As we start the new year, many investors will wonder whether it is the right time to review their portfolios to optimise the returns they aspire for.
Of course, no one can predict the future, not even those with vast experience in asset management and economic analysis. This reality is proven by the contrasting predictions made by investment analysts who interpret evolving trends differently.
Still, it is necessary to consider some investment considerations that are likely to harness the dynamics that will drive financial markets in 2024.
The way inflation will evolve is undoubtedly the first consideration. Today, across the developed world, headline inflation has collapsed from a peak of almost eight per cent to under 3.5 per cent. This fall is impressive.
But will inflation return to the pre-pandemic decade levels? Most analysts predict inflation will continue to cool, but it will likely settle higher than in the past decade.
Labour market pressures, especially in the US, are shifting back into balance after the disruption caused by the pandemic. This is a strong signal for softening wage growth.
However, “nearshoring” and global supply chain adjustments will likely limit how much goods prices could fall. Moreover, the EU’s commitment to greening the economy may, in the short term, lead to persistent inflationary pressures.
The rationale for holding on to cash in the investment portfolio is a second consideration. Yields on safe cash holding have risen in the last year as interest rates soared.
Cash works well for investors when central banks hike more than expected, and inflation expectations are increasing, as has been the case for over a year. But today, it is more likely that the Fed and the ECB may consider lowering rates rather than increasing them further.
The financial markets are pricing a 60 per cent chance of the Fed cutting interest rates by March and a 100 per cent chance that it will do so by May. Another prediction is that the Fed will lower interest rates by 125 basis points by December 2024.
One caveat is that no matter how authoritative and astute central bankers’ predictions may seem, no forecast of what the future may hold can be infallible.
Recently, the Fed made several huge mistakes in predicting the economy. In early 2021, Fed chairman Jerome Powell stated that the Fed expected to hold interest rates near zero through 2023. That is probably one of the worst forward-looking statements ever made by a central banker.
Bonds are beginning to gain interest from investors. Bonds provide stability in portfolios with lower volatility than stocks, coupon payments generate income, prices rise when economic growth slows, and interest rates fall.
One caveat is that no matter how authoritative and astute central bankers’ predictions may seem, no forecast of what the future may hold can be infallible
In the pre-pandemic decade, a quarter of government debt globally carried a negative yield. Now, negative-yielding debt has almost disappeared completely. Today, nearly 60 per cent of global government debt offers yields above three per cent.
Equities seem to be on a march to new highs spurred by optimism about the power of AI to boost economic growth. The S&P 500 was up by over 20 per cent last November.
Earning growth is accelerating again in the US and Europe, and many analysts seem to agree that optimism about an increase in equity prices is not misplaced.
Equities are generally believed to be the drivers of long-term capital appreciation. While quality bonds certainly have a more significant role in portfolios today for most investors, it is worth remembering that stocks have outperformed bonds 85 per cent of the time on a rolling 10-year basis since 1950.
Political risk is unlikely to disappear in 2024.
The EU will have a new Commission with an onerous economic and governance reform agenda. The US may have a new president, even if this is unlikely to have much short-term economic consequences. The Russia-Ukraine war is unlikely to be over anytime soon. The Israel-Hamas war may escalate tension in the Middle East with dire effects on global geopolitical stability.
I hesitate to comment on the local financial markets with limited depth, volume and diversification. Moreover, I have doubts about whether the debt market is correctly pricing risk on bond issues.
It is fallacious to think that one can guess the outcome of the complex issues and the risks that affect financial markets. Investors have different risk tolerance limits. They must, therefore, seek advice on how best to calibrate their investment portfolio.
It is always wise to keep your portfolio as diversified as possible to avoid sleepless nights when turmoil afflicts financial markets.