12th January 2024

Whilst at the year’s open recession fears were one of the key risks highlighted for 2023 thus far, we have escaped a material downturn. This is despite the fact that we have seen significantly higher interest rates, US and European bank collapses and takeovers and an escalation of hostilities in the Middle East. Importantly, the US, as the world’s largest economy, actually experienced a period of quite impressive expansion, with third quarter growth its strongest since 2021. This has been helped by the consumer digging deep and continuing to spend with, if not quite abandon, then at least a level of optimism that seems at odds with general sentiment. Elsewhere however, growth has not been nearly as impressive with the UK and Europe stuttering from month to month and slowing slightly in the third quarter. Further afield, China has disappointed expectations but continued to post positive growth, helped latterly by government and central bank economic intervention, including interest rate cuts. These actions have been prompted by a number of factors, not least weakness in the country’s debt laden property market.

The spectre of higher interest rates got a fright towards the end of the year, as inflation in the US and Euro Area slowed to 3.1% and 2.4% respectively in November. This led to anticipation that we have witnessed peak interest rates, a narrative which was further supported by US policymakers stating that they may cut interest rates by 0.75% in 2024. UK inflation fell to 3.9% in November though, unlike the US, the Bank of England (BoE) emphasised that interest rates may need to stay higher for an extended period and could even go higher. Markets still expect UK interest rates to be cut in 2024, responding to the BoE’s comments by merely adjusting the likely date of this to June rather than May. Nevertheless, the encouraging inflationary backdrop was enough to allow the US, UK and European central banks to all keep rates on hold in December.

We have been of a view for some time that we are likely at peak interest rates. Indeed, this was why we increased interest rate sensitivity in our portfolios mid-way through last year, which supported portfolio returns as markets subsequently reacted positively to potentially lower interest rates in 2024. Yet, we are not complacent enough to suggest that the war against inflation has been won and a recession has been avoided, especially due to the lagged effects of higher interest rates. This is why we continue to take a balanced stance in our portfolios and retain exposure to quality (in both bonds and equities) and, where appropriate, diversifying funds, which are strategies designed to have a limited relationship with stock and bond markets.

Nonetheless, the prospects for future returns bode well. Bond yields are at attractive levels and so they could materially add value, as we saw in the latter stages of 2023. Furthermore, if peak interest rates are behind us and we avoid a severe recession then there are many parts of the global stock market that could return to form. Much of 2023 was dominated by the performance of a few massive US companies and whilst a slowdown in them may impact the wider market, it has meant that there are many great companies that have been ignored for some time, not least in the UK.