January 2024
2023 ended with a bang as markets almost everywhere (OK, not China) rallied. Breadth expanded beyond the few stocks that led 2023 strength and financials caught some interest as a benign US economic backdrop became a more consensus view. We are seeing recessions in Europe, clear weakness in China and still some small risk of a brief period of economic weakness in the US even though in late 2023 US growth accelerated. Without a notable slowdown in its economy, accompanied by deteriorating employment conditions, or a concern that deflation could be ahead, we doubt the US Federal Reserve will feel compelled to cut its policy rates too quickly. We expect US 10-year Treasuries at around 4% for a while yet and quantitative tightening to continue even as inflation further comes back to levels seen as acceptable to central banks around the world. However, this is no longer a major headwind for equity markets and indeed we believe it will likely become a tailwind sometime during 2024. September Federal Reserve projections (rates, GDP growth, unemployment) were all revised to reflect a sustainably stronger economic outlook, and nothing thus far has contradicted this.
In many respects the world looks to be in good shape economically. Measures of Consumer Sentiment show gloominess amongst Americans, but this seems somewhat at odds with prospects and perhaps is a function of social media’s negative lens. We continue to see remarkable progress in many areas and excellent opportunities within markets and we encourage a longer- term and disciplined approach by investors.
Areas of consternation largely reflect some level of dysfunction politically and geopolitically – migrant crises, Israel/Hamas, income inequality and high government debt and we can add to that regular weather calamities. Yet in the US economic growth (real) has accelerated and is likely to be close to 3% in 4Q23 vs 0.7% a year ago. Unemployment has been below 4% for the longest period since the 1960s and the participation rate amongst 18- to 64-year-olds is the best it’s been since 2009. With falling inflation, real wages are up and wealth drivers of housing and share markets mean household net worth is up strongly.
Prospects for corporate earnings and cash flows mean an exciting backdrop for long-term investors. New projects are being undertaken as the trends of decarbonisation, digitisation and deglobalisation gain momentum. US non- residential construction spend is strong and has one of the highest growth multipliers (estimated at 3x) of any industry. Even if interest rates do not fall materially, we believe opportunities outweigh the risks within equity markets.
Stepping to the portfolio positioning, we are clearly positive on the opportunity to deliver wealth creation in global equities. We believe there are boundless opportunities in front of us for our superbly managed companies with strong competitive advantages to deliver exceptional earnings and cash flow growth in coming years. There may be some share price bumps along the way as bond yields fluctuate and sector rotations within markets affect prices through flows, but we are confident in valuation upside for the portfolio. Strong earnings mitigate rate volatility risk over a longer time horizon and so the portfolio is tilted towards those companies we believe can keep delivering better-than-expected results through time and are yielding high cash flows from their operations even today. Innovation alongside execution excellence is at the heart of many of the companies we own – Microsoft, Amazon, Intuit, SAP, Alphabet, Netflix, Trane Technologies, Stryker and Republic Services, among many others, discuss with us the innovations that place them at the forefront of their industries.
We expect that some volatility in markets may accompany us over the next few months as share prices continue to adapt to the evolving interest rate environment and reshaping of economic growth. Volatility isn’t inherently risky. We work diligently to assess the real risks that face our portfolio companies and will continue to hold the line on our absolute return objective. We thank you for the trust you place in us.
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