A view on Financial Markets and wish for 2024: less conflict, a focus on fundamentals

Tuesday, 2nd January 2024 10:34 - by David Harbage

A significant weakening in inflation and economic activity over the past three months has prompted market commentators to believe that the peak in interest rates has been seen and that, by contrast, 2024 will see the cost of money fall. After a lot of turbulence over the past two years, financial assets are beginning to anticipate a return towards inflation and interest rates moving back towards 3%, taking an eighteen month horizon.

- Financial Markets look beyond media headlines

- A view on Financial Markets Growth has stalled, but is that bad for markets?

Even if one ignores the geo-political uncertainties and overwhelmingly negative consequences of conflict in the Ukraine and the Middle East, the year ahead is set to be a difficult one as elections loom in the United States, Europe and at home. While it might be argued that little may change in foreign or economic policy as a consequence of a change in administration (although the re-election of Donald Trump as US president could rebut that presumption), there will be no shortage of noisy debate and, therefore, the prospect of stock market turbulence.

Moving from the emotive to consideration of the typically more hard-headed subject of economics, slowing real growth in gross domestic product (GDP) around the world would seem inevitable in 2024 – as indicated by survey evidence from China and emerging nations which, seeking to catch-up with the more mature developed countries have been the prime drivers over the past decade. Growth on the continent of Europe and in the United Kingdom looks set to be flat, while ‘the jury remains out’ on the outlook for America’s growth. A few leading commentators have forecast a recession for the latter, but it is difficult to overstate the robustness of the US’ capitalist, pro-entrepreneurial economy and its demise has often been erroneously predicted (“economists have forecast ten of the last two downturns”).

Current consensus expectations suggest global GDP growth will continue to be driven by Asia, recording growth of close to 2.9% for the year just ended, set to ease to 2.6% in 2024 before picking up to circa 3% in 2025. Consensus views for the US suggest a fall from 2% to 1.5% in 2024 while, closer to home, output in the UK and Europe is forecast to be flat – flirting with a downturn - next year, but for GDP to improve to 1.5% in 2025.

Perhaps persuaded by short term news flow, the risks to these predictions of economic activity would seem to be to the downside but any deterioration is likely to be accompanied by lower inflation and a more pro-active response to fears of deflation and recession - by central bankers’ reducing interest rates. Cuts totalling 1.25% by the Federal Reserve and 1% by the Bank of England in 2024 are now being priced in by the bond market, with a reduction coming as soon as March. Domestic ten year gilt yields have fallen to 3.5%, offering hope to both short (think overdraft & credit card) and longer (mortgage) term borrowers.

The prospect of a shallow downturn is something that well-run businesses can cope with, evidenced by better than expected trading updates and barely changed estimates of corporate earnings in 2024 from stock exchange listed companies. By contrast smaller family-owned firms – with less access to cash - are likely to encounter greater difficulties in next year’s likely subdued economic clime. It has been evident that listed companies operating in difficult segments of the market have acquired at ‘knock-down’ prices private firms who are struggling - for instance in UK retail Fraser Group (FRAS) has benefitted from opportunistic purchases of smaller peers who were succumbing to the squeeze on discretionary consumer spending.

After experiencing a sluggish first half of 2023, in which investors worried about the rising cost of money and apparently undervalued investments were being downgraded by the market, the year ended in a much more positive mood in expectation that inflation had been brought under control and the money- tightening cycle had ended. In previous blogs, the writer has endeavoured to justify his faith in close-ended investments whose share prices ignored decent growth in their underlying assets net asset worth and were neglected by investors seeking shorter term momentum.

That many of these company investments maintained a level of financial gearing (typically up to 10%), to own more of their chosen assets, only exacerbated their short term performance ‘pain’ – but conversely offers exceptional bounce back-ability as those assets appreciate. The traditional ‘Santa rally’ or window dressing for year-end valuations, according to the observer’s perspective, has already seen many fixed income, equity and property investments appreciate by between 5% and 10% in the last two months of 2023. The income produced by such assets will appear more valuable and attractive, as returns on cash diminish over the next year or so.

It is to be hoped that individuals and associated bodies that own real estate, inflation-linked securities, company shares and credit (corporate debt or bonds) are long term investors and, possessing such a perspective are not tempted to exit when market sentiment deteriorates. Active managers of a portfolio will take a view on the current valuation of an asset – assessing its inherent merits, relative to the apparent risks – and finesse the asset mix by allocating more or less monies according to their perspective.

Looking forward into 2024 and beyond, the big issues mentioned in our previous blog - in November entitled ‘Financial assets look beyond media headlines’ – remain, which could spook nervous investors. Equity markets will continue to be vigilant about the risk of company profits being squeezed by higher labour costs (noting the 9.8% increase in the UK’s National Living Wage from April 2024) through to falling consumer discretionary spend as the tax burden rises. Beyond the economic concerns, investors will be wondering who the next President of the US will be and if a change in UK Prime Minister would result in any meaningful change in policy.

Yet again, the old adage about the “market climbing a wall of worry” can be reiterated without apology and hopefully provides a boost to confidence, as we have seen businesses cope with pestilence, war and financial stress over the past three years - but still manage to generate higher revenues, buy back their own shares and pay higher dividends. This has not just applied to listed firms, but private ones too – where progress in asset values and earnings have seemingly been overlooked.

Making no apology for repetition, this author retains confidence in successful businesses and real estate investments for the appropriate longer term as it is only this kind of asset which can offer the potential to deliver rising income to investors. While anticipating difficult economic and uneasy geo-political conditions will prevail throughout the year ahead, we believe the change in direction on interest rates will provide confidence that the market cycle (which is always considerably ahead of the economic data) is about to change for the better.

Lower costs of money can be the catalyst to a revival in merger and acquisition (M&A) activity, with neglected (and therefore undervalued) domestic assets being particularly vulnerable to both overseas predators and domestic trade buyers. Allied to an increasingly penal capital gains tax regime, a reduction in the appeal of cash (as interest rates fall) and the prospect of a change in rules surrounding individual savings accounts (ISAs) could prompt bargain hunters to alight upon domestic company investment.

Readers must carry out their own due diligence in considering individual selections but, in response to numerous requests for suggestions, the writer would continue to advance the case for the following diversified investment trusts (as opposed to following a path of choosing individual company stocks) – most of which were detailed in the 23 May 2023 blog ’The Value Portfolio’:

UK Equity: (bias towards larger, listed businesses): Artemis Alpha (ATS), Baillie Gifford UK Growth (BGUK) and Lowland (LWI).

UK Equity: (bias towards smaller, listed firms:) Aberforth Smaller Companies (ASL), Henderson Opportunities (HOT), Mercantile (MRC) and Schroder UK Mid Cap (SCP).

Overseas Equity: AVI Global (AGT), Herald (HRI) and Pershing Square Holdings (PSH).

Alternative Flexible Assets: Greencoat UK Wind (UKW) and Harbourvest Global Private Equity (HVPE)

Commercial property: Schroder Real Estate Income (SREI), Tritax Eurobox (EBOX) and UK Commercial Property (UKCM).

Finally, it is to be hoped that 2024 will be a more peaceful year for the world – both in terms of political polarisation and warfare. Insofar as financial markets are concerned the prospect of focusing on fundamentals – rather than extraordinary events or risks - against a backdrop of a more benign global macro-economic backdrop, is an appealing one. Best wishes to all our readers.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.