Insights from Colin Vella, head of wealth management at Jesmond Mizzi Financial Advisors, for a strategic approach to 2023's market trends and anticipated developments in 2024.

The last quarter saw the US Federal Reserve and investors anticipating a number of interest rate cuts for 2024. Are you as optimistic as the market about this?

There's reason to be optimistic about this year, though we should also brace for some volatility. In 2023, despite significant volatility, the market remained mostly flat until October. The optimism in the US was largely focused on big tech giants like NVIDIA, fuelled by the AI boom.

Since October, however, we’ve witnessed a broader, more organic recovery across various sectors. In fact, the equal weighted S&P 500 remained flat until October, while the standard weighted index saw about a 10% increase. Post-October, both indices have shown growth, with the equal weighted index up by 15%. This positive trajectory, if it continues into 2024, bodes well for the markets.

In the fixed-income realm, longer-dated yields have declined substantially towards the end of 2023, reflecting higher expectations that rate cuts will commence sooner than previously expected as markets envisage a more optimistic medium to long-term outlook on inflation figures. In fact, we have witnessed the US ten-year treasury bill dropping from 5% to roughly 4%, as similar European bonds declined from about 3% to below 2%. Yields move inversely to prices, and as a result of this, fixed-income portfolios with higher durations started to reap some benefits by year-end – albeit still a long way to go from the high levels (low yielding environment) back in 2021.

Which sectors stood out in their performance during 2023?

Over the last few months, sectors like IT, telecommunications, and consumer discretionary have exhibited significant growth. However, sectors closely tied to inflation and prevailing interest rates, such as utilities and energy, faced challenges. Looking back at the entirety of 2023, the financial services sector, particularly in Europe, stood out prominently. This includes banks, insurance companies, and similar entities, which benefitted from higher interest rates.

Are there sectors expected to face higher volatility?

The energy sector, which is vulnerable to wars, geopolitical conflicts and sustainable investing trends, is likely to see higher volatility. Utilities may also face fluctuations, particularly if actual interest rate cuts don’t align with market expectations or if unexpected negative developments occur. This could hinder utilities from realizing their potential gains. Growth stocks and smaller companies, highly sensitive to interest rate shifts, could also experience significant impacts.

Looking ahead to 2024, what does this mean for investment portfolios?

On the bond side, there are still opportunities for long-term attractive returns. Investment-grade bonds, despite appreciating in value, offer yields considerably higher than the near-zero rates of a few years ago. This presents a dual opportunity for capital growth and solid yields. As we anticipate further interest rate cuts, we can expect a boost in price appreciation within the fixed income market. This opportunity persists, even though the investment-grade and government bond market remained flat until October. Since then, we've seen a recovery of 6-8%, notable but not yet compensating for the approximately 20% decline from 2022. In equities, certain sectors poised to benefit from rate cuts, particularly those that haven't recently performed well, are now relatively undervalued compared to their peak levels at the end of 2021.

Are you concerned that a year’s worth of positivity might have been prematurely priced into the market, leading to potential negative surprises in 2024?

This is a valid concern. The market rally we have witnessed in the last two months of the year, fuelled by a collective sense of euphoria, led to a surge in market levels as investors scrambled to join the uptrend. We’ve already seen a slight retraction this year, likely a mix of year-end profit-taking and market corrections. So, while we may have factored in a year’s worth of positivity a bit too early, there could be negative reactions if the timing and magnitude of the planned interest rates cuts don’t align with market expectations. Nevertheless, if the cuts materialize, we should see a positive shift, especially in sectors closely correlated with interest rates, like utilities, healthcare, and consumer staples. These sectors have underperformed in the past year but could witness robust recoveries with declining interest rates. Of course, surprises are always possible, and central bank decisions will largely hinge on key economic indicators and their trajectory throughout the year.

Why would the Fed hint strongly at potential cuts this far in advance without knowing what future economic indicators will show?

The Fed’s announcement likely accounts for the inherent lag between policy decisions and their tangible impacts on the economy. When interest rates first began to rise, inflation didn't immediately fall. It took some time for the effects of those hikes to materialize. Rate cuts work similarly, so central banks aim to pre-emptively address shifts in economic trends. We've observed a substantial slowdown in inflation, though it remains a concern, particularly with core inflation. The decision reflects the central banks' anticipation that the economy will need a number of interest rate cuts this year to maintain stability and growth.

So, are central banks still aiming to induce some economic discomfort in 2024?

The goal remains to orchestrate a moderate economic slowdown, aiming for a soft landing. The intention is certainly not to cause substantial economic harm but to moderate the pace to a level that necessitates a reduction in interest rates. Many predicted a recession in 2023, which did not occur. While some speculate a recession in 2024, current indicators don't support this theory. Almost all economies are projected to experience some GDP growth in 2024. It seems likely that we'll avoid a technical recession, even if a general slowdown persists into the year.

This interview is issued by Jesmond Mizzi Financial Advisors Limited and does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA, under the Investment Services Act. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 21224410, or email info@jesmondmizzi.com