Dear readers,
Wishing all a happy new year!
After two years marked by economic uncertainty and heavy inflation, 2023 unfolded as a comparatively calmer year. Describing 2023 is a nuanced task - it defied the widely predicted recession, presenting a landscape of distortions, a generally conservative investor stance (with ample cash reserves for most of the year), and a significant focus on inflation and rate trajectory. Personally, the year reiterated crucial lessons for me on avoiding an overemphasis on macroeconomic factors in shaping investment decisions, acknowledging that economics and asset markets do not always align, and keeping a simplified investment approach.
The financial markets began the year with substantial volatility, driven by the Fed's sharp tightening cycle (a total hike of 550 basis points), which caused disruptions in certain segments, notably affecting some regional banks in the USA. The first half of 2023 and the early second half were dominated by global recession fears amidst an aggressive rate hike cycle. Subsequently, the US debt ceiling issues underscored the considerable debt accumulation on the balance sheets of several developed countries. The year concluded on a positive note with equity markets rallying, buoyed by the AI theme and renewed speculation on peaked interest rates.
Equity Markets
As we commence 2024, equity valuations slightly exceed average levels but are not overly stretched. We are just starting to see a resurgence of optimism among market participants (One evident example is in the surge of SME IPOs and subscription numbers in India, which provides some insight at least for the domestic risk tolerance). Our investment strategy in 2023, emphasizing US Tech in H1, overweighting India and Japan throughout the year, and favoring infrastructure, energy, and select banking names (still feel has legs to perform well in 2024) in the Indian market, proved successful. As discussed in earlier updates, we have adjusted some positions, particularly reducing exposure to US Tech and reallocating to select Pharmaceuticals, and chemicals in the Indian market, Gold, UK, and Japan.
Entering 2024, I maintain a broadly positive outlook on equities. Global equity markets are approaching resistance levels or breaking out from a two-year sideways trend. Factors such as increasing liquidity flow and easing inflation further support equities. While remaining slightly cautious about fresh positions in high-momentum segments, I’m vigilant on trailing stop-losses (happy to see these not get triggered so far).
As a closing thought on the equity side, 2023 was a good year to recognize the complex relationship between rates and equities. The simplistic notion that lower rates automatically increase the equity multiple and subsequent returns has proved to be inconsistent throughout history and 2023 was another example. Steady market liquidity (despite the apparent “Quantitative Tightening” policies from the Federal Reserve- see chart below) and the prospect of inflation cooling off were pivotal factors that led us to go overweight on equities in late 2022-early 2023.
Source: CrossBorder Capital
Fixed Income Markets
The fixed-income markets experienced volatility throughout 2023. Despite the 10-year Treasury yield showing no net movement (starting and ending the year at 3.88%), the year's dynamics were far from static. Duration and curve positioning were crucial to portfolio performance. Our low-duration strategy fared well until October 2023, adapting to the steepening trade. However, with the Fed adopting a less hawkish tone, bond yields rallied, and long-duration bonds followed suit in the final month and a half of 2023. The fixed-income markets appear somewhat distorted, with an inverted yield curve persisting for the 17th consecutive month.
The yield curve has become an unreliable predictor for gauging the business cycle in my opinion. The US Fed and Treasury’s action to heavily skew debt issuance through short-term bills vs. issuing coupons at the longer end of the curve is as clear as an indication of yield curve control and somewhat distorts the use of 10-year treasury yield as the “risk-free” rate but that’s a separate discussion.
At some point, I expect the US Treasury to reverse the debt issuance dynamics– an underlying thesis to position for the steepening trade to pick up again. The below data presents the gross issuances from the US Treasury.
Source: TreasuryDirect, SIFMA; All figures in $ Billion
The below table sets out how significant the inversion is (see the differential between 10Yr - 3m and 10Yr - 2Yr yields over the last 30 years). The 10-year treasury yield is already quite low in my opinion and may have priced in most of the potential rate cuts well ahead of time. Going into 2024, my preference is to remain invested in a low to moderate-duration portfolio and favor corporate bonds over government bonds.
Source: Creative Planning, Charlie Bielello, Data as of 29 December 2023
Commodities
2023 proved uneventful for commodities, with Gold standing out as a noteworthy exception. Our bullish stance on Gold remains due to its effectiveness as a hedge against monetary-led inflation. Although headline inflation has receded with the normalization of supply shocks, monetary-led inflation remains a concern given the substantial debt burden in most developed countries. Gold has defied expectations by performing well despite a sharp rate-hiking cycle. With expectations of rate cuts ahead, Gold has an additional tailwind. Technically, a decadal breakout in 2020, followed by a reset and a strong rally, supports our conviction.
Source: Tradingview
The debt re-financing story
The debt burden keeps building with most of the developed market central banks. As long as this can continue to be re-financed, we don’t have a problem (for now). Decent short-term solutions for longer-term implications. However, the CBOE projects a daunting 181% debt-to-GDP for the US government by 2053. Add household and corporate debt-to-GDP on top of it and numbers are staggering. Currently, the corporate and household balance sheets continue to look better as compared to government balance sheets in terms of capacity to take on debt - one of the key reasons why I believe the corporate sector did well in 2023 over Govt. bonds. As did Emerging markets, which again have much better debt positions and have been well ahead in the rate cycle.
This constant stream of liquidity generated with debt issuances lined up ahead will act as a support to broader equity markets as well.
In conclusion, our outlook for 2024 is broadly positive on equities, exercising caution in segments with inflated valuations. In fixed income, I continue to favor short to medium-term duration exposure over long duration and prefer corporate over government exposure. I am working on a project to deliver more granular portfolio details consistently, aiming to roll it out in mid-2024. Until then, happy investing!
Best Regards,
Shivam
Disclaimers:
The information provided in this content is for educational purposes only and should not be considered as financial or investment advice. I am not a registered investment advisor and do not provide personalized investment recommendations or guidance.
Please consult with a qualified financial professional before making any investment decisions.
The views and opinions expressed in this content are my own and do not necessarily reflect the views of my employer. The content is intended to share educational insights and general information related to investments and macroeconomic trends. It should not be interpreted as official statements or representations from my employer.
Any references to specific investment products, services, companies, or strategies in this content are for illustrative purposes only and should not be considered as endorsements or recommendations. You should conduct your own research and due diligence before considering any investment opportunities.
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