Quarterly Investment Update

During the year global markets were marked by a banking crisis, volatile bond yields that reached 16-year highs, and several instances of geopolitical turbulence. Still, equity prices rallied fuelled by a frenzy in AI stocks, blindsiding most Wall Street forecasters, while bonds managed to pull a last-minute come-back with prices advancing just before year end.

The US economy defied several setbacks over the year including soaring interest rates, two US debt ceiling crisis, the failure of three regional banks and a debt rating downgrade to be the strongest performing large economy in the world. During Q4 markets were once again dictated by investors’ interest rate expectations. This time around investors became increasingly optimistic following Jerome Powell’s dovish pivot at the December policy meeting when the Fed maintained a pause in its’ interest rate tightening campaign and started discussing possible rate cuts in 2024. More positive news followed as inflation cooled down to 1.9% in November - lower than the central bank’s 2% target. Following the above, yields dropped triggering a rally across equities and bonds. In a year that was thought lost for bonds, Q4 helped reverse YTD losses with the global aggregate index advancing by 8.4%, ending the year up 6%. The greenback posted its worst year since the onset of the pandemic. The end of the Federal Reserve’s historic rate-hiking cycle in combination to optimism that a recession will be avoided, sparked a rally in US equities with the S&P 500 returning 11.2% in Q4. Also aided by the AI rally that started in Q2, the S&P 500 gained 24.2% this year. Nasdaq returned 43.4%, its best year since 1999. With inflation back down to the central bank’s target, growing consumer confidence, low unemployment rates and a strong economy, this has sparked hopes that the central bank has managed to engineer a soft landing.

Inflation concerns have also eased in eurozone, down to 2.4% in November as energy prices fell. ECB has also paused its interest rate hiking campaign but appears more keen to maintain rates at current levels. As the Fed is expected to cut rates sooner, this narrows the interest rate differential between the two currencies, supporting EUR’s latest advances vs the USD. In Q4 EUR appreciated by 4.4% vs USD, ending the year up 3.1%. Eurozone’s economy contracted by 0.1% in Q3 after stagnating for most of the year. Next year’s outlook doesn’t look that great either as the bloc’s supportive fiscal policy is coming to an end and as countries start to repeal measures aimed at countering inflation impact. In light of the latest signs of economic weaknesses, European bonds rallied and German 10-year bond yields reached 2% the lowest since March, disregarding Lagarde’s more hawkish rhetoric. European stocks advanced this year along with other global equities, as optimism surrounding the expected rate cuts has outweighed concerns regarding China’s uneven recovery. European equities were up 8.3% in Q4 bringing YTD gains up to 19.2%. Among other countries, Greece, Italy and Spain outperformed this year. Banking shares also beat the benchmark rebounding from a March selloff following a banking crisis that resulted in Credit Suisse’s takeover from UBS.

UK stocks extended gains for a third year and rose by 3.8%, but underperformed European peers as the index’s heavy commodity exposure weighted on performances. Miners and energy stocks were amongst the worst-performing European sectors following a recovery in global supply chains and China’s weak economic outlook which is casting a shadow on global demand. Stronger sterling added further pressure on companies that measure their revenues in dollars. Domestic shares were also impacted by tepid macro-outlook. While inflation has dropped to 3.9% in November, this came at a price. The Bank of England has raised rates to 5.25% which has significantly increased mortgage rates. This, in combination to higher prices has created a cost-of-living crisis across the country. GDP fell by 0.1% in Q3, while the country’s long-term growth prospects have been dragged down by higher taxes that aim to tackle public debt.

Throughout the year Sweden had to deal with stagnant economy, rising unemployment and a struggling property sector. Inflation has been the root of many of these problems. Since prices skyrocketed in 2022, the central bank had to aggressively increase interest rates. Swedish households have been particularly impacted as their mortgage rates are only fixed for short-term periods. This has been evident from declining consumer confidence, shrinking economy, plummeting housing construction and a sharp slowdown of lending. Bankruptcies jumped 29% in 2023 to the highest level since the 1990s. The over-leveraged real estate sector continues to suffer as it has to refinance debt at much higher levels, with some companies’ credit rating being downgraded to junk. On the bright side, the Riskbank’s efforts are starting to pay off as headline inflation dipped below 3% in December. Swedish stocks gained 17.3% in 2023 supported by a positive global sentiment. Currency weaknesses in the midst of the year drove the SEK to record lows and supported large exporting companies. Following these currency weaknesses, the central bank intervened in September and rolled out a program to sell part of its USD and EUR reserves in exchange for SEK. Since then, the SEK has rallied and closed the year up 3.1% vs the USD and mostly flat vs the EUR.

Chinese equities saw four straight months of foreign outflows during the second half of the year, as stocks plummeted by -11.4% in 2023. Investor’s hopes for a post pandemic rally were crushed amid weak economic recovery and disinflationary pressure. While this should have allowed the government to prompt up economic support, markets were disappointed to realize that government stimulus was held back due to the country’s elevated local debt levels. Domestic consumption has been weak as record-high youth unemployment and highly in-debt households are choosing to save up rather than spend. A lingering real estate crisis following a series of developer failures has been driving investors away. Demographic issues (i.e. aging population) and tensions with the west has escalated efforts to diversify global supply chains away from China. One of the countries benefiting the most by this is India. Unlike China, India’s younger population, economic growth-oriented government and strong ties with the west has made it an appealing destination for investors in the emerging markets space. Emerging markets rose by 7% in 2023 underperforming developed countries, weighted down by China. Elsewhere in Asia, Japan has finally escaped deflation after the country lifted pandemic era restrictions which has supported consumption. Japan’s stock market experienced a resurgence in light of Warren Buffett’s added investment in the market and ongoing corporate reforms aimed at increasing returns on equity that have triggered a wave of stock buybacks. Inflows were further supported by weak JPY and by the country becoming a ‘China alternative’. Following years of yield curve control to keep interest rate down, the Bank of Japan showed sign of loosening its grips on yields, however the increasing interest rate differential vs USD has caused the JPY to depreciate by 7.57% in 2023.

In commodities, crude oil dropped by 21% in the past three months bringing YTD performance down to 10.7%, reversing any gains generated by the OPEC+ output cuts in Q3. Gold on the other hand rallied by 11.6% in Q4, which accounted for most of the YTD gains of 13.1%. Over the year gold performance was held back as investors expected higher interest rates for longer which drove safe-haven asset seekers out of the market. However, with the Israel-Hamas conflict boosting demand for the safe haven asset and with Fed turning more dovish in Q4, gold rallied.