Overview
Not only did Santa arrive this December but more importantly for financial markets, so did Goldilocks, or at least the expectation she would appear in the not too distant future. In financial markets, a Goldilocks Scenario is one in which economic growth is just right i.e. not cold enough to cause a recession and not hot enough to necessitate restrictive policy such as high interest rates.
Consumer confidence in the UK, US and Europe all improved in December, as did the UK Confederation of British Industry (CBI) total order book and US existing home sales. UK inflation also fell more than expected. All these releases supported the benign outlook that investors currently have for the coming months.
The hope that Western economies would avoid anything other than a very mild recession (with the US experiencing no recession at all) and that interest rates would fall next year across the western hemisphere enabled equities and bonds to build on the strong rally witnessed in November.
The star performers were long-dated bonds, reversing some of the pain endured in the prior two years and returns reached high single digits for this asset class. In another change from recent history, small and mid-cap stocks edged out returns from mega caps, which themselves delivered positive outcomes. The major equity market exception was China where investors are concentrating on any news that does not meet expectations and downplaying any positive developments. Such behaviour led to the asset class falling. Oil was the other asset class which fell in the month as investors fretted about both increased supply from the US, potentially reduced demand from China and a perceived fraying at the edges of OPEC+ discipline. Oil has been poor most of the year after delivering spectacularly positive returns last year in an environment where most other asset classes struggled. Oil traditionally does not perform well in the sort of deflationary conditions that markets are now pricing in.
US bank Raymond James highlight that in every interest rate cycle in America since 1970 in which the oil price has remained benign then indeed a soft economic landing has been achieved. So with the recent falls in oil prices, current optimism in markets may have some justification.
However, in the same report Raymond James note the extent of the recent rally in US shares has taken the valuation discounts versus their 5 year averages to 2%-8% (depending on which index), from 15-30% only nine weeks ago. Re-ratings have also happened in other Western markets so in the short term, markets may be due a breather in order to digest recent moves.
As we move forward in 2024 economies such as Europe, the UK and China will make incremental progress whilst, at least in the near term, inflation will continue to fall (except China where it will increase from very low levels). So we are optimistic that despite an expected increase in volatility this year, returns to investors are likely to be positive for the period as a whole, just as they were in 2023.
UK
The UK was a strong performer in December, led by the FTSE 250 which gained 8.2% in the month and had a second very strong month in a row on the back of inflation data continuing to move in the right direction. The large cap FTSE 100 index was not quite as strong as we again saw relative weakness in the oil majors on the back of a falling oil price.
As mentioned, inflation came in much better than expected in December at 3.9%, while core inflation also came in better than anticipated. Average weekly earnings (incl. bonus) fell to the lowest level in 5 months and although still elevated, the rate of change is encouraging and may indicate a further decline in the overall inflation rate in the coming months.
Elsewhere we may be starting to see signs of a recovery on the economic data front. There was a very notable rise in services showing the fastest pace of expansion since May, retail sales were also up showing the strongest level of activity since January and consumer confidence rose. On the flip side we did see a decline in manufacturing activity after a strong rebound last month and industrial production came in weaker than expected.
The labour market continues to remain tight in the UK with unemployment unchanged in the month at 4.2%.
Sterling was also up as it continued its strong performance in 2023. The pound finished the year at 1.27 against the dollar.
US
The rally continued this month in the US with the S&P up 4.54% and the Nasdaq up 5.56%. The best performing sector was real estate while the worst was the energy sector on the back of a sharp decline in the oil price. Similarly to other parts of the world, the performance was broad, with small and mid-caps participating strongly and it is worth highlighting that since the rally ensued in late October, small cap indices are up over 20% (more than large cap peers).
Inflation came in slightly lower than the prior month (as expected) while core inflation was unchanged at 4%. Core PCE prices also increased but by less than expected. On the back of this and the continued improvements in the inflation trajectory, University of Michigan consumer sentiment hit the highest level in 5 months. The US Fed Chair Jerome Powell also did not push back on rate cuts next year which was a change in rhetoric by the Central Bank.
