2023 didn’t play out as strategists expected

All across Wall Street, on equities desks and bond desks, at giant firms and niche outfits, the mood was glum. It was the end of 2022 and everyone, it seemed, was game-planning for the recession they were convinced was coming.

Over at Morgan Stanley,?Mike Wilson, the bearish stock ‘strategist of the year’, was predicting the?S&P 50O Index?was about to tumble… a lot. There was then a lot of confusion as the markets started to rally.

Wilson spent most of 2023?warning?the rally would reverse itself, sounding alarms on?technology?shares and arguing that March’s banking turmoil portended a?“vicious”?selling climax that was needed before shares could start rising again.

A few blocks away at Bank of America,?Meghan Swiber?and her colleagues were?telling clients?to prepare for a plunge in Treasury bond yields. And at Goldman Sachs, strategists including?Kamakshya Trivedi?were talking up Chinese assets as the economy there finally roared back from COVID lockdowns.

Blended together, at the start of 2023 these three calls — sell US stocks, buy Treasuries, buy Chinese stocks — formed the consensus view on Wall Street.

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Going up, going down

And, once again, the consensus was wrong, and not just a little wrong. What was supposed to go up went down, and what was supposed to go down went up — and up and up.

It’s a testament in large part to the way the economic forces unleashed in the pandemic — primarily, booming consumer demand that fuelled both growth and inflation — continue to bewilder the best and brightest in finance and, for that matter, in policy making circles in Washington and abroad.

And it puts the sell side — as the high-profile analysts are known to all on Wall Street — in a very uncomfortable position with investors across the world who pay for their opinions and advice.

“I’ve never seen the consensus as wrong as it was in 2023,” said?Andrew Pease, the chief investment strategist at?Russell Investments, which oversees around $290 billion in assets.“When I look at the sell side, everyone got burned.”

Money managers came out looking alright this year, generating returns in stocks and bonds but that is because they can only really buy, and sit on their longs. This year they got it right, but not on purpose.

Everyone had a nagging sense that the US — and much of the?rest of the world?— was about to sink into a?recession.

This was logical enough. The Federal Reserve was in the midst of its most aggressive interest-rate-hiking campaign in decades and spending by consumers and companies seemed sure to buckle.

There have been few signs of that so far, though. In fact, growth actually quickened this year as inflation receded. Throw into the mix a couple of breakthroughs in artificial intelligence — the hot new thing in the world of tech — and we had the perfect cocktail for a bull market for stocks.

The year started with a bang. The S&P 500 jumped 6% in January alone. By mid-year, it was up 16%, and then, when the inflation slowdown fuelled rampant speculation the Fed would soon start reversing its rate hikes, the rally quickened anew in November, propelling the S&P 500 to within spitting distance of a record high.

Through it all, Wilson, Morgan Stanley’s chief US equity strategist, was unmoved. He had correctly predicted the 2022 stock-market rout that?few others saw coming?— a call that helped make him the top-ranked portfolio strategist for two straight years in Institutional Investor?surveys?— and he was sticking to that pessimistic view. In early 2023, he said, stocks would fall so sharply that, even with a second-half rebound, they’d end up basically unchanged.

“This is what bear markets do: they’re designed to fool you, confuse you, make you do things you don’t want to do.”

He suddenly had plenty of company, too. Last year’s selloff, sparked by the rate hikes, spooked strategists. By early that December, they were predicting that equity prices would drop again in the year ahead, according to the average estimate of those?surveyed?by Bloomberg. That kind of bearish consensus hadn’t been seen in at least 23 years. Even?Marko Kolanovic, the JPMorgan Chase strategist who had insisted through much of 2022 that stocks were on the cusp of a rebound, had?capitulated. (That dour sentiment has extended into next year, with the?average forecast?calling for almost no gains in the S&P 500.)

It was Wilson, though, who became the public face of the bears, convinced that a?2008-type crash?in corporate earnings was on the horizon. While traders were betting that cooling inflation would be good for stocks, Wilson warned of the opposite — saying it would erode companies’ profit margins just as the economy slowed.

