Insights
Market Review for December 23
Pathfinder makes solid gains, Microsoft overtakes Apple and inflation peaks
2023 ended on a high note, with a Santa rally across financial markets that saw equity market index returns for the month of December reach +4.5% for the US, +7.3% for Australia and +3.9% for New Zealand. The NZ market managed to return +2.6% in 2023, while across the Tasman the Australian market gained +12.4%, and the US market rallied a whopping 26.3%, lifted higher, in the most part, by the seven mega-cap* US technology stocks. After a brief dip at the start of January, risk sensitive assets have remained well supported with the US S&P 500 index trading just below the record it reached in January 2022.
All Pathfinder funds made solid gains in December (as shown below), with bond markets also seeing a period of sustained increases as interest rates continued to trend lower. Fixed interest investment* returns were positive in December and the 12-month returns for NZX Investment Grade Corporate Bond index was 7.5%. In saying that global bond yields picked up off their late-2023 lows as investors may have gotten a little too excited with their expectations for imminent significant rate cuts by the US Federal Reserve.
Inflation and interest rates in NZ compared to overseas
The latest US inflation data provided a reason to pause for those still keen to believe the Fed will be cutting as soon as March. US inflation growth accelerated to 3.4% from 3.1%, while expectations sat at 3.2%. Progress in bringing inflation down remains a lot more concrete in the than it is here in NZ, though some of that is due to timelier data*.
Taking a big picture view, falling US inflation and possible Fed easing are seeing an increase in talk of a benign slowdown in growth for the economy rather than a sharp recession. Leading economic indicators point to slowing economic growth but not a collapse, and this is what is currently being expected by markets. There’s still a risk of a global recession this year; the important point is that even if it did occur, it is likely to be a mild one.
Risks and challenges to be aware of in 2024
As always, there are risks and challenges to be aware of as we look towards the year ahead. Risk and uncertainty around the US election and geopolitical policy may be intensified by slower economies. There are also issues with regard to public sector financing given the massive deficits of government budgets around the world. Additionally, we are also seeing a concentrated rate of return from the largest and most influential companies in the market, particularly in the tech sector.
The mega-cap US tech stocks, now led by Microsoft (who recently overtook Apple to become the largest listed company by market capitalisation), experienced huge gains in 2023. Equity valuations are at the high end of the range for the US market, but closer to average when adjusting for the size of the mega-cap stocks. Valuations that peaked in 2020/2021 are no longer relevant now that the Fed will presumably maintain interest rates consistent with pre-COVID levels. After adjusting for their higher earnings growth expectations, the mega-caps don’t look nearly as overpriced.
The challenge is however, that the view on mega-cap US tech stocks not being overvalued has become a very crowded place for investors. We also can’t underestimate the risk that regulatory action, targeting anti-competitive behaviour, can impact both margins and long-term business plans of tech giants.
Overall, we see a well-diversified portfolio of high-quality corporate bonds and equities as a good way to think about investing.
Cash vs Bonds
We often get asked “why not just hold cash rather than bonds”. Yes, cash yields are tempting but we think this is as good as it gets. Cash works best relative to stocks and bonds in periods when interest rates are rising quickly (as we have seen recently). Cash works less well when interest rates are falling (as you are reinvesting at lower and lower yields).
Our expectation of lower cash rates reflects our view that inflation has likely peaked, and central banks see their current policy positioning as restrictive. As such, bonds look like a better option than cash, given bond prices are paying attractive yields right now and will make capital gains if interest rates continue to fall. It has been a brutal stretch for bond investors, no doubt about it. But we think the end of central bank tightening cycles and cooling inflation will offer more than a reprieve - they’ll bring stability back to the asset class.
Financial Literacy
Sometimes finance terminology needs decoding, we've supplied definitions for the less common terms here:
Megacap stocks are listed companies with a capitalisation (market value) of over $200 billion.
Fixed interest investments are a class of assets and securities that give certainty by paying a set level of cash flows to investors. Please read our SIPO for more details.
Note on 'timelier data': When making investment decisions you should understand the time period that data covers and in particular want to know how current it is. For example, US inflation data is released monthly while NZ data is released quarterly. This means that US inflation data will generally be more current or ‘timelier.’
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