With the rise of Artificial Intelligence (AI), companies like NVIDIA (NASDAQ: NVDA) and more, investors are wondering – what’s next for the share market? Drew Meredith, CFP of Wattle Partners writes…
As the page turns on the new financial year, we reflect on what was once again a significantly better result than many expected.
Looking back 12 months, few predicted that most major global share markets, including the Nasdaq 100 and S&P500, would re-enter a bull market, nor that most major economies would remain so resilient in the face of relentless interest rate increases.
Both investors and advisers have the tendency to extrapolate recent events into the future, with our inherent recency bias, central to this, but the last six months have shown why this is dangerous.
Tech stocks rally
The biggest story of 2023 thus far is the significant outperformance of the technology sector, driven by the boom in artificial intelligence and resultant benefits to some of the largest companies in the world, be that NVIDIA Inc (NASDAQ: NVDA), Apple Inc (NASDAQ: AAPL) or Microsoft Corp (NASDAQ: MSFT).
This outperformance came despite broad calls for the return of ‘value’ investing or the need for investors to focus on more ‘cyclical’, traditional business as the rate cycle turned.
Among the more interesting pieces I’ve read in recent months was an extensive paper by the US Federal Reserve, which very broadly suggested that nearly all of the returns generated by share markets over the last three decades were a result of falling interest rates.
This trend, the paper asserts, boosted corporate profits via lower borrowing costs and supported higher price-earnings multiples.
The release of this paper triggered an interest in assessing what lies ahead for investors, and advisers, for the rest of 2023. Thus, I’ve put together what I believe are the five key issues that should be at the front of everyone’s minds when reviewing and building portfolios today.
My 5 key issues for the rest of 2023
The first is linked directly to movements in interest rates, and that is the growing uncertainty in unlisted asset valuations. By no means am I suggesting that the massive infrastructure, direct property, private equity or venture capital investments that dominate the balance sheets of industry funds and other professional investors are all overvalued. Rather, I’m suggesting investors be wary amid what will likely be a period of transition and volatility.
Consider for instance an investment property, say, an industrial warehouse, which was purchased on an income of 4 per cent when term deposit rates were offering 1 per cent. With the low-risk alternative now offering the same yield, naturally the value of said asset must be lower.
While I agree, this may be oversimplifying matters, it is clear there is something afoot as valuations across the listed property sector continue to fall and the regularity of major property assets selling at a discount to their carrying value increases.
A similar story would be said for private market investing, particularly venture capital, with Canva, a case in point that attracts more than its fair share of attention. It is clear the valuations of the past are a long way away, that said, it doesn’t necessitate a significant reversal in fortunes in the very short term.
The message here is really to tread carefully, and to make sure you have confidence in the valuations of the assets you are purchasing. In previous cycles, providing the capital to act opportunistically in this environment has tended to pay off.
This extends to the second challenge, which is the ‘rolling over’ of floating rate fixed income securities. Floating of variable rate investments attracted the lion’s share of flows in 2023, as investors flocked to their inflation hedging characteristics. However, with bond yields falling there is a growing risk that both income and capital values fall should the outlook for the economy worsen, eventually triggering rate cuts.
Returning to the message of ‘recency’ bias, is the growing calls that ‘active management is back’. Higher volatility, the saying goes, offers a better opportunity for active managers to outperform. Yet we know from the last few years, among the most volatile in history, that a rising tide does not lift all boats.
There clearly remains value in active management, yet history has shown many broad-based managers struggle to outperform consistently. Thus it remains apparent that a blend of both passive and active strategies will be key, particularly for retirees, and that it is as important as ever to ensure you are truly getting what you pay for on the active side.
The last point may be the least interesting, and that is that from first-hand experience, both advised and unadvised investors may be taking more risk than they need to. Higher interest rates have brought an entire asset class back into investability, that being fixed income and bonds, yet these remain underweight and broadly misunderstood by most.
Central to any investment portfolio should be the focus on taking as little risk as possible to achieve one’s stated investment and income objectives.