The Santa rally in equity and bond markets in December was driven by inflation continuing to fall. In the US, the headline CPI figure fell to 3.1% broadly in line with forecasts and although core inflation remained sticky due to elevated wages, the tone from the US Federal Reserve was extremely dovish. Jerome Powell’s comments that the possibility of rate cuts was discussed at their latest meeting proved to be the key catalyst for end of year investor exuberance. In the UK inflation slowed sharply 3.9% which saw the FTSE rally and the pound fall in value on increased expectations that it will enable the Bank of England to cut interest rates in the first half of 2024. Whilst an unexpected fall in UK economic growth (GDP falling -0.3% in figures released for October) has seen markets now believing that the UK will see interest rates fall by 1% during 2024. Inflation in the Eurozone also continued to dampen with the latest reading showing CPI down to 2.4%, whilst the the latest GDP figures saw the eurozone contract in the third quarter. It feels like the UK and Europe are both flirting with a technical recession (two quarters of contraction) going into 2024.

The Chinese economy continues to struggle, and deflation is more of an issue than inflation. Policymakers have set the expected economic growth at 5%, the lowest level for decades. CPI in China fell by 0.5% year on year in November, and major state banks cut interest rates in December to try help the ailing Chinese property sector and stimulate demand.

Going into 2024 the consensus over prospects for the global economy is shifting from a bearish outlook to hopes that we will see a ‘goldilocks’ scenario soft landing. This time last year the (incorrect) consensus was that recession was inevitable, yet economies have proven remarkably resilient despite the sharp increase in interest rates. Modest recessions in Europe and UK may happen but a severe economic downturn seems unlikely.

We are in that strange stage of the cycle where bad news on the economy is viewed positively by investors on the belief that it will lead to interest rates being cut faster. Elevated levels of volatility can be expected but the sharp recovery in markets in recent weeks has shown the danger of trying to be too clever second-guessing short-term market movements. It is important to remember that investment markets traditionally pre-empt economic recovery and the backdrop feels more sanguine than twelve months ago.

Market Watch

2023 finished as it had started with a sharp stock market rally driven by technology stocks. The MSCI World index increased by 4.2% in December. Given a backdrop of rising interest rates, elevated inflation, high profile bank collapses and geopolitical conflict it is remarkable that the global equity benchmark generated a return of 23% in 2023.

The US benchmark S&P 500 gained over 4% and the technology stock laden Nasdaq index extended its strong rally with a monthly gain of 5.8%, hitting a new high in December to finish the year showing an extraordinary annual gain of 45%. The development of AI has been the key theme of 2023 and has benefited the “magnificent 7” of tech behemoths that have driven the Nasdaq and the broader US indices.

Whilst the Japanese market fell by 0.2% in December it was perhaps the surprise package over the year. Both the Nikkei and Topix delivered 25%+ gains in 2023 on the back of a weak yen and more importantly improved corporate governance and a focus on shareholder returns. The MSCI Europe ex UK index was up by 3.2% in December. It was a good year for European equities with the benchmark up by 16%, with technology and financial stocks the big winners on the Continent.

At home The FTSE rallied by 4% on hopes of interest rates falling in 2024, it was the only area of developed markets not to generate a double-digit annual return but still finished the year in decent territory up by 7.9%. It does feel like the UK is probably the global cheap developed market now.

In emerging markets, the key theme in December and for the year has been the contrasting fortunes for India and China. The Indian stockmarket hit a new high during the month. The MSCI India index was up by 7.8%, resulting in annual gain of 21%. But foreign investors continue to shun China (having started the year optimistic of a post Covid bounce back). MSCI China index fell by 2.1% in December to compound a miserable year where it fell by 10.7%

Over to the bond markets now and borrowing costs on both sides of the Atlantic continued to fall in December as traders price in rate cuts in the first half of 2024. The US ten-year treasury now yields 3.88% compared to 4.33% at the start of December and the ten-year gilt now pays 3.53% compared to 4.17% a month ago. Despite wild fluctuations throughout the year Govt bond markets ended up broadly where they began, with the FTSE World Government Bond index eking out an annual return of 1.6%.

On the commodities front Gold was up by 1.1% in the month to finish at $2071 an ounce; geopolitical tension and possible falling rates are good for the shiny stuff. Oil has been weak in 2023, surprising after robust US growth and the conflict in the Middle East. A barrel of Brent finished the year at $77, with the price falling back 5% in December.

In currency markets, sterling was broadly flat against US dollar and Euro in December, although the Yen rallied by 4% regaining some of the weakness that has been the currency theme of 2023. Currencies have proved less volatile over the past year but the reversal in the dollar strength has been notable.

Fund Watch

Turning to funds now and ironically it was some of 2023’s most out of favour areas that finished the year as flavour of the month. This was highlighted by the Property sector leading the way with a monthly gain of 8.1%, whilst healthcare, UK and European smaller companies were also in the top five sectors. There has been significant underperformance of smaller companies over blue chip companies in 2023, so the recent bounce was evidence of contrarian investors exploiting the value in small caps.

Looking at individual funds now and biotech and healthcare stocks lead the way in December. Bellevue Healthcare topped the monthly performance tables, whilst Pictet, Polar Capital and AXA Framlington’s Biotech funds all saw monthly gains more than 15%. At the foot of the tables was JPM Emerging Europe Equity which fell by 10.3% whilst China funds once again featured heavily.

The investment trust world was the usual esoteric mix with the Property Securities sector topping the tables with a gain of over 14% and several specialist REITs bouncing strongly. Grit Real Income topped the tables up by 57% in December.

Manager watch

Last month our email inboxes were bulging with asset managers outlooks for 2024. The most used phrase has probably been higher for longer with expectations that interest rates are going to remain elevated in 2024. Although these had probably been written before cooler inflation data at the end of the year saw increased hopes of aggressive rate cuts. The end of year rally is now seeing material rate cuts priced so there is a risk that markets could have got ahead of themselves.

There was a lot of talk about US politics taking centre stage in 2024 (but it is probably pointless trying to predict a winner or the market reaction). Smaller companies and renewable energy are two areas that have had a torrid time over the past couple of years and managers in both areas are feeling more optimistic with valuations looking undemanding going into 2024.

Market projections are always best taken with a large pinch of salt but for the record, Bloomberg's Live Pulse Market survey of investors suggests that markets will rally in 2024 as interest rates fall and the US avoids recession, although consensus is that a weaker consumer means gains will be smaller than 2023. More than two-thirds of respondent believe there will be a soft landing for the US economy and the majority expect the Federal Reserve to begin cutting rates in the first half of 2024.

The numbers…

1 month returns - Performance figures 30/11/23 to 31/12/23, source FE Analytics.

N.b. the fund sectors exclude money market funds, markets are in local currency, and investment trusts exclude VCT's.

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