This is the Principia Investment Consultants review of financial markets for 2023. This time last year, analysts were busy telling the world about their forecasts for the year ahead, which centered around how Australia and the rest of the world were heading for recession, tech stocks had further to fall, and now was a great time to be in bonds. But none of that happened…

Introduction.

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It’s not quite the end of 2023 yet, but with data to November 30 it’s close enough to review the performance of the Australian and global equity markets and the global bond market. We are not expecting any big changes as we come into the final weeks of the year, but of course the unexpected could always happen!

Before reviewing the performance of markets this year, it’s always a good idea to do this in the context of what happened last year. The threat of rising interest rates against a background of soaring inflation pushed stocks down in the first months of 2022, and coupled with the conflict in Ukraine and the start of the aggressive interest rate cycle that began in May the market remained volatile throughout the year.

In Australia, the ASX 200 index reached its lowest point at the end of September and was down negative 9.6%. The last quarter saw a recovery, and the index finished 2022 down negative 1.1%. But that was relatively good compared to the rest of the world – in the US the S&P 500 index was down by more than 20% at times – what’s termed a bear market – and finished the year down negative 18.5%. The high-tech stocks did even worse – they ended the year down by negative 32.5%.

And as interest rates rose from essentially zero to end 2022 at 3.1% after 8 consecutive rate rises the bond market delivered its worst returns on record, with the Australian bond market down near negative 10% and the global bond market coming in at negative 12.3%.

What were the predictions this time last year? Given that central banks had more work to do to bring inflation back to their target 2 – 3% band, the general view was that Australia and the global economy were heading for an unavoidable recession. It was going to be another tough year for equities, and particularly for high-tech stocks – which in theory are more interest rate sensitive than other sectors. But bond managers were very bullish on fixed interest, with commentary that bonds were about to make an historic recovery in the face of the economic slowdown.

So how has 2023 played out?

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Australian Equities.

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2023 kicked off with a bang for the ASX with one of the strongest January returns on record. Why? Well no one really knows, but at the time commentators were saying that the market had reassessed the effect of interest rate rises and concluded it's not going to be as bad as they thought back in December.

The market did fall over in early March when several US regional banks got into trouble and collapsed, and regulators had to step in to rescue the depositors. This reverberated across the global banking system, and in Europe Credit Suisse was sold to fellow Swiss banking giant UBS. But the banking “crisis” passed swiftly, and from there the market continued to rally – despite the continuing rate increases from the RBA – reaching a peak of 7.5% at the end of July, as shown in the chart below.

It was about that time that both here in Australia and the Federal Reserve Bank in the US reiterated that they expected interest rates would not be coming down anytime soon – rates would stay “higher for longer”.  This became a mantra for quite a few weeks, wiping out the gains for the year and by the end of October was sitting on a year-to-date return of zero.

Global Equities.

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In fact, festive cheer has come early to world markets on growing certainty that central banks will start slashing interest rates next year. Global stocks posted their best monthly performance in three years in November and global investment-grade bonds returned almost 4% - the best month on record going back to 1997.

While major markets were beaten down in 2022 it's the exact reverse in 2023 - even though interest rates have continued to go up. As mentioned, this is meant to be bad for high-tech stocks (at least that's what we were told way back in January) but the high-tech Nasdaq index has returned a staggering 37% this year, as shown in the chart below.

The Benefits of Diversification.

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Of more interest to an Australian investor is how these returns from other markets have played out in a diversified portfolio. While Australia has returned 4.8% developed markets (represented by the MSCI World ex Australia Index) has returned an impressive 21%, while the Emerging Markets (represented by the MSCI Emerging Market Index) are up just over 8% for the year.