What a difference a month makes.
2023 looked very different at the end of October: the gold and money markets were both on the podium of the best performing asset classes of the year, while most of the fixed-income segments were negative.
As we write today, global stocks have jumped 9 per cent in November alone, and US Treasury yields have tumbled, bringing their 2023 returns back to slightly positive territory. As a result, the 2023 returns of our multi-asset portfolios changed dramatically: from +1,+3 and +4 per cent at the end of October to +5, +8 and +10% as we write.
The crucial question is obviously not about the past, but about perspectives. We will look at the reasons behind the November rally, before analyzing whether they can be extrapolated. We would highlight two key reasons.
A full U-turn from investors
The first one is a fundamental shift in expectations from market participants with regards to the US economy, inflation, and monetary policy in the middle. October was depressing: the Fed’s September meeting had already pushed back against expectations for an imminent pivot, an anxiety reinforced by a spectacular number of job creations, and risk aversion was only amplified by October geopolitical events.
Interest rates shot up; stocks tumbled. Gold, the only haven, resurrected. But then, the tone of the Fed started to change, being more balanced on inflation, growth, and taking note that the bond markets were already tightening financial conditions, maybe enough for now.
With a little help from data - a slightly better than expected CPI inflation report, followed by a softer US job report - market participants suddenly made a U-turn on their anticipations. They embraced the scenario of a soft-landing in the world’s largest economy.
One where inflation can fall sufficiently for the central bank to become more friendly, while growth would not crash into outright recession. ‘Goldilocks’ was reloaded.
This was not the first sentiment shift of 2023, which we call the ‘Year of Unpredictability’. But the ‘rally of everything’ was brutal. The reason is our second factor: investors’ positioning was extremely risk-adverse at the end of October.
Rush to reclaim positions – and bonuses
Many hedge funds were outright short of both equities and bonds, and a large majority of conventional asset allocators were underweighted on the same, favoring capital preservation over any kind of risk taking. This explains the magnitude of the reaction: hedge funds had to buy, at any price, the assets they were short of. And money managers, seeing the year-end coming, could not afford to miss out on the rally - for their clients, and for their bonuses.
Does the rally have legs? Let’s look at the same two factors. First, the scenario. A soft-landing in the US has always been our base case, and we stick to it, especially for the coming months.
Employment and consumption are in a good place. We have also always believed that the Fed was done with hikes in July, and we see no reason for inflation to reaccelerate in the medium term.
Of course, there are open questions for 2024, which will only be answered down the road. The state of the global economy, inflation, geopolitics, and US election.
Meantime, the soft-landing scenario is the most reasonable, and we will know a bit more in the coming days, with global PMIs, various inflation reports, and the always important US job report.
Now, to the second factor: positioning. In a word, we believe that most of the ‘forced buying’ is now behind us. This is not great news, but this is not adverse either.
‘Dose of caution’
We believe that positioning has evolved from very pessimistic to pretty much neutral. There is no euphoria: the performance of gold, very close to an all-time high, and the behavior of US Treasury yields, indicate a good dose of caution for the year ahead.
The short-term is always unpredictable and we may see some turbulences after such an atypical November. We would however be extremely surprised to see another parabolic rally of everything. Our base case is for a benign end to 2023, most probably rounding up the current year-to-date returns.
2024 will undoubtedly be a captivating year. A time for answers, with hopefully better fundamental visibility after the constant questions (and surprises) of 2023. We will share with you our key convictions for the year ahead in January.
