What a difference a couple of months makes! After a dismal period in August through October, markets swung around completely in November and December as investor sentiment turned for the better. Following November, when positive market action was largely due to short covering, price movements in December reflected a generally increased risk willingness on behalf of investors. This was also reflected in the improved market breadth which, not least, included small and mid-cap stocks.

Strong finish to the year

The strong markets owed basically everything to the falling price of money and anticipation for central banks’ coming rate cuts. Long-term bond rates continued to decrease in December, and thus bond values rose, making for the best two-month stretch in a very long time. At year´s end, the yield on US 10-year government bonds stood at the same level as at the beginning of 2023 and some 120 basis points lower than at the peak in October. Even though some central bankers warned that the market’s projection of significant rate cuts might be too optimistic, investors penciled in several cuts both in the US and in Europe.

Russian aggression continued, but without material changes to front lines

The Russian aggression towards Ukraine continued with massive missile attacks on the large cities of Kyiv and Kharkiv while the front lines on the battlefield did not change materially. The counter-offensive launched by Ukraine last spring was widely seen as not having met its targets. This, and the increased Ukrainian difficulties to muster enough support from its western allies, led to speculation that the conflict would become frozen along the current lines although both sides denied that this.

War in Gaza could hamper world trade

Following the terrorist attack by Hamas, the subsequent Israeli offensive in Gaza continued. The prospect of Israel reaching is ultimate objective of destroying Hamas was put in question. Meanwhile, Houthi rebels launched repeated attacks on tankers and other cargo ships in the Red Sea, said to be a response to Israel’s offensive in Gaza. Even though the US Navy started patrolling the waters many of the world’s largest shipping companies decided to re-direct their vessels. This meant going round Africa instead of through the Suez Canal, a significant detour, which could possibly hamper world trade.

World index up, with differences in currency 

The world index followed up on the gains seen in November. However, significant FX changes meant that returns differed depending on base currency. Industrials and materials led the advance while energy and consumer staples declined. Looking at the regions, the NASDAQ was the best performing market. Otherwise, Europe and Japan outperformed the broader US indices while Hong Kong experienced yet another weak month.

A better than expected stock market in 2023

As a whole, 2023 turned out to be a significantly better stock market year than most had anticipated at the beginning of the year. Even though, to a large degree, the overall performance rested on the so-called Magnificent Seven (i.e. Apple, Microsoft, Alphabet, Amazon, Meta Platforms, Tesla and Nvidia) market breadth improved successively towards the end of the year.

OUTLOOK

The very strong markets seen in November and December came as a result of lower interest rates and reduced concern about both inflation and recession risks. This led to a clear positive sentiment in the stock market. The movements were so significant they were historic in nature. The reversals will likely be cited in reports and books for decades, along with other dramatic shifts in the past.

Currency differences

In situations with strong shifts in market sentiment, the relative values of currencies also tend to change. Interest rates in the US had a greater opportunity to continue down because they were at a higher level and in addition there is a faster normalization of inflation, high productivity improvements and good economic growth. In short, the US is more dynamic. Nevertheless, capital flows out of the high-interest country when interest rates fall. Even a small country like Sweden gets a significant boost of its currency when the US is pulling the world’s economies out of hard landing risks.

The year ahead

The consequences for 2024 should not be underestimated. What then can we anticipate in the coming year? Smaller companies should do better than during the past two years, high multiple companies should see their valuation multiples maintained if expectations for profit and turnover growth are met according to market forecasts. We are also likely to see a higher willingness to take on risk, and capital raising could therefore slowly return to a higher, more normal level. This would also impact the possibility for IPOs and we should see more buyouts. Even value stocks could do well as the markets broadens out beyond the Magnificent Seven.

Potential speed bumps

However, two important points should be borne in mind. Firstly, it is not certain that a recession will be avoided even if this seems likely. If we have a shallow recession, the stock market could certainly continue to rise, but if a more traditional recession becomes a fact, we could see a correction in the stock market. Secondly, 2024 is an election year in the US and, according to historical patterns, we often see a weaker market at the start of an election year when the incumbent president is to seek reelection. We will therefore continue to be disciplined, although we share the basic optimistic attitude and will try to participate in the opportunities that risk-on can offer. One thing is certain, the number of interest rate cuts during 2024 will be rather uninteresting. Fewer interest rate cuts may very well be good because it would probably reflect stronger economic growth due to higher productivity rather than due to higher inflation expectations. That would be fine for most investors, just like it was in 1995.