Market update
As we move into 2024, it’s a good time to look back at 2023, take stock of the market environment, the major themes which influenced markets and how these affected investment returns. We will then look ahead to what 2024 might bring.
There were three major themes which dominated markets in 2023
1. Inflation
Starting in 2022 and continuing into 2023, inflation rose in most countries around the world, including in Australia. The result is that inflation has been, and remains higher than central banks around the world, including the Reserve Bank of Australia (RBA), want it to be.
Some inflation is good for an economy, because it shows the economy is growing, but when inflation is too high it becomes a problem. It means many people may no longer be able to afford the things they usually buy or the things they need, like electricity and medicine. And when input costs for businesses go up, they pass these onto consumers in the form of higher prices – making inflation worse.
When thinking about inflation, it’s important to recognise that many factors can cause prices to rise and create inflationary pressure. Supply chain disruptions during COVID led to increased shipping and production costs which translated into higher prices for consumers – creating inflationary pressure. And even post-COVID, lingering supply chain issues combined with a surge in consumer demand for goods continued to drive prices higher, again contributing to inflation.
Supply chains have mostly normalised post-COVID, but the reality is that global and localised events will always contribute to inflation. Extreme weather events like floods and bushfires, intensified by climate change, can increase the costs of agricultural products. And in addition, the increased frequency of these events has repercussions on other industries, like insurance, increasing costs there as well.
The only certainty in investing is that no one has a crystal ball for predicting market movements. This underscores the importance of taking a long-term view, and building a diversified portfolio of assets which can help mitigate risks and uncertainties.
2. Interest rates
Interest rates are central banks’ main tool when it comes to controlling inflation. When they raise rates, the aim is to slow the economy down because this is expected to bring inflation down as well.
Most central banks around the world have kept interest rates on an upward-moving trajectory throughout 2023, while they carefully analyse economic data and navigate the tricky path of slowing inflationary pressures without triggering a recession. In Australia, the RBA has raised rates 13 times, from 0.1% in May 2022 to 4.35% in December 2023.
The good news is that inflation has been gradually coming down as a result of the higher interest rates. In Australia, the monthly inflation measure has fallen from a high of 8.4% at the end of 2022 to 4.3% at the end of November, which is a significant drop. However, inflation is still a long way outside the RBA’s target range of 2-3%.
There’s always a lag between rates going up and the economy slowing down, so it is difficult to predict with certainty how quickly, or by how much inflation will fall when rates rise. So even though inflation has continued to gradually fall, no one can say for certain if the RBA has done enough or whether rates will need to be lifted again. Inflation is notoriously lumpy, something we saw clearly in the 1970s when inflation appeared initially to have been tamed by higher rates, only for it to later resurge. The old adage that “it’s hard to put the inflation genie back in the bottle” has often proved true.
Markets move up and down in line with investors’ reactions to different pieces of news and world events. During 2023, investors were unsure about how quickly central banks would raise interest rates, or how high rates would go. It was this uncertainty that caused periods of volatility, or ups and downs, during the year.
A good example of what happened during the year is the difference in the performance of shares in the September and December quarters. In the September quarter, many investors thought that interest rates would stay high for a long time. This made them believe that if they invested in ‘riskier’ assets, like shares, they might not make a good return. When investors worry about the performance of riskier investments, we call it a ‘risk-off’ mood. This is what happened in the September quarter, and it caused shares to perform badly.
In December on the other hand, the mood changed. Investors began to believe that rates might not stay high for much longer. They started to think that central banks had done enough to curb inflation, and that we could even see rate cuts as early as March 2024, creating a ‘soft landing’ rather than a recession. This made investors more willing to take risks, and we call this a ‘risk-on’ mood. Because of the more positive outlook, shares performed well in the December quarter.
If you're concerned about market activity or you want to review your investments, make an appointment to speak to your Financial Planner to review which strategy is best for you.
3. Geopolitical tensions
Geopolitical tensions and conflicts cause volatility in markets because they create investor uncertainty. This year we saw on-going global conflicts around the world, and these made markets volatile at times.
