2023 Review & 2024 Outlook

Review of 2023

The year gone was another one in which investors had to hold their nerve as a number of Macroeconomic, Geopolitical and Industry events unfolded, each with potentially far reaching ramifications for markets and real economies alike. The announcement in January that Chat GPT had reached 100m users despite only being released the prior November unleashed the Artificial Intelligence (AI) frenzy that dominated market returns and gave rise to the nomenclature “The Magnificent Seven”. The statement in February from Nvidia, the leader in AI enabling semiconductors, that AI was “at an inflection point” and that their sales and profits would dramatically accelerate going forward added fuel to the rally in any company investors thought might benefit.

Chart 1 – Largest 5 and 10 US Stocks as a proportion of S&P 500 market cap

Source: Berenberg ResearchEquity Strategy, 4 December 2023

Another sector breakthrough (in commercialisation terms) that had significant macro and market impact, occurred in Healthcare. Celebrities for some time had been touting the weight loss capability of a class of drug called GLP 1’s, which were originally approved as diabetes drugs. However, as they became widely prescribed for obesity with claims to reduce body fat by 15-25% (not officially proven to this extent) and some online pharmacies started shipping direct to consumers, the uptake increased exponentially. Not only did this lead, unsurprisingly, to huge outperformance for the pharmaceutical companies who patented and sold these drugs, but it also led to significant underperformance by other segments of the wider healthcare industry that are likely to see lower volumes of demand as the number of obese people reduces going forward. Heart related drug makers, replacement hip and knee manufacturers and hospitals are but three who suffered negative fallout from GLP 1’s in 2023. The other significant issue for large pharmaceutical companies was that as part of the Inflation Reduction Act (IRA), the US Federal Government said it would renegotiate the pricing on ten of the most popular drugs on the market. Although the immediate economic impact of this will be small, it did serve to further dampen already subdued sentiment towards the sector.

The third sector which hugely impacted markets was the banking sector, when Silicon Valley Bank became the second biggest banking failure in US history. Signature Bank and Silvergate Bank suffered a similar fate whilst in Europe, the huge and aggressive Credit Suisse only avoided collapse by being forced into the hands of fellow Swiss giant UBS. All the above banks suffered “runs” on their deposits where savers rushed to withdraw money thus depriving the banks of enough capital to run their lending operations. In the US in particular, this was expected to have adverse consequences for the commercial real estate sector which relies on finance from smaller sized banks for most of its funding. Investors initially feared that there would be a general run on banks, particularly smaller ones, so the Federal Reserve had to step in and effectively counter act its own program of reducing liquidity in the system (Quantitative Tightening) by flooding the system with cash to restore confidence in the banking system. This action by the Fed did prevent a systemic seizure in the banking system, but in the aftermath, investors across Western markets eschewed banks, cyclicals and small caps and focussed primarily in the Mega Cap tech stocks (Magnificent Seven). This is because the latter don’t require bank financing, they had the halo of AI and very unusually, were almost all just exiting a period of significant cost cutting. The market does not usually give high multiples for cost cutting stories but this time they did as for many of these  companies revenue growth re-accelerated from a very poor 2022.

Chart 2 – The bar for tech earnings keeps getting higher

Source: JP Morgan Asset Management, 12 December 2023

As 2024 progresses, it is very likely that the three lines on the right hand side above will move closer together and performance will broaden out after one of the most concentrated years on record.

In another of the several factors which were the opposite of the prior year, energy stocks performed very poorly despite generally good discipline on the supply front from OPEC+. This poor performance was due to fears of a recession in the West, less incremental demand from China but also because the US allegedly increased production by an incredible 1 million barrels per day between July and October. Whilst there is still some incredulity about the accuracy of the latter statistic, its release has had a meaningful impact on the energy complex, particularly pricing. Lowered Energy prices have obviously helped reduce inflationary pressures.

The above were just the big sectors stories. Macroeconomic developments and the actions of Central Banks and Authorities, particularly in China, also gave investors more to consider than one would have expected. To start with Central Banks, those in the West more or less adopted a “data dependent” strategy whilst simultaneously providing the market with a narrative that they were determined to bring inflation back down towards their 2% target and thus they would not repeat the 1970’s mistake of ending the tightening policy too soon, never mind consider cutting interest rates. So as Central Banks continued to raise rates, even as market participants anticipated a peaking in inflation, fears of recession rose even more. Such fear was exacerbated by a collapse in money supply.

