The proverbial ‘Santa rally’ was on many investors’ wish lists, and Christmas 2023 certainly delivered. Not only were returns strong virtually across the board in December, but upward moves seemed to increase further as the month progressed – including a burst of cheer into the close for Christmas. It was a continuation of the good feeling that swept capital markets in November, with investors hopeful about financial conditions and the global economy for 2024. Inflation is substantially and unmistakably lower than feared last year, and central bankers have recognised this. Policymakers continued to hint at looser policy stances in 2024, leading to a 3.7% monthly gain for global stocks in sterling terms. The table below shows December’s results across major regions and asset classes
There was a notable consistency across regional equity returns, with most headline indices gaining around 4% in sterling terms through December (with the glaring exception of China, which we get to later). This reflects the general improvements in expected monetary policy, which pushed bond yields down significantly and made all risk assets more attractive by comparison. UK 10-year yields, for example, ended 2023 almost exactly where they began, despite a huge move up in the first half of the year. Some of the so-called ‘peripheral’ European nations even ended the year with lower yields than 12 months ago.
We suspect that end-of-year readjustments played a big part here. Investment managers naturally reassess their positions at key points like year-end, with a particular focus on reducing risks. It is likely that, after an uncertain and at times difficult year for the global economy, many traders had short positions (i.e., those that make money on market declines) which had to be squared-off. Since this came at a time when general risk sentiment – and indeed economic expectations – was improving, it meant an optimistic market shift.
Expected interest rate cuts were perhaps the biggest part of this adjustment, but were far from the only part. We formulated our own 2024 outlook last month – many investment houses no doubt did the same – and this occurred when cyclical expectations finally seemed to be turning. The outperformance of Europe and Emerging Markets (EM) – excluding China – showed that investors are not only excited about the prospect of lower rates having a positive impact on risk asset valuations, but also the near-term economic growth opportunities this might bring. European equities gained 4.3% in sterling terms through December, while EM ex-China gained an impressive 5.1%.
In the same vein, the UK’s small and medium-cap equities outperformed their larger-cap peers, with an 8.2% gain against the latter’s 3.9%. Returns for both indices were decent, meaning 2023 ended fairly well for UK stocks despite myriad economic and monetary policy worries. The outperformance of smaller businesses, which are more oriented toward short-term growth, shows that a domestic cyclical turn is now expected. That has gone hand-in-hand with a fall-back in UK bond yields and expected interest rates, despite the Bank of England (BoE) signalling it wishes to stick with higher rates for a while yet. It seems investors do not believe the BoE’s sterner messages, thanks to the underlying weakness in the UK economy.
Rallying bond prices were the greatest support to equity valuations in December, as they were in the previous month. But as noted, falling yields (the inverse of bond prices) were not a response to weakening growth expectations since the latter held up well. Falling nominal yields were instead a reflection of significantly lower price pressures, and hence a general move down in inflation expectations. Weak energy and goods prices proved the biggest source of disinflation, as was the case for most of 2023. Lately, though, the feeling is that these weaknesses will persist.
China is a huge part of that story. The world’s second-largest economy was the only major equity market that posted negative returns for December, falling 3.1% in sterling terms and continuing the trend of Chinese growth and financial markets being completely out of sync with the west. Growth was severely hampered last year thanks to weak domestic demand and weaker foreign demand for Chinese goods – particularly from the US.
Historically, Beijing responds to such weaknesses with massive policy stimuli, but this time the policy response was stop-start at best. In particular, the central government was unable to cut back production in the face of this weak demand, meaning it was essentially pushing oversupply out to the world. This was certainly the case for goods, but weaker Chinese demand for energy has acted – and will likely continue to act – as a swing factor for global energy markets, moving them toward oversupply and hence lowering global prices.
That said, more recent policy signals coming out of China were more decisively pro-growth. This led to a slight pickup in Chinese asset prices into the end of December, and should bode well for 2024. A revving of China’s growth engine will help not just the country itself but global growth in general. We suspect this is a big part of stronger growth expectations as we start the new year, particularly for EMs. It is telling that, even with severe equity disappointment and global growth concerns in 2023, EM equities managed to end the year 4.4% up in sterling terms.
In general, investment returns for 2023 were overwhelmingly positive. This outcome looked unlikely even just a few months ago, when investors feared central bankers’ ‘higher for longer’ mantra. Moreover, we take heart that the leading lights of the Santa rally were those that suffered before: small and mid-cap equities, and corporate bonds. The lows of last year were not bad enough to cause too much pain, and now the green shoots of a recovery are in sight. Santa brought us a soft landing after all.
The text is taken from The Tatton Weekly and is provided by Tatton Investment Management. The information in this document does not constitute investment advice or a recommendation for any product and investment decisions should not be made on the basis of it.
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