How should investors protect themselves?

Market fluctuations could spike towards the end of the year…

How should investors protect themselves?

-As November draws to a close, the world witnesses a convergence of events that have left investors wondering about what 2024 would bring. Based on the data released in November, it wasn’t exactly crisp clear whether the US economy would have a soft landing or slide into recession. While weak labor market was accompanied by a slowdown in housing, retail sales and ISM Purchasing Manager Index (PMI) for both manufacturing and non-manufacturing, there were still parts of the housing market and GDP which seemed resilient.

–There were also some bright spots such as a tick up in the annual housing price index, and higher quarterly gross domestic product which pointed to some resilience. What drove the positive sentiment in the markets however wasn’t the positive macroeconomic data. To the contrary it was the slow-down in the economic fundamentals accompanied by gradually retreating inflation. Indeed, the US annual consumer price index (CPI) and core CPI which excludes energy and food prices, both dropped from 3.7% and 4.1% in October to 3.2% and 4% in November respectively.

–As of November 28^th, the US equity index S&P 500 and European stock index Euro Stoxx 50 were both up by +8.6% and +7% on the month, jacking up their year to date returns to +18.6% and +14.6% respectively. Over the same period the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM were both up by 8.6% and 8.2% on the month respectively. While ACWI almost doubled its year-to-date return to 15.2%, EEM finally moved into the positive territory with +4.8% year to date return.

–November witnessed a monthly gain of +3.3% in the first month futures contract for gold, contributing to a year-to-date return of +12.8%. Investors seeking a store of value and a hedge against inflation tend to find solace in this precious metal. Crude oil, the heart of the energy market, experienced a global drop in prices during November. As of November 28^th, the first month futures contract for US crude oil WTI was down by -5.7% on the month, finally dragging its year-to-date return to the negative territory with -4.8%.

–It remained a bit complicated in the land of rates and bonds in November. As we had noted in our previous issue, normally when there is a risk-off or negative sentiment in the markets, investors tend to shift their investments to safer assets such as bonds, and particularly government bonds. This increases demand for bonds, driving up their prices and thus reducing their yields… and the opposite tends to happen when there is a risk-on sentiment where bond demand tends to drop.

–Performance of the crypto assets in November made it clear that 2023 will be an amazing year for crypto. As of November 28^th, Bitcoin delivered another strong month with +9.6%, contributing to an astounding year-to-date return of +130%. Ethereum dazzled with a monthly surge of +13.2%, propelling its year-to-date performance to a remarkable return of +71.3%.

-Turkish stock market reversed course in November and had a decent return both in local as well as in US dollar terms. As of November 28^th, Turkish stock market index BIST 100 gained +7.7% in local currency terms (+5.4% in US dollar basis). While this increased the index’s year to date return to 47% in local terms, its return in US dollar terms continued to remain underwater with -5%. The reason for the monthly performance in US dollar being lower than the one in local terms was due to 2.2% appreciation in the greenback against Turkish Lira.

-Towards the end of the year there tends to be more volatility as market players unwind their positions as they head out for the holidays. Reduced liquidity periods create the perfect storm for wild market moves. This period therefore warrants high caution for investors. For example, moving towards cash or safer investments such as gold or safe haven currencies like US dollar may be less risky than riding the fluctuations.

As November draws to a close, the world witnesses a convergence of events that have left investors wondering about what 2024 would bring. The month has seen a flurry of economic data, a pivotal FED interest rate decision, and the unexpected war in Israel, which sent shockwaves through the global financial landscape as we discussed in our previous issue.

Let’s start with the heartbeat of the US economy.

Based on the data released in November, it wasn’t exactly crisp clear whether the US economy would have a soft landing or slide into recession. While weak labor market was accompanied by a slowdown in housing, retail sales and ISM Purchasing Manager Index (PMI) for both manufacturing and non-manufacturing, there were still parts of the housing market and GDP which seemed resilient.

