As the new year begins, many investors will be wondering whether it is the right time to review their portfolios to optimize their targeted returns.
Of course, no one can predict the future, not even someone with extensive experience in asset management and economic analysis. This reality is evidenced by the conflicting forecasts of investment analysts who interpret developing trends differently.
Nevertheless, it is necessary to take into account some investment considerations that are likely to take advantage of the dynamics that will drive financial markets in 2024.
The way inflation will develop is undoubtedly the first consideration. Today, overall inflation in all industrialized countries has collapsed from a high of nearly eight percent to below 3.5 percent. This autumn is impressive.
But will inflation return to pre-pandemic levels? Most analysts expect inflation to continue to cool, but it is expected to settle higher than in the last decade.
Labor market pressures, particularly in the US, are rebalancing after the disruption caused by the pandemic. This is a strong signal of a slowdown in wage growth.
However, nearshoring and global supply chain adjustments are likely to limit the possible decline in commodity prices. Furthermore, the EU's commitment to a greener economy could lead to persistent inflationary pressures in the short term.
The reason for holding on to cash in the investment portfolio is a second consideration. Yields on safe cash holdings have risen over the past year as interest rates have skyrocketed.
Cash is good for investors when central banks raise interest rates more than expected and inflation expectations rise, as has been the case for over a year. But today it is more likely that the Fed and ECB will consider cutting interest rates rather than raising them further.
Financial markets estimate a 60 percent chance that the Fed will cut interest rates by March and a 100 percent chance that it will do so by May. Another forecast is that the Fed will cut interest rates by 125 basis points by December 2024.
One caveat is that no prediction of the future can be infallible, no matter how authoritative and clever the central bankers' predictions may be.
Recently, the Fed has made several major mistakes in predicting economic developments. In early 2021, Fed Chairman Jerome Powell stated that the Fed expected to keep interest rates near zero through 2023. This is probably one of the worst forward-looking statements ever made by a central banker.
Bonds are attracting increasing interest from investors. Bonds provide stability in portfolios with less volatility than stocks, coupon payments generate income, prices rise when economic growth slows, and interest rates fall.
One caveat is that no prediction of the future can be infallible, no matter how authoritative and clever the central bankers' predictions may be
In the decade before the pandemic, a quarter of government bonds worldwide had a negative yield. Debt with negative returns has now almost completely disappeared. Today, almost 60 percent of global government debt offers yields of over three percent.
Stocks appear to be headed to new highs, driven by optimism about the power of AI to boost economic growth. The S&P 500 rose over 20 percent last November.
Earnings growth is accelerating again in the US and Europe, and many analysts seem to agree that optimism about a rise in share prices is not misplaced.
Stocks are widely believed to be the engine of long-term capital appreciation. While quality bonds certainly play a more important role in the portfolios of most investors today, keep in mind that stocks have outperformed bonds 85 percent of the time on a rolling 10-year basis since 1950.
Political risk is unlikely to disappear in 2024.
The EU will have a new Commission with a difficult economic and government reform agenda. The US could have a new president, although this is unlikely to have much economic impact in the short term. It is unlikely that the war between Russia and Ukraine will be over any time soon. The war between Israel and Hamas could increase tensions in the Middle East and have a devastating impact on global geopolitical stability.
I hesitate to comment on local financial markets with limited depth, volume and diversification. Furthermore, I have doubts as to whether the debt market correctly assesses the risk of bond issuances.
It is a fallacy to believe that one can guess the outcome of the complex issues and risks affecting financial markets. Investors have different risk tolerance levels. They therefore need to seek advice on how best to calibrate their investment portfolio.
It is always advisable to keep your portfolio as diversified as possible to avoid sleepless nights when financial markets are hit by turmoil.
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