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Insight - Making Sense of the Narrative


The Bond markets have curbed some of their enthusiasm over rate cuts while momentum stays with US tech. Japan and EM ex China continue to behave well, although China continues to behave like a bear market, This has little to do with fundamentals like value or earnings and more to do with perceptions of risk and uncertainty that are driving liquidity flows. However, we would note that the stock market is not the Bellweather of the Economy that it is in the US and that intervention will take place only for stabilisation. They do not believe in the so called Fed put, or the wealth effect.

Year in Review notes are often separated from Year Ahead pieces, but we find it helpful to combine the two in order to get context. 2023 was a much better year for 60:40 funds as both markets mean reverted from a terrible 2022. In Bonds, the mean reversal came late, following a dramatic selloff in Q3, the compelling bond math finally brought long term investors out of cash, taking hem from oversold to if not overbought, then fair value given rates are being eased not slashed. In Equities, the dominance of the Magnificent 7 meant active investors either made money not owning them in 2022 or owning them in 2023. Few did both. This year opportunities are likely to lie elsewhere, suggesting diversification either within the US market or geographically. International markets largely traded sideways with a positive year end (Europe, UK, EM ex China) or appeared to have started new bull phases - Japan and India. China, which remains in a bear market thanks to weak sentiment and aggressive narrative management is the equivalent of buying Meta in January 2023. One for the brave, but also one to watch. Politics will play a large part in narrative management this year and thus be key to risk management.

The traders unofficial year end at Thanksgiving produced a lot of mean reversion including powerful short squeezes in Equities and bonds and even if they have run out of momentum they have catalysed cash to move into Equities and bonds, focussing the mind of Asset Allocators on the challenges for 2024, first and foremost being that they need to generate real returns and beat cash rather than simply hug it.

Recency bias might lead us to think that the weakness in October was all about Gaza, but there were clear signs of fragility already appearing in bond markets as the mark to market impacts of the bond bear market continue to lead to forced selling, particularly in Japan. The key to stability is for cash to move out along the bond curve in fixed income even though we would not expect cash rates to fall much. however, the narrative will likely turn to slowdown to support the bond narrative, and we suspect the cash pile destined for equities will go to high quality dividend yield stocks offering the prospect of quality compound real returns. We thus expect a flip in Asset Allocation - from Long Duration Equities and short duration bonds, to Long Duration Bonds and Short duration equities

Watching flows helps us to look for influences other than fundamentals. We are watching Money Market inflows show a sign of slowing and reversing, the trader flows into the Magnificent seven (the only part of the market with inflows) doing something similar - also demonstrated in the long NASDAQ short S&P 500 flow and the trade to switch from EM to EM excluding China also appears to have stabilised. The first stop for those money market funds we suspect will be longer dated bonds, while the second will be shorter duration equities with strong cash flows and higher yields. While the world sits in cash it is worth doing some research as to where to go, when, not if, they start to deploy. Here too, flows can help us with our searching.