Five big things in 2023 and the outlook for 2024

What a huge reversal 2023 turned out to be. We saw stock and bond markets across the globe do a 180 degree turn from 2022 and generate positive returns with equities globally delivering over 20% returns. It’s an even bigger surprise as we began the year with such pessimism. 

We have to ask - are we optimistic enough or too optimistic as we begin 2024? The market and its participants seem confused and so we’ve decided to wrap up 2023 and bring in 2024 with a look back and a look forward to the key themes that we see moving markets. 

Another year goes by where expert forecasters got many things wrong - from the direction of markets and interest rate policy to escalating geopolitical tensions. The long forecasted recession never arrived in the US. While many saw the advent of AI and ChatGPT as an important technological development, yet many underestimated its impact on financial markets. Many also overestimated the impact of and the concerns that were raised during the collapse of banks such as Credit Suisse and Silicon Valley Bank, and few now understand the structural shifts occurring within the industry.

Here are five major market themes to highlight from 2023 and the various ways in which each is evolving as we enter 2024, and how these themes are likely to continue to play an important role and impact economic and market performance this year. 

1. The Return of 60/40 and “Magnificent 7”
2. AI and ChatGPT
3. The Fed and the soft landing
4. The Demise of Banks
5. Wars and geopolitics
   

The Return of 60/40 & the Magnificent 7

People have called the demise of the 60/40 for many years and 2022 was the worst year for the balanced portfolio as it is otherwise known. However, it is the biggest comeback kid. In 2023, the 60/40 portfolio¹ would have generated a positive return of 15.5% compared to the 2022 return of -17.2% (in USD terms).

[¹60/40 portfolio - 60% MSCI ACWI USD + 40% Bloomberg Global Aggregate USD (unhedged)]

But it’s not all good news as the whole philosophical basis of the balanced portfolio is the benefits that the 40% or so allocation to fixed income would have when economic cycles are down. It is very clear that the correlation between equities and fixed income has gone up and both were down together in 2022 and up together in 2023. 

The Magnificent 7 was one of the major reasons why equities were up. It’s no secret that not only correlation between asset classes have risen, but also the concentration of returns has been narrow. These are new phenomena that have meaningful repercussions in traditional asset allocation. 

After a horrendous 2022, when the Magnificent 7 (AAPL, AMZN, GOOG, META, MSFT, NVDA, TSLA) declined by a painful average of 46%, 2023 saw an unprecedented strong rebound. The simple average return of the seven was a jaw-dropping 111.6%. Now, contrast that to the 55.1% returned by the Nasdaq 100 index and the respectable 26.3% delivered by the S&P 500 index last year, it is understandable why everyone seems focused on these names. 

Many have highlighted how the returns of 2023 have been so concentrated and complain that this is not sustainable. However, this is precisely the reason why the market is unpredictable and why diversification still works because the overall market gave us stellar returns even if you were exposed to the losers, with the winners more than compensating. But the important thing is that there is information in markets. Geographically, growth in the US had surprised upwardly compared to China. Technology, as a sector, surprised us compared to other sectors. Equities surprised us on the upside when most people in markets were pushing fixed income throughout the year. Some of these outcomes have gone completely against expert forecasts. This is why the market always wins and forecasters are so often wrong.  

Are they really magnificent? 

However, before we celebrate and pour our life savings into these stocks, it is important to remind ourselves that these stocks have exhibited huge volatility (measurement of risk using standard deviation). Very few would have been able to hold the stocks through the big ups and downs, and certainly nobody has been able to time the buys and sells. Volatility cuts both ways. For example, Meta returned a whopping 194% last year but fell more than 75% from peak and it has returned just 9% over three years, which is less than the benchmark indexes. 

In fact 3 of the 7 names have underperformed indexes like S&P 500 and Nasdaq. Also, despite the perception that Nasdaq would have done better after last year’s strong rebound, Nasdaq and S&P 500 index returns have been largely the same at 10% over the three years. It is tempting to think that we can pick the winners and beat the benchmark but the reality and the data shows that very few indeed can and even fewer actually have. 

The one stock that has been the biggest winner of 2023 was Nvidia but even Nvidia was the 3rd worst performing in 2022 with a 63% maximum drawdown from peak to the bottom last year. 2023 was Nvidia’s year as it came back strongly with a 239% return and a 3 year average return of 56%. Which brings us to the next hot topic of the hour and the Collins dictionary word of the year - AI (Artificial Intelligence - and more specifically Gen AI and ChatGPT). 

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The rise of Gen AI & ChatGPT

It is no surprise that AI is the word of the year. Unless you have been living under a rock, you would have heard of ChatGPT by now. ChatGPT has led to the proliferation and mass adoption as well as a broader societal understanding of Generative AI and its impact on our lives. As highlighted, many of the Big Tech companies are seen as the winners, such as Microsoft through its direct investment in OpenAI, and Nvidia as the key beneficiary of the boom in investment in AI technology and infrastructure with its essential chips. It is not unfair to say that AI has single handedly led to the rebound in markets and especially the tech sector. 