Let’s first look at existing and new home sales. They dropped from 3.96 and 0.76 in October to 3.79 and 0.68 in November respectively (the data is in millions) pointing to a weaker housing market. The retail sales also dropped with an annual increase of 3.8% in October vs. 2.5% in November. ISM’s manufacturing and non-manufacturing purchasing manager index (PMI), gauges of business conditions, dropped from 49 and 53.6 in October to 46.7 and 51.8 in November respectively again pointing to a potential economic contraction.

US LABOUR MARKETS STARTED TO SLOW DOWN

Labor markets which is a focal point for central banks when making monetary policy decisions also showed signs of a slowdown. Unemployment, a vital metric reflecting the labor market’s health, increased to 3.9% in November from 3.8% in October, highlighting a gradual weakening in the job market. The nonfarm payrolls which show the new jobs created in a given month dropped by more than 50% to 150,000 in November from 336,000 in October.

There were also some bright spots such as a tick up in the annual housing price index, and higher quarterly gross domestic product which pointed to some resilience.

What drove the positive sentiment in the markets however wasn’t the positive macroeconomic data. To the contrary it was the slow-down in the economic fundamentals accompanied by gradually retreating inflation. Indeed, the US annual consumer price index (CPI) and core CPI which excludes energy and food prices, both dropped from 3.7% and 4.1% in October to 3.2% and 4% in November respectively.

The US Federal Reserve’s November interest rate decision also played a pivotal role in shaping market sentiment. The central bank opted to maintain the benchmark interest rate at its existing levels of 5.5%, striking a balance between supporting economic growth and managing inflationary pressures. This decision combined with gradually easing inflation and signs of an economic slowdown fueled the expectation that the FED may not just stop hiking but may in fact start cutting rates in 2024.

This created a very positive and risk-on sentiment in the global markets.

EQUITIES PRICED IN THE POTENTIAL FED RATE CUTS IN 2024

Let’s start with equities. As of November 28^th, the US equity index S&P 500 and European stock index Euro Stoxx 50 were both up by +8.6% and +7% on the month, jacking up their year to date returns to +18.6% and +14.6% respectively.

The global equity markets benefitted from this optimistic outlook as well. Over the same period the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM were both up by 8.6% and 8.2% on the month respectively. While ACWI almost doubled its year-to-date return to 15.2%, EEM finally moved into the positive territory with +4.8% year to date return.

GOLD CONTINUED TO RALLY

November witnessed a monthly gain of +3.3% in the first month futures contract for gold, contributing to a year-to-date return of +12.8%. Investors seeking a store of value and a hedge against inflation tend to find solace in this precious metal.

DROP IN CRUDE OIL PRICES HELPED THE POSITIVE MARKET SENTIMENT

Crude oil, the heart of the energy market, experienced a global drop in prices during November. Several factors contribute to this decline, including concerns over slowing global demand and increased supply dampened market sentiment. As of November 28^th, the first month futures contract for US crude oil WTI was down by -5.7% on the month, finally dragging its year-to-date return to the negative territory with -4.8%. This drop in prices helped bolster the expectation that global inflation may soften up further which would pave the way to central banks’ rate cuts.

BOND YIELDS FINALLY STARTED TO SOFTEN UP

It remained a bit complicated in the land of rates and bonds in November. As we had noted in our previous issue, normally when there is a risk-off or negative sentiment in the markets, investors tend to shift their investments to safer assets such as bonds, and particularly government bonds. This increases demand for bonds, driving up their prices and thus reducing their yields… and the opposite tends to happen when there is a risk-on sentiment where bond demand tends to drop. As a result, bond prices either remain the same or go down slightly increasing the bond yields.

As our readers will remember in October bonds reacted counter intuitively, meaning bond yields continued their climb (and therefore prices dropped) despite a negative sentiment. This was due to “higher rates for longer” theme given stronger than expected economic growth and higher than expected inflation. In November bonds also reacted counter intuitively, but in the opposite direction of October. This was due to the prevailing positive market sentiment in November which pushed bond prices up (instead of down) and therefore dragged the yields down. This was due to an expected slowdown in macroeconomic data as well as the markets started to bet on a higher probability of FED rate cuts in 2024.

