DFO Reflections – Q4 2023

A very good year with only a few losers!

Expectations for financial markets in 2023 were modest, especially against the backdrop of continuing inflation and rising interest rates in all major economies except for China. It was therefore even more astonishing to observe that both bond and equity markets performed very well into the summer. In our half-year report, we spoke of results that were ‘too good,’ as many equity investments posted high double-digit returns. A large part of the gains in technology stocks and the Nasdaq 100 Index was primarily due to the unprecedented euphoria about the growth opportunities offered by artificial intelligence. Nvidia, the most important manufacturer of semiconductors for AI systems, saw its share price multiply.

There were also high returns in the bond market despite increased inflation and a banking crisis in Silicon Valley, as well as the implosion of Credit Suisse. However, it should also be noted that at the beginning of the year, both equity and bond valuations were very attractive and offered good entry prices for long-term investors.

Between August and October, a brutal correction came in the form of signals from the US Federal Reserve that its reference interest rates would probably have to remain at a higher level for longer. This was primarily due to the strong US labor market and persistent inflation. The financial markets had speculated on a stabilization or even a reduction in central bank rates as early as the end of 2023. As a result, the bull market of the first half of the year came to an end: bonds had to give back almost all the year’s gains by the end of October. The same applies to the shares of smaller companies, which are very sensitive to interest rates. Small companies are usually less profitable than large conglomerates and struggle to cope with higher financing costs when interest rates rise. Only shares of technology giants in the Nasdaq 100 Index, also known as the ‘Mighty 7’ (Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia, Tesla), were able to escape this correction and retained significant gains.

Sentiment was so poor that the question was raised in October as to whether the year might end well after all! Our answer was to point out that very negative market developments are usually followed by positive ones. However, we would never have dreamed that both equities and bonds would perform a 180-degree turn and make up for all losses by the end of December. The reason for this bull run was, as so often in the last two years, the development of global inflation rates. After both US employment and the US inflation rate fell only slightly in the summer, prompting central banks to talk of ‘higher for longer,’ inflation corrected sharply in both October and November. European core inflation fell to 2.4% p.a. in November, well below the ECB reference rate of 4.0%. The same happened to US core inflation, which at 4% p.a. was also below the US central bank rate of 5.25 – 5.50% in November. This means that both the United States and Europe had relatively high inflation-adjusted interest rates (real interest rates), which shows a rather restrictive monetary policy and was last seen in 2007.

The big losers of 2023 were investors in Chinese equities and Chinese high-yield bonds. This was the 3rd loss-making year in a row and showed clearly that things in China are different now. Tried and tested investment recipes don’t work anymore. We have mentioned China several times over the course of the year and advised against increasing exposure. Even low valuations do not attract us to this market, which is characterized by considerable uncertainty.

Despite many political crises and armed conflicts, global commodities had a rather unspectacular year and saw only minor losses. We’re viewing commodity investments as supplementary investments at best. In contrast, investments in gold were quite successful at just under 13% p.a. In our view, gold is not an attractive investment because it does not match the high long-term returns of equities and is far more volatile than short-term bonds. It is therefore neither a good safety- nor a good high-return investment component. However, it has held up well in recent years and is benefiting from the fact that the central banks of China and Russia appear to be aggressive buyers of the shiny metal.

The US dollar ended the year somewhat weaker, which is probably because the capital market is expecting lower US central bank rates in 2024.