Stock market & economic commentary - December 2023

Charlie Munger, vice chairman of Berkshire Hathaway and a legend of the investing world died on 28 November at the age of 99.

Warren Buffett may be the most famous investor in the world but as his partner at Berkshire Hathaway since 1978, Charlie Munger deserves a lot of the credit for building one the most impressive investment track records in history. According to Reuters, Berkshire’s shares have delivered a compound 18% per annum return, twice that of the US S&P 500 Index over that 45-year period, which is truly remarkable.

Not only was he an investment legend but he also had a unique ability to cut through the mystique of investing in a few wise words. To commemorate his monumental legacy here are a some of his quotes:

Don’t bail away in a sinking boat if you can swim to one that is seaworthy.
You have to keep learning if you want to become a great investor. When the world changes, you must change.
If you are going to invest in stocks for the long term or real estate, of course there are going to be periods when there is a lot of agony and other periods when there’s a boom. I think you just have to learn to live through them. As Kipling said, treat those two imposters just the same. You have to deal with daylight and night. Sometimes it’s a boom. Sometimes it’s a bust. I believe in doing as well as you can and keep going for as long as you can.
Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.

And finally:

If I can be optimistic when I’m nearly dead, surely the rest of you can handle a little inflation.

Economic Update

Inflation is in retreat across the western world. The biggest inflation shock in decades is unwinding as growth slows. In the euro area inflation has dropped from a peak of 10.6% to 2.4% in the space of a year. America’s inflation rate has fallen from over 9% to less than 2%. Inflation has been stickier in the UK falling from 11.1% to 3.9 %.

A period of soaring commodity prices and supply shortages seems to be coming to an end. European gas prices are trading at about a quarter of their August 2022 peak.

Despite the best efforts of OPEC to prop up prices by restricting supply, the price of Brent crude oil has dropped from a peak of $122 a barrel to less than $75. Most metal and agricultural prices are off their highs. Consumers are benefiting as lower commodity prices feed through the system.

Financial markets are increasingly confident that inflation is beaten. Expectations for inflation have fallen and investors are now focussed on when central banks will cut interest rates. The recent decline in mortgage rates in the US and the UK are as a result of falling bond yields.

This is all good news although it might be premature to think that our inflation problems are completely over.

First, rates of inflation are falling, but prices are much higher than they were three years ago and are still rising. In the UK, prices are 21% higher than in December 2020, and are still rising by nearly 4% year on year. Food prices are a particular problem rising by 30% over three years. Agreed, growth in earnings is outstripping inflation again, but for most wage earners spending power is lower than it was three years ago.

Second, inflation is certainly down, but not out. In both the euro area and the UK, inflation is still above the 2.0% target. Most of the fall in inflation has been driven by sharp declines in the price of goods but service inflation, which is more heavily influenced by wage costs, remains at high levels.

Anyone who has recently paid for car repairs in the UK (up over 10% in the last year), package holidays (up 11.2%) or car insurance (up an amazing 48%) has experienced this. Central banks worry that inflation, which was initially driven by supply shortages and commodity prices, may have become embedded in the system through wage and price-setting behaviour.

Big falls in headline inflation throughout 2023 suggest that the worst of the inflation shock is behind us, but ghosts of past mistakes still haunt central bankers. It may, therefore, take a little more time before they are confident enough to ease off the brakes and start on a path of reducing interest rates. Perhaps the turning point will be sometime in 2024.

Stock Markets

As the saying goes, nothing makes investors feel more bullish than rising prices (and more bearish than falling prices). Prices drive narrative often to the detriment of fundamental analysis as to what is going on in economies, industries, and companies.

A bull market in equities is defined as a rise of more than 20%. Since October 2022, when fears peaked that rising energy prices and interest rates would cause a recession, the US S&P 500 has comfortably passed this measure rising by more than 25% in dollar terms albeit largely driven by bumper gains from the “Magnificent Seven” tech giants.

Great bull markets were often disbelieved when they were occurring. Their origins tend to be formulated in the deepest despair of bear markets when fears of structural and negative change are prominent in the minds of investors. These views can take many years to change and often result in investors remaining on the side-lines whilst attractive opportunities pass them by.

We saw this after the great financial crisis of 2009, which sowed the seeds for one of the great bull markets in history. Many investors could not accept a new bull market had begun. Some investors still don’t accept the capital appreciation seen in the 2010s, believing it was fuelled by inappropriate monetary policy, and not by innovation and growth.

Similarly, today very few investors and market commentators believe that the potential for the next 10 years could be one of good returns. Somewhat paradoxically, this makes it more likely to happen.

