Almost every wealth manager, private bank or financial advisor will around this time of year send a note to clients explaining what happened in the markets last year and their outlook for the year ahead. It feels like the right thing to do. In reality, thinking in discrete, arbitrary blocks of time doesn’t make sense in the context of client portfolios that are built for at least several years or, in the case of almost all of our valued clients, decades.
It can force thinking and decision-making into certainly a narrower frame than is desirable and in any event one that is bound not to fit with the rhythm of what really matters: events and changes in our clients’ own, real, lives.
These are by far the dominant factors on decision-making in portfolios.
That’s not to say that we are not carrying out these reviews, however. Testing the assumptions behind our portfolio construction decisions goes on all the time, including a formal annual review. But we are careful to separate this ongoing process, which is about ensuring the robustness of our craft, from the decision-making channel, which must be above all client-driven.
Having said all that, our peers do produce such commentaries anyway, and I suspect many clients (in general) may even welcome and enjoy reading them. I thought I would buck the trend this year and offer some observations, somewhat unscripted – so let’s see if anything interesting emerges from the exercise.
The first nine months of the year saw government bond yields (that is, the interest rate demanded by holders of government bonds) continue their ascent to levels not seen in decades.
This was driven by inflation that remained also at levels not seen in decades.
This has impacted valuations of higher risk, earlier stage companies in both public and private markets. Many of the more speculative venture capital-funded startups of 2020 and 2021 are struggling to raise more funding, or are having to do so at lower valuations, or are going bust. There has been a Damascene conversion among investors from two years ago (“we didn’t even meet the founder we just wired the money in 24 hours #clubhouse” to “I like to invest in profitable companies”).
The biotech sector is probably the most stark example. It is among the most speculative areas among “growth” stocks, since, by definition, revenues and profits are many years into the future. Amidst a broad VC / growth / early stage “winter”, we have seen a biotech Ice Age, from a peak in February 2021 heralding a brutal bear market down 65% by October 2023:
There are many voices in the market, so I won’t call it the dominant narrative, but certainly one clear point of view was that the era of inflation being tamed and remaining somewhere around 1% to 3% per year, with deflation as much of a risk as high inflation, has ended, and we are set for a period of years in which inflation will be difficult to keep down.
If that were the case, central banks would be forced to keep rates at high levels for longer, which would mean the pain for earlier stage, riskier ventures would be more pronounced.
Just to spell out why, in the most simple case, it’s a question of the “risk-free rate”, that is, the rate of return an investor can achieve without taking any (more or less!) risk. Typically this means lending to a good quality borrower such as a developed country’s government (US, Germany, UK) or to well-established, profitable businesses (Apple, Microsoft, Nestle), or simply depositing money in a savings account at a strong and well-regulated bank. When investors found that, in a matter of months, the return on such lending or deposits went from close to zero to 4%, 5% and higher, naturally many of them chose this over allocating to what suddenly seemed to be much riskier, much more volatile start-ups and growth stocks. News flow reinforced this with the dreaded “down rounds” (where a company raises new money at a valuation lower than the previous round) becoming more prevalent.
There was a different tone to the end of the year, however. For one thing, inflation did finally start to fall – in the US, quite dramatically. At the same time, economic growth continued in most developed economies, with “recession” all but disappearing from public discourse. (You may recall I covered this particular topic in the last client letter in October 2023.) Again, the US was a remarkable outlier, but even the supposedly sclerotic EU and decrepit UK eked out growth.
Central banks at first kept their public utterances firmly on message: having been slow to realise the scale of the inflationary pressures that had built up through Covid and the Ukraine war, they would now not rest until they were certain inflation was back under control.
But as the year progressed talk turned to the possibility that rates had now peaked. And over the autumn, momentum built behind the idea that the first interest cuts in this cycle were not only sooner than the markets had priced in, but that there would be more of them in the months ahead.
Of course this was reflected in falling bond yields, but perhaps the most spectacular impact was on what may well turn out to be The Great Thaw following that biotech Ice Age with a 41% rally from the low on 27th October in just 9 weeks:
It’s too simplistic to explain this surge on the basis of lower interest rates alone but it was a factor.
That momentum boosted many of the growth stocks that had suffered until now, resulting in a very strong, maybe even overly exuberant, end to the year for the speculative end of the market.
There’s one major theme I haven’t commented on the Super Seven, the Fantastic Seven, the Magnificent Seven. Yes, it’s the world’s largest, most valuable technology stocks: Apple, Microsoft, Meta (Facebook), Alphabet (Google), NVIDIA (the high end chipmaker), Amazon and Tesla. Come rain or shine, inflation or deflation, they just went up, up and up again, with 2023 returns ranging from a lowly 49% (Apple – just a mere trillion dollars or so of added market capitalisation) through to 236% for NVIDIA. I don’t really have much to say, except thank God for global stock market trackers, because through them we benefit from this Seven-sent success.
Their performance has been so powerful they now represent a historically high proportion of the US market (and by definition also of world markets):
History suggests that when you get distortions in the market like this, they tend to unwind. How, when, in what particular form? It’s all but impossible to say. As the famous 20th century economist, John Maynard Keynes, is reported to have said, “markets can remain irrational longer than you can remain solvent.”
What has any of this meant for you? A lot of study, a lot of discussion, a lot of analysis and modelling of different scenarios on our part; and some action, but not the flurry you might expect. I will summarise.
For clients with lower risk portfolios, both bonds and “real asset” sectors such as renewables and infrastructure offer the opportunity to lock in returns above our targets for years to come. We’ve adjusted for this and may be more active than usual in the year ahead.
For clients with higher risk portfolios, mostly sit tight. We’ve been boosted by the very strong US market performance and held back by much weaker markets in the rest of the world. That’s ok. Our latest reports refer to the fact that the last decade or so of US dominance was preceded by a decade of emerging markets dominance; at the start of 2009 the consensus was that the future was in BRICS (the acronym coined by a former Goldman Sachs banker for Brazil, Russia, India, China and South Africa, presumed to be the combined engine of economic growth for the world). Not many were predicting the return of the former champion, the USA.
What does it mean for 2024? I will draw the line here. As I write, the tragic conflict in the Middle East has indeed widened as many feared; but an exchange of missile strikes between Iran and Pakistan?! I defy anybody, in the entire world, to stand up and say they predicted that one! Which I hope is sufficient for you to accept that I won’t be drawn on predictions for the year ahead. There will be ups and downs and surprises. Your portfolios are set fair at all risk levels to stay in the game in pretty much every scenario – and that is what drives long term returns.