Managers outlook for 2024

Tuesday, 18 December 2023

Headwinds becoming tailwinds

At Witan Investment Trust, we have used a multi-manager approach to global equity investment since 2004. After a year dominated by geopolitical developments, technological innovation and the contest between resurgent inflation and rising interest rates, we asked our managers what they see as the opportunities and challenges for 2024. Common themes include:

1. Energy prices may pick up, assuming China regains momentum, reawakening pressure to accelerate cost-effective investment to reduce dependence on fossil fuels.
2. Falling Inflation, with interest rates expected to decline in 2024.
3. A UK rebound, as bearish factors are discounted in cheap valuations.
4. Soft(ish) landing sees growth improve during 2024, particularly outside the US.
5. Broadening participation from companies on peak multiples on elevated earnings to those on low multiples on depressed earnings.
6. Geopolitical and election outcomes remain opaque, but many risks are factored in.

In 2023, markets have oscillated between premature anticipation of rate cuts, rising forecasts for the peak in rates and fears of recession. These have generated swings in equity performance between cyclical sectors versus those leading the development of generative AI, and between US equities and those elsewhere. Although finding a consistent performance theme has been elusive, 2023 has at least delivered positive equity returns, in contrast to 2022 as a year of red ink across the board.

A year ago, we characterised the peak in interest rates as more likely to resemble Table Mountain than the Matterhorn, a phrase which has been widely echoed since, and built into the “higher for longer” mantra from Central Banks worldwide. These banks have successfully re-established market pricing for the economy’s cost of capital, after a decade of manipulated zero rates. Overdoing the tightening would risk having to cut rates all the way back again, such is the deadweight of debt. So, having reached the Central Banks’ plateau, the question is where we go from here.

Central Banks missed the surge in inflation and have had to act, and talk, tough to regain credibility. There is more pain to come from the tightening already implemented, as low locked-in loans come to be refinanced, while there are signs that more of the inflation was transitory than appeared a year ago. Central Banks therefore look to have got it right in pausing and should probably prune rates gradually in 2024, as falling inflation increases the real rate of interest and past rate hikes tighten their bite.

The nature of growth in the coming decade (energy transition, infrastructure, defence), however, looks more capital- and resource-intensive than in recent decades, with the added impediment of deglobalisation diluting the efficiency offered by comparative advantage and free trade. So, whilst the recent 30-year peak in inflation may be over, the coming decade seems likely to see somewhat higher inflation and interest rates than in recent decades.

In addition to the greater pressure on resources, ageing populations in many developed economies will shift the priority towards improving productivity, as growth has to be generated by the efforts of a smaller proportion of the population. AI is potentially a wild card in jump-starting western economies’ flagging productivity engines and a step change in productivity is particularly needed in the UK, after years of underinvestment. Someone once described the UK market as a Jurassic Park in investment terms, yet in the film Jurassic Park “life finds a way” to do what seems impossible. Dare we hope that the increased focus on the regulatory headwinds that have diverted so much of the UK savings pool away from productive investment will help rekindle the country’s entrepreneurial energies? With second line stocks trading at a discount to a UK market that itself trades on a wide discount to international comparators, a number of our managers see exceptional value here, albeit not for the first time. With the UK having been a perennial underperformer, intensified since 2016’s Brexit referendum made future growth less predictable, many will hope that the maxim that “past performance, while relevant, is not a guide to future performance” will prove correct.

2023 has been another bad year for bonds, possibly the culmination of the repricing needed after the era of near-zero rates. Yields are arguably fair value now but, with uncertainty over the sustainability of public finances, investors are unsure how much extra yield to demand for the risk that governments try to inflate away their debt burdens. A year ago, equities proved to have been too gloomy about the outlook for 2023. Although growth has been anaemic in most centres, it has been better than the anticipated rigor mortis.

2024 will start with low expectations for economic growth but reducing inflationary pressures on living standards. Allied to the prospect of gradually declining interest rates, this means that improvement can be expected through the year. In the absence of further shocks from geopolitical factors (particularly current conflicts) or the multitude of elections scheduled for 2024, a rational hope would be for a broadening of economic optimism beyond the US and that investors will look beyond the ‘Magnificent Seven’ US technology stocks for performance - and consider a wider range of sectors where growth is less-expensively rated.

Below we summarise some of the comments from our managers and their views on the coming year.

Andy Gray, Artemis UK Special Situations
We are increasingly confident in the outlook for the UK market. A multitude of arguments have been given as to why UK valuations have been allowed to fall to such attractive levels. However, many of these points are slowly being turned on their head. Economic headwinds, such as inflation, are on an improving trajectory leading to improved consumer confidence, growing real wages and falling financing rates. This improving outlook has been confirmed by many of the businesses we invest in, particularly those in the UK consumer and leisure sectors. Against that backdrop the magnitude of share buybacks increases the potential rewards for the remaining patient investors. During a time of uncertainty, we have been able to invest in a number of new positions that are towards the beginning of their Special Situations turnaround journey.

Peter Davies, Lansdowne Partners
We are hopeful that H1 2024 should provide a reasonably positive environment for European economies and markets. After a protracted period of rising interest rates and energy costs, the first half of next year should see stable monetary policy, rising real wages and some fiscal loosening. Such an environment offers huge opportunity given that market sentiment has been worn down by volatility over the last few years leading to depressed valuations at a point where profitability is also sub-trend.

The main risks to this remain geopolitical, with the prospect of global instability leading to rising energy costs the most obvious tail-risk. More generally, 2024 sees probably the largest concentration of elections across geographies in recent memory, with the US election in particular likely to create uncertainty for investors.

