Jonathan Armitage, CFS Chief Investment Officer, is joined by Al Clark, CFS Head of Investments, to highlight the market events that shaped 2023, including the big surprises that no one expected. They also discuss what will be the key features of the investment environment going forward in 2024.

Welcome to CFS Market Insights. I'm joined by Head of Investments, Al Clark, to highlight what's happened this year and more importantly discuss what will be the features of the investment environment going forward in 2024.


So Al, if you had told me at the start of this year that interest rates would be at least 2% higher, that three banks in the US would have gone bust and a systemically important Swiss bank have been taken over by its biggest rival, and we would see a major conflict in the Middle East, my expectations would have been that markets would be down probably quite a bit, somewhere between 10 to 15%. That's not the way that things have played out, so what are your thoughts?


So things turned out much better than feared. The cost of living crisis negative that households experienced was offset by rising wages. So consumers were able to keep spending. Because they were able to keep spending, that meant that the resilient consumer propped up the corporations, so US earnings and earnings for the majority of equity markets ended up being much better than expected. Now that optimism was tempered a little bit by inflation remaining volatile so we did have to consider the fact that there is inflation issues still residual in the market, but overall it was much better than expected.


So what are the other things that have been impacting markets?


So aside from the positive surprise from equity markets, which was great for everyone, there was two other positives. The relationship with China turned out to be nowhere near as fractious as expected. So there's been a lot of senior leaders meeting with the Chinese Politburo, and that's generally resulted in tariffs being reduced and just overall a much better engagement with China so that was a positive. The other major positive was the expected productivity boom from generative AI, so models like ChatGPT. Now Nvidia is the poster child for this US equity and Nvidia's shares at this point are up over 200%. So you can see that was a sort of a major positive underpinning a lot of what was going on in the equity market.


So those two positives were offset by one major negative, which was the continued instability in bond markets so bond yields continued to rise. Potentially for the first time since the 80s, we may see negative yearly bond returns, which is something that's very difficult for conservative investors, but very difficult for all asset classes. Seeing that stabilise would be positive.


I think that positive element is really important but I also don't think it's a time for us to be complacent as investors. I think if we look forward, there are still a couple of things that are going to be important. The first one is that you're seeing bond markets really sort of finding their rhythm after two years of very steep interest rate rises.


The geopolitical side of things, whilst the issues with China seem to be more conciliatory from a number of different governments, I think the last couple of years have demonstrated that geopolitical risk seems more heightened than it has been for some time, and surprises can come out of nowhere quite quickly. I think the final thing is that investors need to remain vigilant.


We do think the inflation data is likely to remain volatile and markets seem to react, certainly in the short term, to quite small changes in inflation data. We do think that that's likely to be a bit of a feature of markets as we move into 2024.


So you could say we had a pretty eventful year. What do you think's in store for 2024?


I think one of the most important things that has the potential to impact markets is that nearly half the world's population is going to go to the polls next year. So first up, we've got Taiwan in early January, but we've got some major populations like India going to the polls and nine countries in Europe, including some major economies like Germany and very likely the UK.


The reason this is important is that it has the chance to see some real changes to government policy. And one of the things that we have learned in the last five or six years is that polls can produce some unusual results and you continue to see the rise of populist governments, particularly in Europe. The other sort of critical thing for markets is that we've got probably the most important election of all, which is the US presidential election in November.


And so we do think that this is going to be a sort of area that markets will continue to focus on and it will sort of impact not just what happens at a domestic level, but also around trade and whether or not we see the sort of 'realpolitik', which is emerge between China and a lot of developed economies continuing, or whether or not we see relations go back into the deep freeze. That's a lot of potentially destabilising events.


What does that mean for CFS investments? It's a very good question. So I think that we've talked about some of the geopolitical issues that markets are likely to have to deal with going forward. And it's against a backdrop of increased reversal of globalisation, with restoring or 'friendshoring' of jobs in a number of developed economies.


So we do think that that sort of geopolitical angle is going to continue to be a factor going forward. And notwithstanding the fact that 2023 has produced some really good results, I think as we said before, it's not really a time to be complacent about the way that we manage our clients' portfolios. And with that backdrop, we do think that managing risk is going to be incredibly important.


We've made some significant investments here at CFS in the last 12 months around our investment risk systems and brought in some excellent talent to help manage the investment risks within our portfolios. If we think going forward some of the things that we're doing to position the portfolios to deal with what we think is likely to continue to be an increasingly volatile marketplace, one of the areas that we've added to is private debt. We think the yields there are really attractive and it adds some real stabilisation to parts of our investment portfolio in the markets going forward. And I think in that sort of environment where you are seeing heightened risks, the way that we manage risk within our investment portfolios will continue to be very important.


The other part that will continue to be an important part of what we do at CFS is diversification. Looking forward, one of the areas that we've been looking at is private debt and early in 2024, we'll add that to our investment portfolios. We think that that's interesting because yields from that part of the market are very attractive at the moment.


It provides some really good diversification and some real balance regardless of what actually happens to interest rates going forward. And even as we make those investments, liquidity is going to continue to be an important facet that we have within our investment portfolios, as well as the diversification. There are going to be opportunities that come up as markets move around a little bit over 2024 and those sort of key tenants around diversification and risk management that CFS really stands for, I think will hold us in very good stead whatever markets throw at us in the year ahead.


So what's been the biggest takeaway from the last 12 months?

I think there's a lot, but the one that really stuck out for me was don't underestimate people's propensity to want to spend. We went into the year expecting a recession. We thought that the cost of living crisis would overwhelm all household balance sheets, but people just found a way, post-COVID, to want to experience the world.


Savings rates are low, sure, but there was a build up from what was handed out during COVID and people continued to spend and that was against what all pundits expected. So that to me was probably the key takeaway.


Looking over the year, what was your number one takeaway? I think the thing that has been really interesting is that lots of people predicted a recession.


Whether or not it's here in Australia or most particularly in the US and that's yet to occur. And first of all, I think it just shows you how difficult these things are to predict. But if we look at the different sort of measurements or predictors of recessions, I think they're just taking a lot longer to play out than they have done in previous cycles.


And what's interesting to me about how much that tells us about the way that global economies have shifted and changed, the way the interest rate, the impact of interest rate policy on individuals, you talked about consumer spending, I think that that has changed. And I think that one of the key takeaways is that technology has had a much greater impact on economic activity than I think even the most bullish tech heads would have thought.


Thanks for watching CFS Market Insights. See you next time.

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• This document provides general information for the adviser only and is not to be handed to any investor. Information on this webpage is provided by Avanteos Investments Limited ABN 20 096 259 979, AFSL 245531 (AIL) and Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (CFSIL). It may include general advice but does not consider anyone’s individual objectives, financial situation, needs or tax circumstances. You should read the Financial Services Guide (FSG) before making any recommendations to a client. This information is based on current requirements and laws as at the date of publication. Published as at 26 June 2023.