Global economy surprisingly resilent

Commentary on the 2023 year by Russell Investments, UniSaver’s investment manager and consultant

Global markets

If we draw our minds back to the start of 2023, economists were almost universally concerned about recession risk. The Philadelphia Federal Reserve’s Survey of Professional Forecasters showed that the proportion of forecasters expecting a recession was at historical highs. We also thought that recession risk was elevated given how much the Federal Reserve had tightened interest rates but were cautious about reducing risk too aggressively, given the uncertainty around that.

In the end the global economy proved surprisingly resilient and a strong showing in the fourth quarter ensured that global equity markets returned more than 20% in 2023. Growth companies significantly outperformed value companies in the US, which was driven (again) by megacap tech names.

Indeed, the magnificent seven (Nvidia, Apple, Alphabet, Amazon, Microsoft, Meta, Tesla) accounted for more than half of the S&P 500 return in 2023 on the back of excitement around the potential for Artificial Intelligence after the release of ChatGPT earlier in the year. We think that AI will provide a significant boost to productivity in coming years that will likely align with what was seen during the introduction of electricity and the early internet.

At the country level, the benchmark US S&P 500 Index (24.2%), the tech-heavy NASDAQ Composite (43.4%) and the Dow Jones Industrial Average (13.7%) all posted very strong gains for the year. Stocks were also higher in Europe (19.2% ), Japan (25.1% ) and the UK (3.8% ), but fell in China (-11.4%).

Over this year, central banks have raised rates by more than expected as inflation proved more stubborn in the first half of the year. That said, the Federal Reserve ended the year with a more balanced update – hinting at the potential for three rate cuts in 2024 and highlighting concern about the risks of keeping rates too high for too long.  As a result, global bonds finished the year strongly, returning 5.7%  in hedged NZD terms in the final quarter. This took the full year return to 6.6% which provided some welcome relief to investors after returns of -11.8% and -1.2% for this asset class in 2022 and 2021.

New Zealand shares

The New Zealand share market also performed well in the fourth quarter, returning 4.3% . However returns for 2023 overall were lacklustre at 3.5%.  Limiting the advance was weakness across the broader commodities complex and softer-than-expected economic growth. In terms of inflation, headline prices eased from 6.0% to 5.6% in the third quarter of 2023. Whilst the outcome marked the lowest figure since the third quarter of 2021, inflation remains well above the Reserve Bank of New Zealand (RBNZ)’s 1-3% target range.

New Zealand fixed income

The New Zealand bond market also performed well over the final quarter, returning 6.0% which took the full year return to 6.2%. Similar to their global peers, domestic long-term government bond yields fell in the second half of the year amid expectations global central banks will cut interest rates more aggressively in 2024 and the asset class’s traditionally defensive qualities in the face of heightened geopolitical uncertainty. The yield on New Zealand 10-year government debt closed the year at 4.32%.

How did markets affect UniSaver’s investment options?

With gains from both equities and bonds, all of the diversifed member options delivered good returns to members over the last quarter: 5.8% for Growth, 5.3% for Balanced and 4.2% for Conservative.  Returns for 2023 overall were strong with gains of 5.9%, 9.1% and 11.3% from Conservative, Balanced and Growth respectively. Cash delivered a 4.0% return over the same period.

Over the last ten years Conservative, Balanced and Growth have returned 3.5%, 5.5% and 6.9% per annum respectively, after the deduction of fees and tax.

Looking ahead

Global markets have exceeded expectations in 2023, thanks in large part to the mega-cap technology stocks known as the Magnificent Seven. Investor sentiment has shifted from “a recession is coming” to “a soft landing is around the corner.” Our market psychology index indicates high investor optimism, even though market gains have been concentrated. Too much optimism can make the markets more vulnerable to overcorrections. Our outlook for 2024 is more cautious due to restrictive monetary policy, slowing growth, and geopolitical tensions.

The U.S. Federal Reserve’s “higher for longer” approach will likely strain finances in the year ahead, impacting borrowers and refinancers. Meanwhile, we expect Europe and the UK to continue contending with weak demand, high inflation, manufacturing slumps, and Brexit. Lastly, China although stabilising will continue to grapple with long-term issues like debt and property markets and demographics.

Despite all this, markets are pricing closer to a smooth landing in 2024. We aren’t as confident about that, but we still see opportunities in a total portfolio context. Government bonds look valuable as yields exceed inflation and could become more appealing as a hedge against stock market volatility. We prefer quality equities for their relative value and defensive characteristics. Real estate investment trusts and global listed infrastructure are also attractive to us and should benefit from longer demographic and technology trends.

The New Zealand outlook is mixed. Monetary policy is tight and is likely to remain that way for some time. However, aggregate demand should be supported through 2024 by a notable pickup in population growth. The recent change in government from October election results will likely see fiscal policy become less supportive over the second half of 2024, but there is still uncertainty given the National/ACT coalition of political parties did not get a majority. New Zealand bonds look slightly cheap.