Dear client,
As 2023 draws to a close, we confirm, once again, the importance of adhering to a sustained, long-term investment style and not giving way to emotions, which were plentiful in a year wherein the antics of the market compounded anxiety and confusion.
The profile of stock indices in 2023, illustrated in Graph 1, were defined by four distinct phases, all related to changing perceptions of global economic prospects and, above all, the monetary policies of the year’s leading players, the central banks.
Three possible errors in 2023
This precarious evolution set traps to avoid.
In the past year, investors may have committed to three potential errors:
1. Withdrawing from the market: not investing
After a disastrous 2022 for both bonds and equities, and amid pessimistic forecasts about an imminent recession, many investors and countless investment strategists opted to maintain a cash position.
This was an unfortunate decision, resulting in a loss of purchasing power and a failure to participate in the dazzling recovery of both bonds and equities after October lows. And, therefore, failing to recover from last year’s diminished valuations.
2. Not capitalising on interest rate peaks
In 2022 and 2023, the central banks applied a restrictive monetary policy with few precedents. It triggered considerable valuation declines.
But, when Q4’23 data suggested inflation had been contained, the markets celebrated with spectacular increases (see our November Opinion Flash), taking into consideration—perhaps overly optimistically—looming US interest rate cuts in March 2024.
3. Taking the continued relief rally as a given
As Table 1 shows, the results from 2023 helped funds recover from 2022 declines and restore 3Y and 5Y annualised results: great news!
But November’s vertical growth only demonstrated how pessimistic investors were at the Q3’23 close.
Linear continuity of this rhythm in 2024 is unlikely, once valuations normalise.
What indices don’t say
The progress of passive management obscures a special phenomenon. Rising indices are attributable predominantly to a small group of companies, without which the same indices would appreciate only marginally.
The so-called 'magnificent seven' are a group of US tech companies whose stock market performance accounts for 36% of the S&P 500’s gains since 2015. This trend reminds many of the dot-com bubble of 2000 or the Nifty Fifty of the 1970s.
In Europe, a small pool of companies dubbed the 'magic eight' account for 50% of Eurostoxx50 gains since 2015.
In this respect, it seems relevant to share the following points:
1. The importance of stock picking. EDM’s global equity portfolios include eight of the fifteen US and European companies mentioned.
2. Unlike previous periods, the current stars are companies of extraordinary quality from a management perspective with very strong balance sheets.
3. The profiles of the eight European companies and the seven US counterparts are completely different, with the former peppered across various sectors with more contained earnings multipliers (P/E ratio).
4. Given the difficulty of formulating judgements about the future profit growth (EPS) of tech companies, it is prudent to continually monitor this data to confirm current valuations.
Bonds: the star of the year
After a devastating 2022, with negative returns of -7.2% for the index (1-5Y Euro Government), bonds had a mixed year: negative in the first half of 2023 and splendid in the second.
In any case, after 14 years of minimal or negative returns, they once again have a place in diversified portfolios, either to generate income and/or reduce long-term volatility.
With the exception of high-yield bonds, the real historical yield (deducting inflation) of fixed income barely reaches 1%. Now that inflation appears to be heading toward the 2% target, it is surprising that 10Y US bonds continue to offer 4%-5%, with the German equivalent at 2%-3%.
2024 and beyond: the years ahead
At our Investment Forums in Barcelona and Madrid, we emphasised our interpretation of the structural factors that have changed the world of economics, politics, and subsequently, investment. This shift, trumpeted some time ago, materialised in 2022/2023 and will extend into the future.
Essentially, we believe certain basic elements will define the decade to come:
• The stabilisation or reversal of the globalised economy
• Ongoing demand for financial resources to support the climate transition, defence spending, and debt refinancing
• Political framework oriented toward populist positions and autocratic public management
• Economic interventionism and probable tax increases.
For these reasons, we suspect that the cyclical decline in interest rates on bond yields cannot obscure the fact that inflation expectations do not fall below 3%-4%.
Significantly, last July EDM’s Asset Allocation Committee agreed to diversify the portfolios under discretionary management and advisory regimes, increasing the weight of bonds. This policy is consistent with an emphasis on quality shares, which has always been the focus of EDM’s equity portfolios that, year after year, offer returns well above inflation.
The enormous uncertainty about economic developments and central bank monetary policies underlies our approach to asset allocation in 2024 and beyond. However, one thing remains the same: quality shares constitute the core of the portfolios managed by EDM.
We therefore enter the new year with the satisfaction of having largely recovered the valuation declines of 2022 and maintaining our characteristic 'sceptical optimism'.
Many thanks for your continued trust and we wish you a very happy 2024.
María Díaz-Morera
Chairperson
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