On the economic data front, there were signs of continued strength across the economy with services, retail sales and new orders for manufactured durable goods all coming in significantly ahead of expectations. Manufacturing was weaker, with the S&P Global Manufacturing index coming in at the lowest level in 4 months but there were some signs of localised recovery such as the Dallas Fed measure.
On the housing front, existing home sales rebounded from the prior month, while house prices again ticked up due to a shortage of housing stock and mortgage rates continuing to move down (30 year fixed rate now 6.61% as of end of December). Housing starts in November saw the biggest jump in 6 months however Building permits did fall 2.1% in November, the lowest reading in 4 months. This may indicate weakness going forward, although this will likely be offset if mortgage rates continue to fall.
After some signs that the labour market was cooling in October, the unemployment rate unexpectedly declined to 3.7%. However, there was some encouraging labour data in the Job Openings and Labor Turnover Survey (JOLTS) report, which showed that the number of job opening fell significantly more than expected. This may indicate further cooling in the coming months.
Europe
European equities ended the year strongly, with the STOXX 600 finishing the year up 13%, propelled by robust performances in technology and retail. In December, the MSCI Europe Ex UK index yielded a 4.42% return, with the DAX, CAC, FTSE Italy, and Spain all up low single digits.
Economic data was generally weak in the month, with the composite PMI data coming in worse than expected in both manufacturing (after we had seen a stabilisation in the prior month) and services. Industrial production was also much weaker than expected and retail sales were positive in the month but again weaker than expected.
Sometimes bad economic news is taken as good news for markets, as has occurred recently in Europe, as it is likely to lead to a lower rate of inflation which the European Central Bank have been working so hard to bring down.
There once again were positive signs regarding inflation. The inflation rate in the Euro Area dipped to 2.4%, reaching its lowest point since July 2021 and came in below consensus, down from October’s 2.9%. The core inflation rate, excluding volatile food and energy prices, dropped to 3.6% in November 2023, marking its lowest level since April 2022. As of result of this, the ECB opted not to raise interest rates at their December meeting and President Lagarde’s remarks after the meeting were taken in a dovish manner. As a result of the improving inflation trajectory, consumer confidence rose to the highest level in five months.
Asia and Emerging Markets
The FTSE Emerging Market index recorded a 3.58% return in USD, with the Brazil leading the way, up 7%. In December, the MSCI APAC and Asia Ex Japan indices gained 4.5% and 3.5% respectively, concluding the year with 11.9% and 6.2% total returns in USD. India rose by 8.1%, driven by favourable state election results for Modi and strong performances in Industrials and Property sectors. Singapore clinched the third spot in performance, driven by Internet stocks while Korea came fourth.
Despite notable improvements in the economy and additional stimulus during the month, China was one of the only markets to post a loss. In November alone, both industrial production and retail sales came in significantly higher than expected. Beijing and Shanghai also relaxed restrictions on the downpayment ratio for first and second homes, as well as mortgage rates. This should have all been taken well by the market but it was not enough to offset a policy mistake made towards the end of the month. This mistake came in the form of a midlevel bureaucrat publishing draft rules for video games that looked like a rerun of prior restrictions seen in the regulatory crackdown of 2021 and this was not taken well by the market. The next steps will be to improve sentiment and it is now widely expected that the People’s Bank of China (PBoC) will cut rates in January. The gaming regulator also approved 105 games in the last week of December in order to reassure the market and this was taken well and a recovery in stock related to this area ensued. It is encouraging to see the Chinese authorities recognising mistakes, but they need to stop making them for confidence to return.
Japanese stocks led Asia in 2023 with the Nikkei and Topix indices surging over 28% and 25% respectively and despite facing challenges such as profit-taking and the persistent strength of the yen, the Nikkei 225 managed to post a 4.9% gain in USD in December.