In January, he said even the downbeat Wall Street consensus was too sanguine and predicted the S&P could drop more than 20% before finally snapping back. A month later, he?warned clients?the market’s risk-reward dynamic “is as poor as it’s been at any time during this bear market.” And in May, with the S&P up nearly 10% on the year, he urged investors not to be?duped:

“This is what bear markets do: they’re designed to fool you, confuse you, make you do things you don’t want to do.”

A similar resolve had taken hold among bond mavens. Yields on Treasuries surged in 2022 as the Fed put an end to its near-zero interest-rate policy, pushing up the cost of consumer and business loans. It was all happening so fast, the thinking went, that something was bound to break in the economy, driving it into recession. And when it did, bonds would rally as investors rushed into haven assets and the Fed came to the rescue by reopening the monetary spigot.

So Swiber and her colleagues on BofA’s rate-strategy team — like?the vast majority of forecasters?—predicted solid gains for bond investors who had just been dealt their?worst annual loss?in decades. The bank was among a handful of firms?calling for?the yield on the benchmark 10-year note to drop all the way to 3.25% by the end of 2023.

For a moment, it looked like that was about to happen. Something indeed broke: Silicon Valley Bank and a few other lenders?collapsed?in March after suffering massive losses on fixed-income investments — a consequence of the Fed’s rate hikes — and investors braced for an escalating crisis that would throttle the economy. Stocks swooned and Treasuries rallied, driving the 10-year yield down to BofA’s target. “The thought was that this would be a tailwind to this view for a harder landing,” Swiber said.

But the panic didn’t last long. The Fed managed to quickly contain the crisis, and yields resumed their steady climb through the summer and early fall as economic growth?re-accelerated. A late-year rebound in Treasuries pushed the yield on the 10-year note back down to 3.8%, just about the same level it was at a year ago.

Swiber said the year has been humbling, not just for her but “for forecasters across the board.”

Humbled overseas

At the same time, Wall Street was being handed another humbling in markets overseas.

Chinese stocks?gained?during the last two months of 2022 as the government ended its strict Covid controls. With its economy unleashed, strategists at?Goldman, JPMorgan and elsewhere?were predicting?China would help propel a?rebound?in emerging-market stocks.

Goldman’s Trivedi, the head of global currency, rates and emerging-markets strategy in London, concedes things haven’t gone?as expected. The world’s second biggest economy has faltered as areal-estate crisis deepened and fears of deflation grew. And rather than pile in, investors pulled out, sending Chinese stocks tumbling and dragging down returns on?emerging-market indexes.

“The boost from reopening faded very quickly,” Trivedi said. “The net positive effect from reopening was smaller and you did not see the same kind of growth rebound that you had in other parts of the world.”

Meanwhile, the US equity market continued to defy naysayers.

By July, Morgan Stanley’s Wilson acknowledged he’d remained pessimistic for too long, saying?“we were wrong”?in failing to see that stock valuations would climb as inflation receded and companies cut costs. Even so, he was still pessimistic about corporate earnings, and later said a fourth-quarter stock rally was?unlikely.

When the Fed held rates steady for a?second straight meeting?on Nov. 1, however, it set off a?furious rally?in both stocks and bonds. The advances accelerated this month after policymakers indicated that they’re finally done hiking, prompting traders to anticipate several rate cuts next year.

Markets have repeatedly erred in expecting such a sharp pivot in the past couple years, and they could be doing so again.

For some on Wall Street’s sell side, doubts are creeping in. At TD Securities,?Gennadiy Goldberg, now the head of US rates strategy, said he and his colleagues “did some soul searching” as the year wound down. TD was among the firms predicting solid 2023 bond gains. “It’s important to learn from what you got wrong.”

What did he learn? That the economy is far stronger and far better positioned to cope with higher interest rates than he had thought.

And yet, he remains convinced that a recession looms. It will hit in 2024, he says, and when it does, bonds will rally.

Kicking the can down the road?

There is a chance that all the doom and gloom that was predicted for 2023 just hasn’t happened yet. Higher rates have had little impact so far. Wilson’s call for lowering inflation hitting earnings could still filter through.