As of November 28^th, Bloomberg Global Aggregate Bond Index, the benchmark for global investment grade bonds was up by +3.2% on the month pulling its year-to-date return to 3.6%. Similarly, Bloomberg Global Corporate Bond and High Yield Bond Indexes were also up on the month adding +4.3% and +4.1% respectively. This brought their year to date returns to 4.7% and 8.8% respectively.

IT HAS BEEN AN AMAZING YEAR FOR CRYPTO

Performance of the crypto assets in November made it clear that 2023 will be an amazing year for crypto. As of November 28^th, Bitcoin delivered another strong month with +9.6%, contributing to an astounding year-to-date return of +130%. Ethereum dazzled with a monthly surge of +13.2%, propelling its year-to-date performance to a remarkable return of +71.3%. These digital currencies continue to captivate investors, driven by their increased daily use, growing acceptance and the potential for decentralized finance alongside their diversification benefits and role as a potential hedge against inflation.

TURKISH STOCKS JOINED THE POSITIVE MARKET SENTIMENT

Turkish stock market reversed course in November and had a decent return both in local as well as in US dollar terms. As of November 28^th, Turkish stock market index BIST 100 gained +7.7% in local currency terms (+5.4% in US dollar basis). While this increased the index’s year to date return to 47% in local terms, its return in US dollar terms continued to remain underwater with -5%. The reason for the monthly performance in US dollar being lower than the one in local terms was due to 2.2% appreciation in the greenback against Turkish Lira.

MARKET VOLATILITY COULD SPIKE TOWARDS THE END OF THE YEAR

Over the last couple months markets have done a zig zag as investors couldn’t seem to be able to make up their minds as to which way the economy is going to land. While the market consensus seems to be to the positive side, it is not clear whether and when inflation will really go back to its 2% target and if this can be achieved without causing recession.

There is still a strong possibility that inflation may remain persistent while the economy keeps slowing down pushing US as well as most of Group of Seven (G7)[2] countries into an unpleasant stagflation environment. Stagflation is generally defined as persistent inflation and high unemployment combined with economic slowdown or recession and tends to be very challenging for central banks. This is because hiking the rates to curb inflation has a tendency to also curb the macroeconomic fundamentals whereas not raising the rates could lead to runaway inflation which would be an even larger problem in the future. Emerging market countries, like Turkey are all too familiar with this conundrum given their past experiences.

As the markets are currently laser focused on each macroeconomic data coming from large economic players like US, Europe and China, the likelihood of sudden shifts in market sentiment is relatively high. As we had noted in our previous issue, towards the end of the year there tends to be more volatility as market players unwind their positions as they head out for the holidays. Reduced liquidity periods create the perfect storm for wild market moves.

Let’s also not forget the non-economic factors such as the ongoing geopolitical tensions and potential COVID-19 variants.

All these factors combined warrant high caution for investors regardless of the asset class they are invested in. For example, moving towards cash or safer investments such as gold or safe haven currencies like US dollar may be less risky than riding the fluctuations.

MARKET OUTLOOK REMAINS CAUTIOUSLY OPTIMISTIC

All that being said, as we approach the end of 2023, the market outlook remains cautiously optimistic. The US economy is poised for growth, supported by resilient fundamentals and the pause in rate hikes. The resolution of geopolitical tensions and ongoing efforts towards stability can further bolster market confidence. Also, the larger central banks will need to be able to figure out the right balance in monetary policy in 2024 if they don’t want to battle recession, inflation or stagflation. Otherwise, 2024 could be a year of really bad surprises.

As always Investors should diversify not only their portfolios but also their risk exposures and remain vigilant, adaptive, and guided by strategic insight as they navigate the ever-evolving landscape.

ELA KARAHASANOGLU, MBA, CFA, CAIA

International Finance Expert

karahasanoglu@turcomoney.com

ela.karahasanoglu@ekrportfolioadvisory.com

https://www.linkedin.com/in/elakarahasanoglu/

https://www.linkedin.com/in/elakarahasanoglu/

[2] Group of Seven (G7) is an informal grouping of seven of the world’s advanced economies, including Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States, as well as the European Union.