Three investment lessons of 2023
This time last year the US Fed Funds Rate was 3.75 to 4.00 per cent, on the way to its current 5.25 to 5.50 percent.
In December 2022, for the eighth month in a row, the RBA hiked rates, and the Australian cash rate went beyond 3 per cent for the first time since 2013.
These were among the fastest and steepest rate rises in history, and the market feared dire economic consequences. The US yield curve had inverted at the end of 2022.
An inverted yield curve is usually a leading indicator of a recession. A hard landing was imminent, or a soft landing. The market didn’t know, but despite the warnings of higher rates for longer, the market was still convinced that a pivot was imminent.
A pivot is not good for risk assets because it is in response to an economic slowdown. So many pundits, at the end of 2022, were warning investors that equities would not be a good place to be in 2023.
Given the hammering bonds received as rates went up in 2022, they represented good value according to many, especially if rates started to fall.
Don’t even consider gold we were told in 2022, real rates are high again.
So, as we enter 2024, we think there are three important lessons investors can take away from the past twelve months.
1 - Timing the market is a fool’s game.
This may be an investment idiom as old as investing itself but had investors listened to pundits and avoided risk assets in 2023, they would have missed the AI boom. Both the S&P 500 and the MSCI World ex Australia Index are up over 20 per cent so far in 2023 driven by the IT sector, many thought was overpriced in 2022.
There are not many assets riskier than private equity, in 2023 the listed private equity index, the LPX 50 is up over 35 per cent.
Gold? The gold price started the year at US$1,812. It’s now above US$2,000, passing all-time highs.
In the face of higher interest rates, gold maintained its price strength on the back of record central bank buying. The predicted price fall of the precious metal didn’t happen in 2023.
2 – Being selective is key.
2023 taught us to be selective. Prudent investors focus on what is or what can probably go wrong, rather than to attempt to forecast what might go right. Risk management is everything. It was important to focus on balance sheets and cash flow. Two characteristics that are associated with the ‘quality’ factor.
While the international benchmark, MSCI World ex Australia Index has risen over 20 per cent so far in 2023, MSCI’s World ex Australia Quality Index, which screens companies based on quality characteristics is up over 28 per cent.
The importance of selectivity can be seen in other equity markets too. MSCI’s World ex Australia Small Caps Index is 10 per cent behind its quality equivalent so far in 2023. In emerging markets, the MSCI Emerging Markets has returned 7.7 per cent, trailing MSCI’s multi-factor index which has returned more than 16.5 per cent.
Selectivity has also been key in bonds. In Australia in 2023, like in 2022, short-duration floating-rate bonds looks like they will finish the year ahead of the Australian bond benchmark, the Bloomberg AusBond Composite Index despite a late rally for longer-dated bonds.
Australia’s 10-year government bond yield has rose from 3.7 per cent to almost 5 per cent. Bonds more sensitive to rate rises (higher duration) have been hit for the second year running.
This year we have had a change in RBA Governor, and while previous Governor Lowe did all he could to keep rates as low as he could. The new Governor, Michelle Bullock, wasted no time raising rates in November.
3 – Look ‘beyond the usual’.
Australian fixed income provides a good example here.
The world of Australian ‘fixed’ income includes bonds that are not ‘fixed’. Floating rate bonds, including subordinated debt, benefited well-diversified bond portfolios in 2023 as they outperformed longer-dated paper.
We mentioned above the performance of gold and private equity. We think these beyond the usual asset classes should be a part of well-diversified portfolios. It is these asset classes that have become staples of diversified institutional portfolios, like Australia’s own Future Fund.
So, in 2024, it is paramount for investors to look past the ‘noise’ of positive and negative commentary and concentrate on long-term goals. Successful long-term investors survive through the economic cycle by sticking to investment principles that have withstood the tests of time, even if, for a short time it can be confidence-shattering.
For portfolios, this may include better diversification. For fixed income being aware of interest rate risks, credit risks and different types of bonds. For equities, investing in profitable companies with strong balance sheets and stable earnings has historically given resilience to portfolios.
Happy New Year.
This is an amended version of an Australian Financial Review op-ed published under the title, ”Why investors were right to ignore the warnings of 2023”