James Bullock, Lindsell Train
With America’s seven mega-cap tech stocks resurgent in 2023, the global indices will likely enter 2024 at levels of concentration not seen for decades. This creates challenges for both active and passive investors looking to either outperform or diversify risk, and the direction these few stocks take will define returns for many. The rapid progress of AI, the engine of these companies, has been hailed with optimism from investors. But the exact path this technology takes, the disruption and regulation that may follow, and its eventual winners and losers might not be so obvious. Add to this, rising rates and nervous consumers and we look to weather 2024 with essentially the same collection of durable, content rich, high returning businesses that has seen us through past periods, both good and bad.

Andy Headley, Veritas
The biggest challenge is likely to be the deferred impact of interest rate rises on the consumer, leading to weaker growth. The balance sheets of lower income consumers already appear exhausted and higher rates are likely to pose further problems in 2024.

The biggest opportunity continues to be the recovery in travel and in particular the recovery in air travel. This could start to include Asia (which is still below 2019).

Investment team/Jon Tringale, WCM
Navigating macro volatility continues to be a challenge, especially since most industry cycles have been thrown off their typical patterns coming out of COVID. We see ongoing opportunities driven by market participants that are plagued by more short termism than we’ve ever seen. This leads to volatility, but more importantly, to moments of opportunity to add some wonderful businesses to the portfolio when the market may be fixated on meaningless noise and misses the bigger picture.

Mark Baribeau, Jennison Associates
Sentiment in the near term is clouded by uncertainties that will likely weigh on economic growth into 2024. We continue to evaluate the investment landscape against a mixed backdrop and focus on companies with the ability to innovate, invest, and grow through various macroeconomic environments. AI and cloud computing are revolutionizing industries, and we are optimistic about productivity-enhancing applications and the infrastructure layer where compute power is generated. Additionally, a boom in manufacturing and high-tech facilities leveraging AI is driving advanced automation of industrial processes to enhance efficiencies. We also see a large opportunity among global consumers. As populations with healthy disposable incomes are reshaping consumption patterns and generating persistent demand for luxury goods, we favour strong, global consumer brands that have direct-to-consumer business models. Finally, in health care, an innovation cycle marked by advanced research capabilities, game-changing therapies, and digital supply chains is fostering demand for more integrated ecosystems.

Investment Team, GQG
Risks. The primary risk for equity markets in H1 2024 is a meaningful increase in interest rates, most likely due to a reacceleration of inflation.

Opportunities. We remain sanguine on Energy due to limited supply and disciplined production growth by the larger energy companies and OPEC+. Additionally, many Energy companies are now prioritizing profitability and shareholder returns.

We are constructive on Semiconductors as the pandemic-induced overearning has normalized to pre-Covid trends, in our view. We believe the fundamental picture is improving with semiconductor inventories declining while demand for servers, PCs, and smartphones appears to be bottoming. In addition, recent advances in generative AI and large-language model applications are expected to be a growth driver for data centers as well as select hardware providers.

Lastly, we believe that many pharmaceutical companies, particularly those with exposure to the anti-obesity drugs, will remain attractive investment opportunities due to their potentially enormous global addressable market.

Lucas White, GMO
Climate change continues to move faster than most thought possible and it is having a dramatic impact on the world. Economics will drive the transition to a clean energy economy, and the climate change sector will experience strong secular growth.

Yet there has been turbulence on this path to transformation and the clean energy sector broadly faced headwinds over 2023 from inventory gluts, higher interest rates and slow implementation of public policy announcements. This in turn has pulled down performance of the sector and our portfolio. We consider these headwinds to be cyclical in nature, whilst the structural case for clean energy growth has not changed. Due to the cost competitiveness of many clean energy solutions, growth is all but guaranteed with or without policy support. And it is much more likely to surprise to the upside, as it has for the last 10 to 15 years. The tailwind of the EU’s Green Deal Industrial Plan and the US’s Inflation Reduction Act, despite the implementation drag, will be felt for many years to come. Valuations, on the other hand, have seen a significant reset and now price in negative or negligible growth for many of the companies we like best. For those able to navigate the bumps in this sector, the valuation opportunity is almost unprecedented. As of the end of October 2023, the Climate Change Strategy traded at a 38% discount to the broad equity market (11.4x forward earnings for the Climate Change Strategy vs. 18.4x forward earning for ACWI). The current discount is very close to its maximum level since inception. We don’t expect a smooth ride, but we see a highly profitable future for clean energy investors and those focused on the climate change sector.

This material is a marketing communication issued and approved by Witan Investment Services Limited FRN446227 on 13 December 2023. Please remember that past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise as a result of currency and market fluctuations and you may not get back the amount originally invested.

* Source: Morningstar, percentage growth. Total return includes the notional investment of dividends.
** Witan’s benchmark is a composite of 85% Global (MSCI All Country World Index) and 15% UK (MSCI UK IMI Index). From 01.01.2017 to 31.12.2019 the benchmark was 30% UK, 25% North America, 20% Asia Pacific, 20% Europe (ex UK), 5% Emerging Markets. For more information go to www.witan.com/support/legal-information.

The views expressed herein represent those of the specific fund managers (as at the date of publication) and not those of Witan Investment Services. No reliance may be placed for any purpose on the information and opinions contained in the newsletter or their accuracy or completeness. No part of this material may be copied, photocopied or duplicated in any form or distributed to any person that is not an employee, officer, director or authorized agent of the recipient, without Witan Investment Services Limited's prior permission. Witan Investment Services Limited is registered in England no. 5272533 of 14 Queen Anne's Gate, London SW1H 9AA. Witan Investment Services Limited provides investment services and is authorised and regulated by the Financial Conduct Authority.