The last quarter of 2023 was a good one for investors as it was characterised by a strong rally in almost all asset classes that we follow. As the disinflation narrative continued to gain traction, investors became more confident that inflation could fall back close to target while avoiding a recession, the so-called soft-landing scenario.

Furthermore, the Federal Reserve (Fed) shifted to a more dovish tone, and by December, the Federal Open Market Committee (FOMC) projections indicated three rate cuts in 2024. The FOMC appeared to be more comfortable with the progress made in bringing inflation back towards target.

The return of a typical 60/40 (60% STOXX 600 index and 40% in European Sovereign bonds) amounting to a total of 12.1% in 2023, with 5.1% return in November and 3.7% in December. It highlights how much of the good news has already been priced-in but also the extent to which financial markets could be susceptible to a rates shock.

Despite the FOMC projecting three rate cuts for 2024 in December, the market was expecting c.140bp of rate cuts or six rate cuts of 25bp each. The divergence between central bank and market-implied projections was very wide, which meant that volatility in rates was likely to remain elevated.

Asset class performance in January 2024 was relatively mixed, with the return of a 60/40 portfolio amounting to +0.7%, the lowest return since October 2023. Within the asset classes, European equity (+1.5%), European High Yield (+0.5%) and European Investment Grade credit (+0.1%) all generated a positive return in January.

At the other end of the spectrum, European Sovereign bonds (-0.5%) generated a negative return. This performance was driven by a combination of stronger economic data and some push back from central bankers on market rate cut expectations, which weighed on the return of the sovereign market.

The outperformance of the US economy compared to other developed market economies has persisted for longer than expected. Economic growth in the fourth quarter of 2023 surpassed even the most optimistic of forecasts (even if perhaps driven by the more volatile stock building). Personal spending surged to 0.7% month-on-month in December, up from 0.4% in the previous month.

This suggests that consumer spending remained solid at the end of the year supported by healthy household balance sheets. The savings rate of 3.7% in December is below the pre-pandemic average of 6.2% (2015 to 2019) but is well above the lows seen in June 2022 (2.7%). Historically, households have sought to replenish the savings rate to a long-term average level, so as to have funds available for a rainy day.

There has been speculation around potential stimulus announcements in China to help prop-up the economy

Yet, the US economic backdrop remains strong, and more importantly, the labour market is solid, reducing the probability of unemployment. The January employment report in the US was also very strong, with new job additions almost double the consensus forecast and unemployment edging slightly down.

At the other end of the spectrum, the European economy continued to stagnate, though escaped a technical recession based on the first release of the fourth quarter 2023 GDP figure. Italy and Spain outperformed France and Germany, and this seems to have persisted in January.

The Purchasing Managers’ Index (PMI), which is generally seen as a forward indicator of economic activity, remained in contraction territory in Germany and France but in expanding territory in Spain and Italy. The deterioration seen in China’s economic fundamentals has no doubt weighed on Europe’s manufacturing sector over the past months.

There has been a lot of speculation around potential significant stimulus announcements in China to help prop-up the economy, but this has so far not materialised.

The impact of this on markets has been a pullback in rate cut expectations, from c.140bp at the end of December to c.99bp on February 5, which would be equivalent to four rate cuts of 25bp each. This led to yields in sovereign markets moving higher, with the 10-year US Treasury yielding 4.0% on February 2 compared to 3.9% at the end of December. This undoubtedly weighed on the performance of the bond and credit markets.

The backdrop was more favourable for equities; however, as the lower probability of a recession is generally supportive of the asset class. Growth stocks were notable outperformers so far this year, with European growth stocks up 3.3% compared to -0.8% for European value stocks. The outperformance was even more pronounced in the US, which probably implies that earnings for the fourth quarter need to significantly beat expectations to avoid a pullback.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.

Robert Ducker is head of investment strategy and research at Curmi and Partners Ltd.

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