Market sell-offs are impossible to time. When they happen, everyone sits back and says it was inevitable, but the fact is, most were calling for it throughout 2023 and it never came. The buying at the end of the year could be repositioning or it could be FOMO, but what will happen during the first quarter of 2024 is a much of a mystery as just how wrong all the Wall Street strategists were at the start of 2023.

Warren Buffett famously said that his favourite holding period is forever — a philosophy that aligns well with investing in companies that consistently increase their dividends. However, this doesn’t mean he’s not going to sell any of the stocks in his portfolio.

In fact, Buffett’s company Berkshire Hathaway sold $7 billion worth of equities while buying only $1.7 billion in Q3 2023 — meaning it was a net seller of about $5.3 billion worth of stocks.

Berkshire Hathaway’s cash pile surged to a record $157bn in a quarter in which chief executive Warren Buffett continued to sell stakes in publicly traded companies, as the so-called Oracle of Omaha found a dearth of appealing investments.

The company sold more than $5bn worth of US and foreign stocks in the third quarter, according to results released on Saturday. The sales lifted Berkshire’s divestments of listed shares to nearly $40bn over the past year.

Proceed with caution

It looks like many, including Buffett, feel it is a time to be cautious. Stocks rallied when most thought they shouldn’t. Tech took the lead, even though higher rates tends to be a bad thing for growth stocks.

The market often confuses and bamboozles. BUT, just because the market didn’t fall in 2023, doesn’t mean it won’t in 2024. In fact, what the market did, teaches us little other than to constantly expect the unexpected.

Higher rates are here to stay, and we haven’t really seen any consequences. WHEN they come, we will all sit back and say ‘I knew it’, but timing is everything. Without real cause, a large correction, or a bear market is unlikely, but that doesn’t mean we won’t see some action to the downside. We don’t know what’s going to break or why but take your pick:

1.????Such an incredibly fast increase in interest rate increases must break something. It might be construction, it might be a bank, but it will surely be something.

2.????Inflation is still high, if it starts to increase again, this will cause a massive market correction as rate cuts get taken off the table.

3.????There is still war in Ukraine and it isn’t dissipating, in fact, it’s escalating. Ukraine’s counter-offensive failed to achieve a major breakthrough. A solution to the conflict is unlikely, therefore escalation is the most likely outcome and the West will become more involved.

4.????There is now war in Gaza and that too is escalating rumblings coming out of Iran. In recent days a senior Iranian commander was killed in a suspected Israeli strike in Syria.

5.????A terrorist attack is likely given all of the geopolitical tension.

6.????Chinese actions in the South China Sea. Taiwan remains a significant issue that has so far gone under the market radar.

7.????Increased rates mean increased debt payments.National debt in the UK is nearing the ￡3 trillion mark. In the US that number is nearly $33 trillion.

Japan’s national debt is now 255% of GDP at1.30 quadrillion Yen (￡7.8 trillion)

Greece’s national debt is 167% of GDP and never went away despite other issues removing it from the papers.

8.????The most recent numbers for European GDP averaged -0.1%. France, Germany and the UK all recorded a negative quarter.Europe is on the edge of a recession.

"Europe has been through a year of zero-growth and is now heading into a year in which both monetary and fiscal policies are designed to put a brake on growth," UniCredit economics advisor Erik Nielsen said.

The European economy has been flat on its back for a year and the monetary and fiscal policy plans for 2024 seem to accept the high probability of another lost year.

Growth expectations are dour. EU GDP is forecast to increase 1.2%in 2024 and then 1.6% in 2025. This is minimal.

In the UK the OECD expects even less. It forecasts UK GDP to grow by only 0.7% in 2024. ?

None of this really lends itself to a market rally, but as we said earlier, the market does what the market does and what you think will happen, may not happen. If the wars don’t escalate, the job market remains strong, interest rates begin to come down, who knows, maybe 2024 won’t be so bad after all.

We won’t assume the worst, but we won’t assume the best either. The most likely outcome is we push on through another year with a few ups and a few downs. Which side will win is down to the outcome of a number of major events.

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Happy New Year, and here’s to a great 2024.