It is always a temptation to meet economists and strategists to hear their predictions for the year ahead. It is usually an interesting way to pass an hour, but after 40 years in the industry it is an offer that I always decline.
Maybe it’s because the discussions never inspire me enough to change my portfolio, or perhaps it’s because I am sceptical about their ability to predict with any accuracy. More likely it is a combination; I would not change my portfolio even if I knew they were likely to be 100% accurate.
I suspect the main narrative through, at least, the first half of 2024 will again be around interest rates. Unlike last year, rather than discussing how far they will rise, forecasters will concentrate on how fast and how soon they will be cut.
When I was at university, a long time ago, I was told that equity markets lead economics by around 12-18 months. Who knows whether that is true today, but if it retains any truth, it suggests that we should be looking at industries and businesses that will benefit from the next economic cycle.
This has clear implications for equity market leadership. Falling interest rates should take some pressure off mortgage holders and stimulate economic growth. However, as the decline in economic activity has been relatively modest since the beginning of the increase in interest rates, the recovery when rates decline will similarly be modest, though positive for investor sentiment.
Most forecasters claim the one attribute that I am confident they do not possess, is timing. The allusion of timing encourages activity. I remember many years ago asking a broking analyst his recommendations for a sector. He replied: ‘My recommendations remain, as always, trade vigorously’.
The most interesting trends and the ones that really matter are longer term, such as population declines, environmental changes, efficiency and artificial intelligence (AI), to name just a few. Two powerful factors which encompass most of these trends can be labelled, replacement and transformation.
Most businesses did their utmost to conserve cash during the Covid period. As we return to the new normal, corporates are under pressure to reformulate supply chains and bring them closer, improve energy efficiency and reduce harmful emissions.
The age of many assets is also at historic highs, evidenced by the state of infrastructure and the average age of equipment in many sectors. To maintain efficiency, businesses will need to replace unproductive assets with new equipment that can deliver greater performance, with more recycling, less waste and pollution.
Winners will not just be from the tech sector, but businesses who can combine hardware with software to deliver bespoke solutions to customers. Almost every sector will be required to invest to meet changing demands and regulations. This is likely to lead to wider market breadth, which should be positive for market sentiment and returns.
The engine for this change is likely to come from industrial businesses. Many have transformed significantly in recent years, both by exiting from low margin, low return segments, to faster growth, higher margin and less cyclical businesses.
Government funds already allocated to infrastructure will provide a tailwind. Some of these businesses have started to perform, but often valuations are still very attractive.
Conversely, sectors with high levels of debts, who are being forced to invest are likely to struggle. Utilities look exposed in this scenario. Consumer and so-called defensive sectors may also lag, due to high starting valuations and competitive pressures.
Globally there will be many challenges, from ongoing conflict in Ukraine and the Middle East as well as US elections. Near shoring appears to be benefiting Mexico and other South American countries that can offer stability. India and other Asian countries have many attractions as companies invest outside China and as favourable demographics, developing technologies and infrastructure, should drive faster growth than more mature European markets.
There are many reasons to be positive in 2024. Lower interest rates will revive optimism and the broad sector investment in replacement and transformational processes and technologies will broaden equity investor returns.
Rather than focus on the uncertainty of economic forecasts and predictions, this looks like a good time to find the companies that will benefit from these long-term trends.
Businesses that can survive the hardest recession and prosper in good times, that invest through the economic cycle and deliver for global customers. Find the right business, be patient and unlike the advice from my former broker, trade infrequently.
Graham Campbell is senior investment director at River Global Investors. The views expressed above should not be taken as investment advice.