All eyes will be focused on the fortunes of the main asset classes as investors prep their diversification models for the coming months. After a torrid 2022, during which bonds and equities fell in tandem – with the MSCI World index down 7.8% in sterling terms – we saw improved fortunes for global equity investors in 2023 as the index rose by 16.8%. During the same time frame, the UT Fixed Interest sector was up 3.1%, versus the 23% decline recorded in 2022.
In an environment of falling inflation but rising geopolitical risk, what should investors expect from global equities this year and where should it fit into their asset allocation plans?
In this head to head, Alison Savas (pictured right) of Antipodes looks at the factors that drove performance in 2023 and explains her cautiousness to begin 2024, while Rathbones’ David Coombs (pictured left) explains why his equity portfolios will continue to be dominated by the US in coming months.
Alison Savas, investment director, Antipodes Partners
Global equities had a strong 2023 driven by the seven largest tech stocks for most of the year, until the back end saw an increase in breadth.
The 2023 laggards have begun to lead the market on the view that inflation has been vanquished, meaning rates will fall while economic growth and employment can remain intact. This is one possible outcome, though we see greater uncertainty ahead with risks around an inflation wall, tightening liquidity and the delayed ramifications of tight policy. We expect greater volatility around the economic cycle and lower equity multiples.
The pathway for inflation is down but the last mile may be harder to achieve than expected. We see core inflation getting stuck around 3% mid-year, owing to a sticky shelter component resulting from a large and continued undersupply in US housing.
We expect some rate cuts over 2024, but with the market already pricing in around 140 basis points in cuts, the risk is disappointment over the pace of loosening. If the Fed cuts too early it could reignite inflation. Investors need to be open to rates staying higher for longer.
We also expect liquidity to tighten from Q1 as the very large fiscal deficit in the US will increasingly need to be funded via issuing long-dated bonds. With the Fed out of the market (adding to supply via quantitative tightening), banks, insurance companies and households will need to soak up this issuance, which means less capital available for holding other assets.
A supportive liquidity environment in 2023 disproportionately benefitted a narrow set of winners, so a deterioration will have implications for equities. Investors should focus on finding tomorrow’s winners rather than wedding to yesterday’s success stories – and paying a fair price for the quality of a company and its growth profile, not any price.
Our base case remains a mild recession in the west. The US has been more resilient as the transmission of tighter monetary policy to the real economy has lengthened largely due to the prevalence of fixed rate mortgages, but the threat of tight monetary policy may not have passed.
The labour market continues to loosen and nominal wage growth is slowing. The US could still experience a downdraft in activity, for which US equities are not priced. At 21x, earnings valuations are expensive relative to history and other regions like Europe (11x) and China (9x), which have already experienced an earnings downgrade cycle.
‘Picks and shovels’ play
The Antipodes global portfolios remain relatively defensively positioned with exposure to attractively priced healthcare stocks (such as Merck and Sanofi) and consumer staples (Diageo, Tesco). We’ve been selectively adding to global cyclicals that have attractive supply/demand dynamics (TotalEnergies) or are exhibiting bottom-of-the-cycle characteristics and are priced on low multiples.
But despite the risks, opportunities exist. We’re finding beneficiaries of emerging investment cycles in energy transition and cloud/AI monetisation that remain mispriced. Companies such as Siemens, a global leader in factory automation, energy efficiency systems that manage power consumption and rail signalling equipment.
Siemens not only benefits from the move to a lower carbon world but also onshoring. Also, Taiwan Semiconductor Manufacturing Co, the ‘picks and shovels’ play of the AI age. TSMC manufactures chips for semiconductor companies globally, with a near monopoly at the leading edge.
We’re also finding opportunities in emerging economies like Brazil, Mexico and Indonesia. Fundamentals are improving, inflation is under control and there’s scope for policy rates to fall. Examples include one of the leading private sector banks in Brazil, Itau Unibanco, and the dominant convenience store operator in Mexico, Fomento Economic Mexicano.
If it becomes more apparent that the Fed can engineer a soft landing then we will lean into our cyclical exposures – mature cyclicals and beneficiaries of long duration investment trends – and ex-US listed multinationals are an attractively priced way to play a soft landing.
David Coombs, head of multi-asset investments, Rathbones
We broadly left our equity positioning unchanged over 2023, despite the macro noise, but did take the opportunity during the summer to trim our positions in the five members of the ‘Magnificent Seven’ we held.
We also added to our medical-technology names in Q3 as they sold off on concerns relating to falling demand for their products as weight reduction drugs cured obesity for all – according to the prevailing narrative at the time.
It is easy to overgeneralise, but I think it is safe to say our focus has been on quality and growth with a significant bias to the US, given our view that the US would avoid a recession in 2023. This is despite the negatively sloping yield curve, due to fiscal stimulus offsetting higher interest rates.
We continue to see long-term opportunities in med-tech and, more controversially, in industrials benefiting from the US spend on infrastructure. Both do come with challenging valuations and the promise of more volatility as sentiment swings from ‘soft to hard landings’ and back.
Legislation such as the Inflation Reduction Act and the Chips and Science Act are encouraging investment into manufacturing through incentives worth many billions of dollars. We also believe the trend towards onshoring, where companies look to move some of their manufacturing operations closer to home is benefiting a whole ecosystem across industrial America.
This should continue whoever is elected president at the next election as the US aims to shore up its supply chains and encourage further investment into strategically important sectors.
As we head into 2024 we think that with rates having risen so far and so fast, this will weigh on economic growth. But inflation is likely to continue to trend down, which is probably what prompted Fed chair Jerome Powell’s December ‘Pivot press conference’ with interest rate falls back on the agenda, resulting in a relief rally for interest rate sensitive sectors such as Reits and retailers.
We remain cautious in this regard, with a working hypothesis that rates will stay higher than the more optimistic commentators are predicting. This keeps us away from more highly leveraged areas or deep-value cyclicals. So our equity portfolios will continue to be dominated by the US this year.
Elsewhere we have concerns around UK growth, and while the impact of economic policy may not have a material effect on the FTSE 100, which is largely full of global businesses, we maintain limited exposure to companies with significant revenues from the UK economy in the portfolios. The Bank of England, at the time of writing, seems hell bent on creating unemployment and a recession to reduce inflation – mostly caused by external factors – while the government and opposition looks to squeeze businesses and the consumer through a high tax regime.
Europe could be interesting if there is a resurgence in the Chinese economy, which seems more likely than it has since Covid. We see value in many mid-cap industrial names, which have had a torrid few years. We also expect the European Central Bank may turn more dovish by Q2. Asian and emerging markets could benefit from a weaker dollar if US rates start to fall. However, within a multi-asset context – or from a risk/reward perspective – we still prefer to own businesses in the US and Europe with customers in the region, rather than owning local companies.
In 2024, we expect there will be greater dispersion in share price movements and a broadening out of performance leadership. This is due to the impact of multiple years of higher costof-capital starting to feed through into operating margins. Forget geography, access to cheap capital is the key to success – together with sector dominance and markets where the consumer still has money to spend.
This article was written for our sister title Portfolio Adviser’s January magazine.