However, while the record breaking adoption of ChatGPT to the first mission and beyond users is truly impressive, the adoption of Gen AI has not even truly begun and the lasting impact of Gen AI is likely to be felt not in the first order impact of companies that develop or sell AI solutions, but in the lasting impact to the global economy in the gains it can bring to productivity and efficiency. 

At the heart of it, Gen AI is about enhancing two things - efficiency and experience. It drives meaningful gains in efficiency if our coders can code 30-50% faster and our content creators and writers can be more efficient and proficient at the same time. At Endowus, we have been the first adopters of AI in the Asian wealth industry by developing the first ChatGPT-based Gen AI chatbot that we launched during our Endowus WealthTech Conference in beta mode. We are continuing our investment and application of GenAI across the firm that we will be sharing with our clients in the coming year. 

While the second order effects of the adoption of AI and its implications - both positive and negative - to the world are still being debated, it is clear that the trend of AI adoption by individuals and businesses and its far reaching impact on innovation, productivity and thus to markets, will be meaningful again this year. 

While Endowus espouses a broad and globally diversified core allocation to equities, we have on the platform the ability to express your views and goals through the Fund Smart platform that allows for exposure to more thematic funds and through our advised portfolios such as the Technology satellite portfolio for those clients with a higher risk appetite and can absorb the volatility. There is no guarantee that 2022 cannot happen again but there is also no guarantee that markets, AI and technology may surprise us again in 2024. 

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The Fed and the soft landing

Source: JP Morgan 

Another word that has been bandied about a lot is “soft landing” or in marketspeak the “goldilocks” scenario of an easing of inflation and a slowing down of growth without triggering a recession. Market experts and economists around the world are clamouring to predict this and even the US Treasury Secretary, Janet Yellen, is calling it - the Fed has achieved the elusive soft landing. 

Admittedly inflation is now continuing to trend lower and demand has continued to weaken more broadly across the economy. However, recent data suggests that job growth and higher wages still remain elevated and are a concern. Prices of goods and services such as gas,  flights and lodging as well as used car prices, have moderated significantly. Easing supply side pressures have contributed as well. 

There are still significant risks to the soft landing scenario. Chief among them is the lagged effect of monetary policy and the impact of the rapid rate hikes on credit and liquidity. This could still push the economy into recession. But also, we need to look beyond just the US, the impact of high interest rates and a stronger dollar has had a devastating effect across the global economies especially for developing and emerging economies with many already deep in recession.  

Furthermore, although the Fed’s actions and the direction of interest rate policy impacts economic activity and financial assets more broadly, there is a direct impact to fixed income markets, where optimism coming into this year has been sky high. We have to remind ourselves that this time last year we also had the market forecasting peaking interest rates and falling inflation and Fed rate cuts. This was the basis for a lot of forecasts for fixed income to do well in 2023. However, we ended the year at peak interest rates and fixed income markets struggled throughout the year. While the global fixed income indices bottomed in October 2022 and we saw a strong rebound at the end of 2023, returns for the full year were still disappointing compared to the high hopes at the start of the year. 

What is in the markets favour is a stronger visibility of the Fed dot plot that clearly shows that if inflation is tamed, if the economy is not in recession, there is a definite desire and a plan for the Fed to gradually bring rates down. This is a better position to start the year than last year when Fed rhetoric was still hawkish. In fact, for the fixed income market, slower growth and lower inflation and even a recession is not a bad scenario as that would accelerate the desire for the Fed to cut rates. So bad news is good news for fixed income when it comes to economic data in 2024. 

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The demise of banks

The first quarter of 2023 saw much upheaval in the banking industry. It started first on the west coast of the US and slowly made its way over to continental Europe. Starting with Silicon Valley Bank and ending with the demise of Credit Suisse.

This has been another major fall out of the high interest rate environment, where the speed of the rate hikes caught many off guard and complacent in managing their asset and liability mismatch as deposits fled and banks had to deal with large mark to market losses in its fixed income book on its balance sheets. It goes to show that government deposit insurance schemes alone are not enough to safeguard your assets when there is a bank run going on. 

In the US, following SVB, many others collapsed or were taken over by larger banks, such as Signature Bank and First Republic Bank. It did not end there. Shortly after, Credit Suisse was acquired by its long-time rival, UBS, in a takeover engineered by the Swiss National Bank and the Swiss Financial Market Supervisory Authority (FINMA) fearful of a collapse and an ongoing bank run. Many were affected, least of them were many Asian investors who had been pushed into the AT1 bonds for Credit Suisse that were wiped out to zero by the Swiss authorities. 

These events are also a timely reminder for us that single name exposures are risky especially in an economic downturn or bear market and the true benefits of diversification and proper due diligence that allows us to manage risk and mitigate major impact on our valuable invested assets. 

