Hezbollah do next? As a military force they are far stronger than Hamas. Last – and most critically – what about Iran? Hamas, the Houthis and Hezbollah all take their orders from Iran who backs them financially and militarily. Although Iran denies it, it is fighting a proxy war through these groups. A conflict with Iran is something everyone wants to avoid. To what extent Iran wants to get involved is unclear but the bombings at the tomb of the former Quds Force commander, Qassem Soleimani resulting in the deaths of some 100 Iranians will not go unpunished.

The stakes have clearly risen and the conflict is no longer isolated. The latter marks an escalation in the conflict which was not really expected last year. At the very least, it’s hard to see Hezbollah standing by doing nothing if Hamas starts crumbling. There’s no sign of the latter yet. If Hezbollah does intervene, how will Israel cope on both fronts (North and South)? Risk premium will soar, markets will take a dive and sentiment will be hit hard. This is the sort of thing recessions are made of. Until now, recession talk was overblown.

Inflation: The progress on the inflation-front during 2023 has been encouraging. It is this same progress that has fuelled euphoria around rate cuts. The decline in inflation has been more around the headline rates globally (driven by energy and food) as opposed to the core rate (driven by services).

It is early days but we have already seen a pickup in inflation per the latest US inflation print. The extent of the rise was more than analysts had expected. Worryingly, headline inflation rose at a higher rate than energy and food inflation. Even more worrying is that core inflation saw services rise strongly (+0.50% m/m) driven by shelter and healthcare costs. Concerns have also been expressed by some in markets that inflation will prove to be cyclical and show gains from time-to-time.

Insurance costs are rising too and recent events in the Middle East – especially the impact of Houthi attacks on cargo ships – is resulting in rising insurance costs as ships start to take longer routes to evade the conflict zone. This is costly. The path of inflation from here really depends on the outcome in the Middle East. If the supply side is severely hit, oil prices will escalate and oil dynamics will change. Rising oil prices is a boon for OPEC(+) members. In 2023 some questioned (and still do) whether the combined leverage of OPEC(+) was losing its “Mojo”. OPEC(+) slashed oil output at least four times last year with little impact on prices. Oil and Brent prices today ($72 and $78 pb) are less than at the time of the disruptions in the Red Sea last year when prices exceeded $80. With US shale output surging again, supply-side dynamics have been altered - at the margin, US producers are powerful enough to make a real difference helped by technological advances in drilling and better economies of scale (lower costs). The combined OPEC(+) cuts have resulted in some 6mn barrels per day of idle production capacity. Saudi Arabia – which is already pumping the least amount of crude in more than a decade – needs a fiscal break-even oil price of $88 per barrel to fund its economy and development plans. Higher oil prices are a function of either rising global demand (which is lacking right now given how subdued the global economy is looking) and/or rising geopolitical risk (as we see in the Middle East). The consequences of the former will be rising inflation which leads to rising rates. The consequences of the latter (which is the situation we find ourselves in) is much more likely to leads to a recessionary/stagflationary type of environment. In this case, rate cuts will be needed to stimulate the economy. Oil only has to settle in the $85 to $90 per barrel and that relaunches inflation. Currently, it is around $72 per barrel - not a million miles away!

Election calendar: 2024 is full of elections, supposedly 60 or more around the Globe. The terms in office range from 4 years (US) to 6 years (Russia). Those in the global limelight are:

• Taiwan: this played out largely as expected with the ruling “anti-China” party gaining the largest share of the vote. However, it lost its majority. Had the opposition (China-leaning) parties got their act together in the days leading up to the election, we would be looking at a different story!
• Russia: It’s pretty much a given who will win there. Putin has defied critics that Russia would fold given all the sanctions placed upon it. state spending is at a record and much of it is driven by defence spending on Ukraine. Putin has to keep spending on his people to maintain their living standards while maintaining macroeconomic stability. There’s really only one asset he has to enable him to get remotely close to doing this without incurring the full wrath of inflation – higher energy prices (Russia’s main export)! It’s very much in his interests too to help “fuel” the conflict in the Middle East.
• US: This will be the big one to watch towards the end of the year. If Trump is cleared to run, it totally changes the picture in the Middle East. He definitely has momentum and Biden is being blamed on a variety of fronts – especially health. Trump is strongly allied to Israel and should he win, this would really stir things up in the ME.
• India: Modi’s government should remain in power.
• South Africa: this will be interesting as it could well mark the break up in the traditional ANC-dominated powerbase for the rainbow nation and, with it, risk pricing.
• Austria, Belgium, Portugal: will all be closely watched seeing as the far-right has made substantial gains there over time.

The election timetables are spread across the year. Taiwan’s has already been held. The US is last in the calendar (November) so there won’t be any shortage of excitement – and volatility.

Our portfolios remain balanced between fixed income (where we have chosen to stay in short duration (short maturity) bonds as these are least prone to interest rate volatility while our equity exposure remains in undervalued (therefore less likely to lose money in further, market downswings) and cash-generating, quality defensive companies (these have better pricing power and dominant market share).