What factors have the greatest influence on financial markets and determine current investment strategies?

Recently we have summarized the results of the third quarter of 2023. We have revealed quite a few interesting patterns. For most of the year, we were focusing on the macroeconomic component of the central banks' global interest rate strategy, and especially on the potential impact of their policies on financial markets.

For the first time in several decades, high interest rates, high oil prices and difficult credit conditions have coincided in time.

After the crisis of regional banks, global markets began to grow dynamically: in the USA - amid a strong labour market, in Europe - amid the growth of some sectors (luxury, travel), in China - amid the thesis of opening the economy. All these were complemented by a reduction in volatility and have enabled large market participants (pension funds, systemic hedge funds) to record growth, and hold a defensive position on the market until the end of the year.

How do these trends affect investment portfolios? Simply put, which assets makes sense for an investor to focus on? We recommend focusing on the stock market, debt instruments and commodity assets.

Let's consider each category in more detail.

Stock market

The positive aggregate profitability of the stock market in the first three quarters inspires to find out which companies have formed the leadership cluster and what their characteristics are. In fact, behind the tens of percent absolute returns of the growth of seven to eight high-cap companies (heated by AI topic), there is a rather weak structural growth of the S&500. For example, the share of companies trading above their average is less than 15%, and there is not a single company, that would trade positively for each month of the year, in the index structure itself.

Overall, the US economy is teetering on the edge as a weaker growth could lead to a recession, while a stronger growth could revive inflation and FRS activity. Under such conditions, companies from sectors that do not miss possible rallies, but are more stable in relation to the market and possible macro-risks, look attractive. First, these are the companies from the healthcare, financials, consumer staples, and industrials.

Among the main criteria of choice, the following can be distinguished:

- Dividend yield higher than that of S&P 500

- High coverage of interest payments and low debt load

- Stability of generating net cash flows.

The debt market

The debt market can become a shelter for investors amid a pause in monetary tightening and a correction in the stock market. The market of debt instruments again was marked by an increase in yield. The stable US economy in certain categories and the accompanying pro-cyclical fiscal policy can be called one of the main reasons for such dynamics in the third quarter.

For hedge funds, pension funds and other large market participants, there are not many alternatives for capital flows out of the stock market other than bonds.

Protracted and intense cycles of interest rate hikes globally have resulted in medium-term bond yields outperforming short-term bonds. However, as we approach the terminal interest rate, there is not only a reversal of this trend, but also reinvestment risks. More and more investors are increasing the duration of their portfolios, seeking to capture higher yields on debt securities.

Commodity assets

The growth of energy prices and demand for industrial metals attracts the attention of investors who are looking for alternative sources of profitability. A strong dollar in the third quarter did not contribute to the growth of commodity indices, but further prospects for the currency allow a return to the topic of commodity markets with even greater enthusiasm. Oil and oil products, copper, gold can be noted among the most attractive assets.

Oil and industrial metals (copper, aluminium, etc.) are gradually increasing against the background of declining reserves. From a structural perspective, gold and platinum group metals maintain demand of the green energy and auto sectors.

Gold has strong strategic growth prospects due to central banks building reserves, rising geopolitical tensions, and demand for versatile assets that act as alternatives to the dollar and US bonds.

Recently, global geopolitical tensions have played in favor of the universal exchangeable asset, and the share of gold in reserves has begun to grow (currently around 17%). For the most part, this can be explained by political polarization, where instead of US public debt, some central banks began topurchase gold intensively.

International gold reserves reached a record value of 38.7 thousand tons, which exceeded the level of 38.3 thousand in 1965, when the share of gold in global gold and currency reserves was 58%.

Oil.

After a significant decline from mid-2022 to mid-2023 (from $120 to $65), oil recovered price levels

to $90. The energy sector has outpaced even fast-rising stock indexes, including the S&P500 and NASDAQ, in terms of the pace of expansion this year. OPEC+ production regulation (production cut by 1.15 million barrels/day, announced in April) can be one of the main reasons supporting oil prices.

According to the IMF, Saudi Arabia will be able to balance the current budget at an average oil price of $80. In a global perspective, the demand for oil remains inelastic, high and stable, so any reduction in production has a sharp impact on the price of oil. While US producers are increasing production, the cost of production has fallen by 60% from its peak in 2014. This enables companies from this sector to distribute dividends to investors. According to forecasts, the level of oil reserves will remain low until the end of the year, which will support the level of prices.

Industrial metals. According to the IEA, by the end of 2023, about 18% of sold cars will be electric cars (by 2030, this figure will increase to at least 35%). Strategically, this transition means structural changes in demand, in particular from the direct consumption of oil products to the metals needed for the production of cars. This applies not only to the rare earth metals needed in the production of batteries, but also to industrial metals. While a slowdown in manufacturing activity in China (including mechanical engineering and a stagnant real estate sector) is reducing demand, global copper inventories are at multi-year lows and production ramping up is a rather slow and sluggish process. From an investment perspective, copper is one of the most attractive long-term assets.

Among the main risks of the upcoming periods, we identify the following.

1. The thesis about the fragility of the global economy remains unchanged. As a result, this may create volatility in the stock markets in the next 2-3 quarters.

2. Further reduction of liquidity in the market.

3. Geopolitical crisis, emergence of new armed conflicts and wars.