The case for a structural bull market lies in trends occurring at the micro level. Atoms, bytes, and genes – which represents nearly all things in existence – provide a simple and powerful framework for understanding the trends that could lie ahead. Atoms represent the physical world and ongoing infrastructure investment such as the Inflation Reduction Act in the US. Bytes represent digitisation and the continued prevalence of artificial intelligence (AI). Genes represent advances in medical science such as obesity and Alzheimer treatments.

Investment in the physical world, as people learn to accommodate decarbonisation and exploding quantities of data, will be a feature of economies for many years to come and could offset concerns about recessions and slowing growth.

It is highly likely that digitisation and AI could result in a significant increase in productivity for the overall economy and could offset inflation concerns. Obesity drugs – if taken appropriately, could save healthcare systems significant amounts of money from obesity-related diseases such as diabetes and heart conditions.

Putting this trifecta of positives together, it is possible that we could get a prolonged period of stronger growth, lower inflation and healthier populations than is currently believed. This could provide the platform for a structural long term bull market… although as with previous bull markets there will be doubts and volatility along the way.

Lessons from 2023

As if to support this thesis, 2023 has been a good year for investors largely driven by these factors. We have had a positive end to the year. Strong returns from equities and credit markets have helped to recover some of the falls from 2022 and earlier in the year when investors bore the brunt of higher interest rate and energy costs.

Digitisation, infrastructure, and obesity medicines have all been powerful drivers of investment returns and have offset several macro concerns which investors had at the start of the year.

What else have we learnt this year?

One interesting feature of markets is that they don’t come up with a lot of new content. The same lessons endure, and success depends on how quickly we learn them. Some lessons have, unfortunately, to be learnt more than once before they have permanence. Here are a few that markets have reminded us of this year.

First, time in the market, not timing of markets, is the best way to generate investment returns. After a dreadful October when it felt like investor capitulation had taken hold, the S&P 500 was up more than 8% in November. This could never have been predicted and not being invested during the month will have made a material difference to overall investment returns.

Second, macro forecasts can do more harm than good. Warren Buffett famously said forecasts will tell you more about the forecaster than they tell you about the future. Mr Buffett claims to spend ‘no time’ thinking about macro forecasts. Forecasts of recessions can often prove incorrect and can deter investors from taking advantage of the opportunities presented to them.

Finally, innovation beats commodities. Coming into this year there was a view that the cycle of innovation had ended in the technology sector, and the ongoing war in Ukraine and its impact on commodity markets would favour natural resource stocks. This has proved to be incorrect. Commodities are just that, commodities. A homogenous metal, for example copper, is dug out of the ground and sold for a price set by the market. Sometimes that price will be good, and sometimes it will be not so good.

Innovation solves problems which would otherwise cost society money. This influence on improving societal outcomes makes innovation valuable and gives it pricing power, the opposite of commodities. The oil price is now below where it was before the tragic invasion of Ukraine, yet Microsoft’s share price is more than 20% higher. This is at a time of geopolitical tension, which should be good for commodities, and higher interest rates, which should be bad for technology stocks.

Looking forward to 2024

As an ex-Prime Minister once reminded us, there are no disasters, only opportunities, and opportunities for new disasters. Whilst humorous, it reminds us that we can learn from all our experiences as investors, good and bad, and that we will have many more learnings in the future. Investing is not only about who makes the fewest mistakes (although that helps), but it is much more about who learns from those mistakes fastest.

The new year will bring new challenges which we can’t possibly foresee, but it will also bring opportunities. Our optimistic bias leads us to think that more good than bad will happen in the months and years ahead although we remain watchful of the risks that many investors see today.

2024 will also be a year of political labyrinths with about 40% of the world’s population facing elections. Taiwan comes first in January followed by South Africa, Mexico, India, the United States, the United Kingdom and in about 60 other countries throughout the year.

We will have to brace ourselves for the outcomes. We have taken the blows from inflation, interest rates and stock market valuations, but despite geopolitical uncertainty, we believe the years ahead could be positive for economies, for the companies that operate in them and ultimately for investment returns.

Our greatest belief and hope are in people, in their desire for peace and prosperity, in their innovation, ingenuity and spirit, and their resilience.

With these thoughts, we send you our best wishes for the year ahead and we thank you for your continued support in these difficult and challenging times.

We hope you enjoy reading our regular updates. We are always eager to improve and welcome any suggestions as to any topics you would like us to cover in future editions of The Clarion.

Keith W Thompson

Clarion Group Chairman

December 2023

Creating better lives now and in the future for our clients, their families and those who are important to them.

Risk Warnings

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Stock market & economic commentary – December 2023