Outlook for 2024 & Our portfolio positioning to beat it
Plus The Week in the Markets & Educational
Hi there!
In today’s edition…
We review the main events of the week in The Week in the Markets
The Zoom of the Week: Educational - Bond duration (what does it mean and why it is important)
Outlook for 2024 and our portfolio positioning in the different asset classes: Equities (US, Europe, Small caps, sectors, Emerging markers, China…), Real Estate, Bonds, Crypto, Private Equity…
Details of all companies included in our Equities portfolio (as every week) in our 3 stage monitor
The Week in the markets
Rough start to the year for the main indices due to the reduction of expectations for interest rate cuts that we had when we went on vacation in December. The market has shifted from giving almost a 90% chance that at least 50 basis points would have been cut after the May meeting, to just 50% today.
And this has mainly impacted those that were the main beneficiaries of the December rally, the small caps, whose main index, the Russell 2000, has dropped almost 4% this week.
Similar dynamics unfolded in Europe, where government bonds experienced a notable decline, causing yields to increase. This shift occurred as traders scaled back their expectations for aggressive rate cuts. The yield on the 10-year German bund, a benchmark, rose to over 2.1%, Italian 10y reached 3.8%, UK 10y gilt finished with an almost 3.8% yield.
The week has also been very bad for the Nasdaq 100, where its main component - Apple (>9%) - has fallen by 6%. In fact, among its top 5, it has significantly weighed down the index, with Broadcom falling another 6%, Amazon down 4.4%, and Microsoft and Meta also in the red.
By sectors, the technology sector (Apple, Microsoft, etc.) and discretionary consumer goods (Tesla, Amazon, etc.) were the most penalized, while Healthcare (mainly due to merger activity), Utilities, and Energy were the only ones in the green.
The dollar had a good week (a safe haven during weeks of losses and lower expectations of interest rate cuts), and it's also worth noting that shorted stocks performed considerably worse than the rest.
Performance in U.S. investment-grade corporate bonds turned negative for a significant portion of the week. Despite a substantial issuance at the beginning of the year, the actual amount that entered the market was lower than widely expected. Additionally, a significant portion of the issued bonds had shorter durations, making them less susceptible to fluctuations in interest rates.
A positive week for commodities, where natural gas rose more than 15% due to forecasts of cold weather in the coming weeks, and WTI crude oil saw significant gains, rising by +3% and reclaiming the $73 level, driven by ongoing tensions in the Red Sea and geopolitical tensions involving Iran.
As a result of these tensions, shipping companies are experiencing a strong rebound due to the impact on vessel occupancy resulting from rerouting around the Cape of Good Hope, and freight rates are rising. In fact, this week, Maersk (one of the giants in the container shipping sector) announced that it would continue to suspend all cargo shipments through the Red Sea.
Another topic of the week has been the potential approval of the Bitcoin ETF - which, although imminent, has not yet arrived - this has filled the crypto universe with volatility (and companies linked to it, such as Coinbase). The SEC has held meetings with major stock exchanges such as Nasdaq, CBOE, and NYSE, aiming to conclude comments on the 19b-4 applications submitted by ETF issuers, including BlackRock and Grayscale's Bitcoin ETFs.
Macro Data
United States
The ISM Manufacturing PMI increased to 47.4 in December 2023 from 46.7 in November (expected 47.1). However Manufacturing PMI for December was 47.9 (vs 48.2 forecasted and 49.4 in November)
The non-farm payroll data shows an increase of 216,000 jobs in December, well above the consensus expectation of 175,000. However, the revision of October and November data removes 71,000 jobs, indicating increasing skepticism about the accuracy of these figures, at least in their initial readings, and the market is taking them less seriously.
The JOLTs job openings were the weakest since March 2021. The number of vacancies decreased by 62,000 compared to November, reaching 8.79 million (expected 8.85 million).
Fed’s reverse repo down below 700Bn (It was over 2,250 billion in May, and since then, it has experienced an absolute decline. At this rate, it would be a negligible amount by March.) (And as we explained the week of December 24th, this is directly correlated with market liquidity. In other words, Quantitative Tightening (QT) is becoming more of a joke because the monetary base continues to increase.)
Europe
The Consumer Price Index (CPI) for the Eurozone was 2.9% in December, representing a jump from the two-year low recorded in November of 2.4% (Expected 3%).
The Eurozone Manufacturing Purchasing Managers' Index (PMI) in December was 44.4, compared to the expected 44.2. This marked the highest reading in 7 months, aided by a modest improvement in manufacturing conditions in Germany.
In UK Composite PMI 52.1 (vs 51.7 expected). Services PMI 53.4 (vs 52.7 expected). Manufacturing PMI 46.2 (vs 46.4 expected)
Rest of the world
The China PMI data for December continues to show weakness. The composite figure stood at 50.3 in December 2023, down from 50.4 the previous month.
Zoom of the Week (Educational) - Bond duration
This week, we're focusing on a topic that gained significance in 2023 and that you'll likely find in most forecasts for 2024 – bond duration.
