2023 was a good year for the stock market. The MSCI World index returned +24%.
Our portfolio beat the market by 8 percentage points, returning +32%. The outperformance of the portfolio over the index can be attributed to stock selections, a geographical overweight in Europe, and some timing ability (avoiding part of the March bank crash).
I’m satisfied with the 2023 performance because the Financials sector, in which most of the portfolio is concentrated, did not do particularly well last year. It was easy to post a strong 2023 if you invested in Technology, not so easy if you invested in Financials.
Behind the good performance of the stock market in 2023 was a change in expectations about inflation and the economy. A year ago, inflation was running too high, and the worry was that central banks would have to increase interest rates to levels that would bring about a recession.
These fears have so far proven unfounded. Inflation has come down, and the global economy has been able to digest higher interest rates while experiencing only a mild slowdown.
As a result, investors have become more optimistic, and they have bid up the prices of stocks. In the near term, the rally may well continue, because liquidity conditions remain supportive.
Looking further out, my hunch is that inflation will make a comeback. The labour market is still tight, and the US Federal Reserve is adding fuel to the economic fire for political reasons (it tries to maintain a strong economy for the US November Presidential elections).
If inflation returns, another round of monetary tightening will be necessary, and a recession should finally follow.
It is, however, too early to position for recession, in my view. Underlying inflation is still falling and the economy is strengthening.
If and when these trends change, it may be time to turn more cautious.
Overall, I am neither extremely bullish nor bearish for 2024. I don’t see a bubble in the market, but neither is the market dramatically undervalued. A repeat of 2023’s strong performance for the overall market is unlikely, but I do believe a worthwhile positive return is available from stocks, especially the non-US, value parts of the market.
As far as my portfolio is concerned, the thesis I have about Financials – that they are undervalued and should outperform in the new post-pandemic economic environment – has not yet played out. In a positive scenario, a full normalisation of bank valuations could lead to another strong year.
While we wait for that, the companies in the portfolio pay close to 10% a year to shareholders via dividends and buybacks. This beats investing in cash, even with the higher interest rates now available. So I’m happy to hold the stocks in the portfolio, while keeping an eye on the evolution of inflation and the economy. A reversal in current benign trends in these macro variables may call for a reduced risk approach at some point during the year.