Another quarter, another shift in market sentiment. The prior months’ selloff continued in October only to dramatically reverse into yearend on dovish comments from the Federal Reserve and expectations that softer inflation would lead to 2024 rate cuts in several countries, particularly the US. The large cap, MSCI World ex-USA (+10.5%), and small cap, MSCI World ex-USA Small Cap (+10.6%), Indices had similarly strong returns in the quarter — helped by a weakening US dollar (-4.5%). As a result, the 2023 return for MSCI World ex-USA was 17.9%, while the MSCI World ex-USA Small Cap trailed with a still respectable gain of 12.6%. Large caps ended the year at record quarter-end levels, while small caps remain below their 2021 highs.
The rate-induced rally carried over to Europe, where monetary tightening has had a more pronounced impact on economic activity. Northern European markets were standouts, such as Sweden, where housing prices are off 10-13% from peak levels following 400 basis points in rate hikes, and the UK, where rates are now sitting at a 15-year high. With short-term rates still standing firm at -10 basis points, Japan lagged most European markets and the US, while the yen strengthened on expectations that the Bank of Japan (BOJ) would tighten policy early next year. This drained some momentum from the local market, with the MSCI Japan Small Cap Index up modestly in local currency, but Japanese equities had a strong 2023, ending the year at a multi-decade high.
As we enter a new year it’s tempting to forecast potential events and how the market will react. However, looking back at the predictions made for 2023 with hindsight is humbling. There were four major market moving global events this past year: the SVB and Credit Suisse driven bank melt-down early in the year, followed by the boom in AI stocks, the Israel-Hamas war, and changes in interest rates. Of those four, the first three were total surprises at the start of the year. Many people predicted rates would move this year and they did, but the volatility in interest rates was not in consensus forecasts. The US 10-year Treasury yield moved between 10-20% EACH quarter. Yet, no one would have guessed that with all this intra-year volatility the 10-year would start the year at 3.87% and end the year at…3.87%.
So, this year we’ll skip the forecast. However, as we start the new year there are a few areas of interest worth mentioning. First, 2024 will see a large number of potentially market-moving elections. The year starts with the geopolitically important Taiwanese presidential election in mid-January, a three-way race that is currently too close to call, and will end with the US presidential election. In between we expect the EU parliamentary elections to show continued popular discontent and a likely shift to the right in Europe. The UK general election, possibly in the summer, could result in the only major center-left majority government globally. Normally, such an outcome would be worrisome for markets, but we take a contrarian view that it could be seen as a sign of stability, lacking in the fractured electorates seen elsewhere.
A second contrarian view is that UK inflation has improved its macro environment. The surprise high inflation has resulted in debt-GDP ratios falling to pre-GFC levels, and (while this will change as rates adjust) private non-financial debt service ratios have not actually moved higher. Although the inflation surprise was not good for UK bondholders, it actually makes us positive on UK equity opportunities for the first time in years. Similarly, we see potential opportunities in the EU periphery markets.
Finally, everything in Japan seems to take longer than first thought, but it remains our favorite market for 2024. The focus will be on if/when the BOJ ends the world’s last negative rate regime and may even see excitement grow if the Nikkei can approach 1989 highs. If it is true that flows follow sentiment, which is driven by performance, then Japan could become exciting for the first time in decades.
Despite relatively modest returns in 2023 our view on international markets is constructive. After years of underperforming, primarily due to valuation compression and FX headwinds, not earnings weakness, the set-up for non-US equities in 2024 is positive. We’ll be on the look-out for what events will surprise the markets this year, knowing that there will be some. However, our approach and recommendation is simple, and remains the same as always: hold a diversified (critically including geographic diversification) portfolio of quality, attractively-valued, and financially-strong companies.
Read GW&K’s Quarterly Investment Review for the fourth quarter here.
With contributions from members of our Global Equities Team