Chart 3 – US M2 money supply, year-over-year change

Source: Berenberg Equity Strategy, 4 December 2023

As can be seen, falls in money supply growth to the extent we have witnessed over the last year and a half has only been more dramatic in the lead up to the Great Depression of the 1930’s, so investors had some logic to fearing a recession. We should note that in his December press briefing, the Chair of the US Federal Reserve did a volte face and actually intimated that interest cuts were being actively talked about, so the narrative in markets is changing. However, the reality was that Western economies fared better than anticipated, particularly in the US, whilst Europe and the UK have seen growth stagnate but have so far avoided the serious recessions that have been predicted since early 2022 (but not by us).

In China, growth in Q1 significantly beat expectations as the economy emerged from draconian COVID lockdowns. However, as growth moderated in subsequent quarters, the Authorities have underwhelmed market expectations in terms of policy response by sticking to incremental and targeted easing of monetary and fiscal policy. This has not yet had the effect of unleashing animal spirits among businesses and consumers and so the markets have punished Chinese equities to the extent they were down double digits for the year despite a bright start whilst most other equity markets enjoyed positive returns. This is despite the fact that Chinese companies are reporting a double digit rebound in profits against easy 2022 comparisons and despite the disappointment with macro policy, another double digit gain is expected in 2024. As the chart below highlights, both these years look good in an international context.

Chart 4 – Analysts expect a decent earnings year in 2024

Source: JP Morgan Asset Management, 12 December 2023

2024 Outlook

There are several risks facing us in 2024 but this is always the case for investors. It is usually the risks that very few have thought of that cause the most damage. Elections, geopolitics, the impact of prior rate hikes actually causing a recession and Central Banks making a future  policy mistake are to name but a few of the already feared risks. As is usually the case, it is unlikely valuation will affect one year returns although the impact is greater over the longer term.

We have been in a manufacturing recession for several quarters now and the process of destocking is underway so an uptick in this sector will almost inevitably ensue at some point in 2024. The full impact of interest rate rises is still working its way through, but the preponderance of fixed rate mortgages, especially in the US, means that their impact will take longer to kick in and give homeowners longer to take offsetting action such as building savings to repay some of the debt or using pay rises of 2-3 years to service the higher interest burdens. As we have opined before, the lack of excess in economies at the moment means any recession, if it occurs, is likely to be a mild variety and not last long.

So with markets looking forward to interest rate cuts in 2024, we could see further gains in equities, particularly those outside of the Magnificent Seven, that have been held back by the manufacturing recession, fears over a Chinese economic meltdown or fears of a typical general recession occurring in the West. Mid and small-cap stocks, Asian equities and UK equities each fall into these categories and our portfolios are well represented in all three.

Chart 5 – Relative Valuations

Source: JP Morgan Asset Management, 12 December 2023

As can be seen from the above chart, it is not just different sector composition which explains the valuation discount between the US and UK, as the discount also exists intra sector. Some valuation discount is usually warranted but the chart also shows the extent of the discounts. The narrowing of the discount has taken longer to pan out than we anticipated but the magnitude of gains when it occurs could be significant, assuming the discount returns to the low 20% level.

Within fixed income, the initial gains have been made and if the past is prologue, then yields on short duration government bonds should fall faster than those on longer dated issues. Although AXA used the chart below in relation to short duration corporate bonds, we think it shows an even better risk reward for short dated government bonds. It exemplifies why we were willing to forego duration this year gone, even as we expected interest rates to fall.

Chart 6 – Short dated bonds

Source: AXA Investment Managers, 21 November 2023

With regards credit markets, yields are not nearly as attractive as they were last year at this time and therefore we would not expect a repeat of the stellar returns enjoyed in 2023.

Chart 7 – Fixed Income spreads

Source: JP Morgan Asset Management, 12 December 2023


Returns were generally very poor in 2022 for both bonds and equities, generationally so for the former. In 2023 we witnessed some rebound, but within equities, returns were among the most concentrated in history, meaning that most stocks are still down over a two year period. So whilst we expect volatility to rise from the low levels that existed at year end 2023, we should not confuse heightened intra year volatility with the ability to make positive returns over a twelve month period. Many of our stocks are lowly valued even compared to their own history whilst policy is becoming less restrictive. This is usually a productive combination. With regards to bonds, whilst we think that some market participants have gotten ahead of what is likely in terms of the magnitude of interest rate cuts next year, we do think there will be some. So, we remain confident that our short duration government bond exposure will not only produce positive returns but also offer some protection from possible volatility at the long end of the bond market as investor expectations regarding rate cuts wax and wane. Therefore, we look forward to the year ahead despite most investors having spent the last two years worrying about a variety of potential pitfalls.

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