Duration, in the context of bonds, gauges how sensitive a bond's price is to shifts in interest rates. It's a crucial concept for bond investors and portfolio managers, aiding them in evaluating the potential impact of interest rate changes on their bond investments.
By considering both the time to maturity and periodic interest payments, duration offers an estimate of how a bond's price may change with a 1% shift in interest rates.
To keep it simple, without delving into detailed discussions or mentioning Macaulay:
Duration represents the average time for a bond's cash flows to be repaid, indicating its sensitivity to interest rate changes. There's an inverse relationship between duration and interest rates – as rates rise, existing bond prices tend to fall, and vice versa.
Long Duration Bonds:
Bonds with longer maturities typically have higher durations.
These bonds are more sensitive to changes in interest rates.
Investors might choose long-duration bonds when they expect interest rates to fall, as this would lead to an increase in bond prices.
Short Duration Bonds:
Bonds with shorter maturities generally have lower durations.
Short-duration bonds are less sensitive to interest rate changes.
Investors might opt for short-duration bonds when they anticipate rising interest rates to minimize potential price declines.
Current situation, outlook and our portfolio positioning for 2024
Today, we want to provide a mini-assessment of what 2023 has been, simply to understand the current situation, discuss how we perceive the main macro trends for 2024, and outline our positioning to make the most of the portfolio. We'll be focusing on several aspects, including US & European Equities, Small Caps, debt and bonds, Emerging Markets, China, REITs and Crypto (focusing does not mean we are long on them, simple we believe that are the most interesting to analyse - obviously we are long some of them, but we have some short exposition to others).
We're coming from a strong 2023 for major indices, with the Nasdaq surging over 50% (primarily due to the passive contribution of the Mag7) and the S&P500 rising nearly 25%. Additionally, the last two months witnessed a significant rally in small caps, bonds, and risk assets, driven by the Fed's announcement that the rate hike might have come to an end (later confirmed in December).
The year was marked by the regional bank crisis in March - where the Fed paused the QT to inject liquidity into the system and solve the crisis - and the evolution of inflation and interest rates, the later experiencing sharp increases (one of the steepest in the last 15 years) and expectations of cuts - especially in the last two months of 2023. In fact, the year can be clearly divided into two blocks:
The first ten months of the year, where the Magnificent 7 - Alphabet, Apple, Meta Platforms, Microsoft, Amazon, Nvidia, and Tesla (and consequently, the Nasdaq100 - the Magnificent 7 are present in both the Nasdaq100 and the S&P 500, but their influence is much greater in the Nasdaq (40% vs. 28%)) have lifted the indices due to recession expectations (megacaps are a safer haven than other equities in times of uncertainty), and the influence of passive inflows (as money enters more passively than actively, the primary beneficiaries are those with more weight in the indices).
Since the first week of November, with the CPI reading down and the subsequent Fed meeting (in November, it hinted that the rate hike might have come to an end, and in December, it practically confirmed it, even discussing the possibility of the first rate cuts). In these last two months, the main beneficiaries have been small caps due to their greater sensitivity to recession and sectors with higher exposure to debt, such as REITs or utilities. Consequently, the dollar has shown weakness against other currencies, and emerging markets have benefited.
To understand the first part of the year, it's essential to recall that there has been a continuous anticipation of a recession that has not fully materialized, given the robust state of the labor market. Despite the interest rate hikes, many large-cap US companies have been minimally impacted. The primary reason for this resilience is that S&P 500 debt is now 76% fixed, compared to less than 50% in 2007.
Similarly, and against all odds, US consumer spending consistently surprised to the upside in 2023. This reflects tight labor markets, a wealth effect from rising equity and home prices, and excess savings that are still being drawn down (the peak of post-Covid savings has ended, and consumers are tapping into credit at levels not seen in the last 5 years). Evidence of this can be seen in the latest available data for November and December, where online sales were up 7.5% on Black Friday and up 9.5% on Cyber Monday.
It is also essential to note the poor performance of bonds in the first part of the year. Despite equities performing very well, it has been a relatively weak year for the typical 60/40 portfolio.
The global context of deglobalization continues to consolidate (as seen with countries like Mexico emerging as major winners in 2023, with a growth of +40%). For example, the semiconductor industry, arguably the most crucial in the world today, is racing against time to reduce its significant dependence on Southeast Asia (CHIPs & Science Act). However, geopolitical risk (GPR index) is at its highest level in 20 years (the immediate prior peak being the Ukraine war).
This situation is likely to create tremendous opportunities in certain countries (in addition to the anticipated interest rate decline cycle they are experiencing compared to the US) and specific sectors, as is currently happening in shipping due to tensions in the Red Sea. However, in the face of such events, we advise investing only in industries that one is familiar with. The significant risk is arriving late to the party and enduring substantial losses by buying at the peak.
Taking all of this into account and now focusing on 2024, which happens to be the year with the largest global population in history called to vote (typically indicating a significant increase in public spending), we see very interesting opportunities among several asset class and sectors…
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