Market commentary: 1st October to 31st December 2023

Jan 18, 2024

It appears that the two most important questions for investors in 2024 relate to one micro question and one macro question:

  1. Whither the Magnificent Seven?
  2. Have markets fully absorbed that the period of declining and/or ultra low interest rates are behind us?

The Magnificent Seven

In the 1960 film “The Magnificent Seven” a group of gunslingers led by Yul Brynner, Steve McQueen, and Charles Bronson were hired to protect a small Mexican village from the attacks of marauding bandits. This being a Hollywood film, they succeed, to commercial and critical success. 

In 2023 seven US stocks were also nicknamed the Magnificent Seven (Amazon, Apple, Tesla, Alphabet (Google), Meta (Facebook), NVidia and Microsoft) and they have performed a similar function in protecting the S&P from the ravages of rising bond yields. Perhaps not as crowd pleasing or rousing a sentiment but they win the investment Oscars this year for sure. In fact these seven stocks were responsible for nearly 2/3rds of the total rise in the S&P this year. 

They are all outstanding companies and have achieved remarkable things in short lives. Amazon has redefined shopping, Apple is responsible for the invention of an astonishing number of devices that we would struggle to do without today. Microsoft thrived on its operating system then morphed into working productivity tools and again into web hosting. Tesla has gone from zero to world leader and product revolutionary in electric cars. NVidia looks to be one of the main beneficiaries in a world with growing AI penetration. Alphabet’s Google continues to dominate and control search and associated traffic monetisation and Facebook and Instagram (both owned by Meta) are responsible for making teenagers miserable. All notable and praiseworthy achievements.    

That they have triumphed in their fields in a competitive market is testimony to their respective brilliance. But competition doesn’t stop. It is a brutal and beautiful mechanism for bringing consequence to complacency. And some of the Magnificent Seven (as in the film) come to the end of 2023 party battle scarred and road weary. 

Apple’s revenues have declined for each of the last four quarters yet it is valued at 30x earnings. Google search (the fundamental driver of Alphabet profitability) is going through the process memorably described by Rory Sutherland (of advertising giant Ogilvy) of “enshitification”. When a tech product is launched it is new and imperfect, but the zeal of the founders is to continue to improve the customer experience, to iron out the flaws and make it better. The customer then benefits as the product improves significantly over time. But this process of improvement peaks and goes into decline once the focus gradually shifts to maximising the profitability of the product. Google’s search results are now notably worse because the results are not optimised for the user benefit, they are optimised for maximising the revenue that can be gleaned from advertising and selling search engine optimisation. At some point some clever wonks will create a superior alternative and the world will abandon Google almost overnight – the switching costs are close to zero. That is a significant existential risk for a company worth $1.7 trillion. It is a fair challenge to say that this risk has existed since 2003 without serious threat but it would be folly to presume permanency of superiority.

Amazon dominates online retail, though it makes no money from it – its cash cow is AWS (Amazon Web Services) – an increasingly competitive market. Meta, the new Facebook, is focused on Mark Zuckerberg’s hubristic vanity project the “metaverse”. One of the obvious negative consequences of having asymmetric voter rights (where some shareholders have superior voting rights – often the case with founders of tech companies) is that other shareholders have little ability to counter founders ability to act without recourse. If all shareholders had equal voting rights in Meta then the colossal spending ($36bn to date) on the “metaverse” would never have been embarked upon. Because of the asymmetric voting rights, it looks like this spending will never end. 

Despite these chinks these are remarkable companies. But the challenge for investors is not just identifying remarkable companies, it is to explore whether they make remarkable investments. The Magnificent Seven certainly have been over the last two decades, but at some point in the future they will not be – that much is certain. The data suggests that this day may be sooner than anticipated. 

Of the ten largest firms in the world in 2000 only Microsoft continues to make the list. When considering permanency of dominance you might consider what the intervening years have done to the valuations of companies such as General Electric or Cisco? Even Nokia made the top 10 in 2000.

By 2008 the most valuable company in the world was Exxon Mobil, and the top 10 contained AT&T, Chevron and Johnson & Johnson. There are few things as impermanent in investing as dominance.   

The M7 have driven the S&P500’s progress over the last few years but they now account for 26% of the total value of all global equity markets. Never before has such concentration existed. Partially this is due to the internet and certain technologies trending towards natural monopoly – so single players dominate key areas and become hugely valuable as a consequence. But it is also partially a function of retail investment flows and the popularity of these seven companies and their dominance of the news cycle: they are the “influencers” of global stock markets.               

Have markets finally priced in the end of free money?

Interest rates were pushed to zero in the global financial crisis and remained there for over a decade, but they had been falling since 1980 when they approached 20%. Interest rates at zero fuelled a boom in asset prices and a warping of economic systems as weak and loss-making companies and investments were able to secure plentiful supplies of cheap credit. This persisted because the spectre of inflation remained subdued until the pressure from this period mounted and was amplified by the firehosing of cash into economies as a result of lockdown policies.

Where we are now is that while inflation is dropping it is unlikely to get close to the Bank of England’s target rate of 2%. This means that while interest rates may fall they will not be reducing down to the ultra-low levels we have been accustomed to. The big question is has this reality been absorbed by markets? Have assets repriced to reflect this? Have analysts and economists sufficiently altered their expectations for the cost headwinds of more expensive credit?

Howard Marks made this observation last year “Relatively few investors today are old enough to remember a time when interest rates behaved differently. Everyone who has come into this business since 1980 – in other words the vast majority of today’s investors – has, with relatively few exceptions, only seen interest rates that were either declining or ultra-low (or both).”   

Certainly markets have been driven in 2023 by short term speculation regarding the direction of longer term interest rates and central bank actions and words. Markets seem less concerned over the consequence of central banks’ commitment to reduce their balance sheets after an extensive period of quantitative easing. If central banks turn off their buying taps while governments (especially the US) continue to run at record deficits the period of “free lunch” for spending will be over quickly.  

Another way to look at the problem is US economic growth. The US economy grew at 5% last year which is a strong rebound and should give cause for optimism. But some estimates have the US government deficit fiscal spending responsible for over 2/3rds of that annual growth and if you take inflation into account then the US economy shrank. That sense of optimism starts to diminish.  

We enter 2024 with a defensive position: high levels of cash, low credit risk and duration, no property exposure, significant gold reserves and a focus on value within equity markets. Our base position is as follows:

  • that inflation is declining but sticky (above 3%)
  • interest rates appear to have peaked
  • interest rates will not be reduced below the level of inflation
  • the UK may avoid recession but will struggle to grow
  • UK and US elections are likely to support fiscal interventions in respective economies
  • equity markets have absorbed some of the economic headwinds in pricing but seem exposed to liquidity reduction from central banks and speculative flows
  • gold’s attributes (defensiveness and inflation protection) remain
  • property is behind other assets in reprising for higher debt costs and reduced availability  

We will underperform if the Magnificent Seven return for a sequel this year, but as we have seen with the Marvel cinematic franchise in 2023, you can’t sustain these forever. We will outperform if markets are volatile and if growth expectations falter and interest rate reductions are postponed. The data suggests the latter is more likely.

Either way we are well positioned to act thoughtfully, and decisively, at speed to try and achieve your objectives whatever the economic outcome.