We, sitting in Asia, have actually less to worry about as the Asian Financial Crisis of 1997-8 led to a wave of consolidation led by governments in the banking and financial industries more broadly. This led to the introduction of the designation of systemically important banks and also bank deposit insurance schemes across the region. However, with the only two ways to shore up capital at a bank being a steepening of the yield curve to improve spreads on lending versus deposits, and the liberalisation of fees charged by banks, we have had a cycle of rising and high fees at banks that have gone unchallenged and unregulated for far too long and has led to poor service and poor outcomes for its customers. 

The emergence of financial technology companies disrupting many of the banking services as the banks are dragged kicking and screaming into the digital world of greater transparency and lower cost, as well as the disintermediation of private credit and heavier cost of regulatory compliance, banks are still struggling to remodel itself for the future. In the wealth space, we believe there are meaningful improvements in both the experience and cost of investing and we plan to continue to disrupt this space meaningfully in 2024 and beyond to serve our existing and growing future base of clients in a better way to help them to achieve better experiences and better outcomes. 

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Wars and geopolitics

It is becoming clearer that not only the financial markets, but the geopolitical landscape as we know it, can be divided into a pre-COVID and post-COVID world. This is probably most apparent when we think about its impact on the openness of borders and trade when the pandemic inflicted serious harm on the open travel, transportation and trade among nations and its people. However, the other significant issue has definitely been in the geopolitical space.

The world has changed and evolved in the past few years where rogue actors have been emboldened to act out their aggressions in ways that would have been inconceivable before. We have also seen political parties move further to the extremes - both left and right - and the rhetoric crank up multiple notches with propaganda and political vitriol often filling social media and public news media alike. 

We thought that the Ukraine war was an outlier but since then we have seen escalating conflict in many hotspots, the most recent being the conflict between Israel and Hamas, dragging in multiple other stakeholders in the region and globally. 

On top of that, we have the continued overhang of geopolitical tensions that ebb and flow but generally have remained high and edgy between the US and China. The recurring rhetoric and potential threat coming out of China towards Taiwan, the North Korean young leader Kim’s often erratic and unpredictable behaviour are just some of the ongoing and escalating tensions that geopolitics has brought to the fore in recent years. 

Such conflicts often have far-reaching consequences, not only for the direct participants but also for the broader regional and international community. While the humanitarian, social, and political impacts are profound and long-lasting, affecting countless lives and shaping the geopolitical landscape of the region, the impact of the war on the markets and geopolitics has traditionally been suspect or minimal.

All long term studies have shown that financial markets are not affected much or in a lasting way and often the short term negative impact on markets is quickly recovered as investors refocus attention on the underlying fundamentals driving the listed companies in the market such as earnings and growth. However, it is conceivable that a continued escalation of conflict and geopolitical tension that directly impacts trade, innovation and eventually growth, could have an impact of risk premia in the market and volatility of returns in this cycle. It is something to watch closely again in 2024 as we had to do in 2023. 

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Why Endowus does not make forecasts 

As we enter 2024, we are mindful that we have just experienced some of the most volatile markets in history where intra-year and annual falls and rises have been 20%+ on multiple occasions. The roller-coaster ride for investors may not even be over as we see volatility even in the beginning few days of the year. The data above on the 60/40 portfolio and the magnificent 7 as well as much longer term empirical data across financial history suggests that we would do best in sticking to time-tested methods of investing regularly in an investment plan that works for you and is consistent with the goals you are investing for and therefore taking the appropriate risk to generate the returns that will lead to good outcomes. 

We also must remind you of why Endowus refuses to make forecasts. As we have highlighted in this piece already about the universal failures of forecasters year in and year out, and a few other articles published about this topic, it’s safe to say that short-term predictions are fairly worthless, and paying attention to forecasts is a wasted effort. As the famed economist John Galbraith put it: “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” But this is not just wisdom from the modern West, the Chinese philosopher Lao Tzu from 600 BC said, “Those who have knowledge, do not predict. Those who predict, do not have knowledge.” 

It’s important to remember that the journey is long especially if you are younger and our goals are long term such as retirement. However, even if you are like me, past the half century mark, you still have to manage and invest for the next 20-30 years if not longer. There is a lot of time ahead of us and we need to be consistent in the way we approach investing so we do not chase our own tails, or the forecasts of others, or the whims of our banker or broker. 

At Endowus, we want to be the trusted, truly conflict-free, independent advisor that comes alongside you and your family to be on your side to journey with you to get you to your investment goals with the least fuss, less risk and volatility, and less worries too - knowing that we all have more than our fair share to deal with. 

From all of us at Endowus, thank you for your trust and support for the Endowus team. We remain committed to doing what is always in the best interest of our clients, and to help you achieve better investing outcomes. We wish you an amazing 2024 and only the very best for you and your loved ones. 

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