Fixed Income
Longer duration fixed income markets led this month with notable gains across the US, UK and other developed markets. The catalysts for such a big decline in yields is clear evidence that inflation is moving in the right direction and Federal Reserve (Fed) Chair Powell ending the Central Bank unanimity on tough talk by saying “rate cuts are something that begins to come into view” and are ”clearly a topic of discussion” in his briefing post the December meeting of the Fed. The bond market took this change in rhetoric to mean that policy will be eased in the first half of next year and investors are now expecting 6 interest rate cuts in 2024.
To give a flavour of the moves, 10 Year yields in the US have now fallen over 100bps since their peak in the middle of October and have now moved below 4%. Bond prices and yields move in opposite directions so this fall in yields has fueled a rally in the bond market.
The yield curve still remains inverted, and the current period of interest rate inversion is longer than average. Therefore, as rates peak, shorter bonds will see a sharper decline in interest rates than longer dated bonds. This is likely to happen over the next twelve months and will mean the recent dramatic outperformance of shorter dated bonds is unlikely to last.
This year has been categorized by elevated bond market volatility however it did fall in the second half of the month as yields rallied.
In Japan, there were some signs of a change in rhetoric by Central Bank Governor Ueda in regards to Yield Curve Control policy. However, particularly given the increases in wage inflation, we would continue to expect further policy normalization and as such, bond yields will likely rise next year and should lead to a stronger Yen.
Alternatives
Brent Crude Oil finished the month at $77 per barrel, following a 7% decline in December. This brought the 2023 performance to -10%, which was the first annual decline since 2020. Downward pressure on the oil price was driven by continued strength in US shale production and slowing demand, which outweighed the upward pressure from rising tensions in the Red Sea. Angola’s announcement that they are leaving OPEC+ after 16 years also contributed to the softness in the oil price. The African nation were the 6th largest exporter for the group in 2023, contributing close to 5% of revenues. Their exit will impact OPEC’s ability to control the price of oil going forward and further shifts the power towards the record-producing US. January’s expected entrance of Brazil into the group should in theory more than offset Angola’s exit, but Brazil are only expected to have a passive role and will likely alter production independently of the demands of OPEC+. On the issues in the Red sea, tensions don’t appear to be subsiding. In the final week of December, half the container ship fleet that usually travel through the Red Sea had to take the alternative route, which is 25% longer. Further, the US will struggle to maintain this level of production if prices stay relatively low. Hence, these issues could lead oil to recapture some of their lost gains in the coming year, providing we don’t get a worse recession than feared and a collapse in demand.
Gold remained flat in the month after its best annual performance since 2020. The previous metal is expected to be supported by the pivot in US rates and resulting potential fall in real yields and also as a result of continued Central Bank purchases.
Property
The Nationwide UK House Price Index dropped in December, marking an annual decline of house prices in the UK of 1.8% in 2023. This was significantly less than was forecasted by most market participants at the start of the year. The survey of the Royal Institution of Chartered Surveyors (RICS) also showed the gap between the percentages of respondents seeing price rises and falls moderating. With wages growing at high single-digits, UK homes are on track to cost 7 times the average wage by 2025, which would be the lowest multiple since 2012. Nevertheless, the house price decline in 2012 was relatively muted compared to expectations at the start of the year, largely due to the supply shortage.
China’s property issues continued, with new projects at 2009 levels, sales at 2015 levels and real estate investment falling 8% in the first 11 months of 2023. Consensus from 10 investment banks including Goldman Sachs, is for the Chinese property market to continue its downturn in 2024, with expectations of a further 5% decline in home sales. However, another interest rate cut is expected in January which should help at the margin and the PBoC is continuing to take actions to ease the issues faced by developers and these should help them to complete previously unfinished projects and may restore some confidence to the sector.
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Important Information
All Index data figures are sourced by Morningstar and correct as at 31 December 2023 unless otherwise stated.
The value of investments or any income arising from them may fluctuate and are not guaranteed. Past performance is not necessarily a guide to future performance.