Schroders Personal Wealth’s review and outlook 2023-24

This article is based on a panel-based webinar for ongoing advice clients of Schroders Personal Wealth (SPW), broadcast on 4 December 2023. The panel covered a range of topics, including financial advice, SPW portfolio performance and positioning, and SPW’s approach to advice and investment. This article covers comments concerning our review of 2023 and our outlook for 2024.

The backdrop

The end of the pandemic led to a reduction in stock market and economic uncertainty. This recovery in market sentiment underpinned a broad rise in equities (shares) from March 2020 to the end of 2021.

Government support for global economies during the pandemic helped keep unemployment low. This meant demand for goods and services was delayed rather than being destroyed as the economy reopened.

The pandemic not only caused supply chain problems, but lockdowns shifted household demand from services to goods, contributing to shortages. This combination of higher demand and limited goods supply helped drive up prices, creating high inflation.

Moreover, the tragic events in Ukraine triggered a steep rise in food and energy prices. Ukraine is a key supplier of wheat and Russia a key supplier of energy.

All in all, this led to 40-year-high rates of inflation at the end of 2022. Inflation is the enemy of investors, as it reduces the amount you can actually buy with your cash and savings.

Central banks responded to high inflation by raising interest rates: interest rates are a tool used to try to control inflation. This led to a ‘normalisation’ of interest rate policy after an extended period of ultra-low rates. Higher interest rates raised the attractions of cash-based holdings such as savings accounts, but they also led equities and bonds to perform relatively weakly. Indeed there was an equity and bond sell-off throughout 2022 as interest rates rose.

Our economic expectations

Europe underwent recessionary conditions for some of 2023 and we currently expect a shallow recession in the UK in the near term. But we also believe the European and UK economies will improve going into the second half of 2024 and beyond.

In our view, interest rates may now be at a peak and we expect rate cuts in major economies in 2024. As inflation comes down and interest rates fall, the economic outlook could improve. Inflation has already reduced, even if it’s not yet down to the long-term levels sought by central banks.

The US economy has held up better than the European and UK economies. We expect US interest rates to be kept higher for longer in the US, which means until the second half of 2024. We also expect the US to undergo an economic slowdown, which will help bring inflation down to more normal levels.

Impact on investments

Corporate bonds have had a difficult two years. The tragic events in Ukraine made 2022 particularly challenging for the markets. In times of uncertainty investors often prefer lower risk, safe haven investments, which can include government bonds and high-quality (investment grade) corporate bonds. But this preference hasn’t been as marked as usual in the past couple of years, due to rising inflation. Rising inflation often leads to rising interest rates and the prices of bonds and equities often fall when interest rates go up.

Indeed most asset classes fell in value in the first half of 2022, although commodities rose, due in part to wheat shortages, as Ukraine is a large wheat producer. But markets generally stabilised somewhat in the second half of 2022.

Outlook for fixed income in 2024

We believe now could be a good time to move money into well diversified portfolios with levels of risk appropriate to clients’ circumstances.

We expect interest rates to come down as inflation falls, with a consequent reduction in interest on cash-based savings. But yields on high-quality (investment grade) corporate bonds look relatively attractive. We believe this could be a real opportunity for investors. Moreover bonds should generally do well as interest rates come down, as this often leads their prices to rise.

Even so, we are probably back to more historically ‘normal’ levels of interest rates now. Yes, there might be interest rate cuts, but we don’t expect them to fall to the historic lows of recent years. So, looking to the future, we think fixed income assets could offer real long-term value.

Geopolitical challenges

We do, though, still see significant geopolitical risks, given the rise of political populism. Bond prices have become more sensitive to geopolitical tensions and domestic issues due to central banks winding down their bond-buying programmes. We saw this during the brief premiership of Liz Truss, when prices of UK government bonds fell sharply after the mini-budget of September 2022.

The expansion of globalisation and the emergence of China into the global economy have been big trends of the last 30 years. The production of goods to parts of the world with cheaper workers brought down the cost of many goods worldwide. But this situation started coming to an end in the middle of the last decade, as prices of goods and labour from China began to rise.

Tensions have been building between the West and China in recent years, particularly as US and European exports into China are heavily taxed. So many Western companies are shifting away from China as a source of labour and production and looking to alternatives such as Mexico. This has led to rising prices and an increase in global inflation.

We note that vast swathes of the globe are now influenced by Chinese politics. And we are aware of the current impact of China’s real estate troubles.

Opportunities in Japan

Against this backdrop, we believe Japan can benefit as some countries try to distance themselves from China. The Japanese economy has done well in the past year as the yen has weakened. This has led its exports to become cheaper, leading to increased demand for them. There has also been a significant improvement in the way Japanese companies are governed and in their investor relations.

All in all, we have a positive outlook for Japan. This is despite the fact that potential interest rate rises could dent economic growth, especially as Japan has a relatively ageing population that could be affected by such higher rates.

UK’s high tax burden and property outlook

In November’s Autumn Statement, UK chancellor Jeremy Hunt announced a cut in National Insurance rates from January 2024. But income tax thresholds have not been raised in line with inflation and, overall, the UK is facing the highest tax burden (in percentage terms) since the 1970s.

Moreover recent periods of unpredictable inflation pose challenges for both individuals and companies. Concerningly, Office for Budget Responsibility (OBR) forecasts consider that government tax policies are detracting from economic growth.

Turning now to property, UK residential property has declined by around 4 percent from its peak. We expect interest rates to begin to fall from around May 2024 and we expect property values to decline by around 10 percent. But, for an average couple, house prices would have to fall by around 30 percent to compensate for the financial impact of the interest rate rises of the past two years. So there’s currently an ‘affordability gap’ and we believe this will drive house prices lower in the short term. However we think house prices could stabilise if interest rates fall sufficiently in the next two years.

Deglobalisation, decarbonisation and demographics

Working age populations have started to shrink in many economies, raising questions about how countries can expand with smaller workforces. And while we welcome the positive environmental impact of decarbonisation, at present we often end up replacing our energy supplies with more expensive versions. These issues of deglobalisation, decarbonisation and ageing demographics could be raising inflation by an estimated 1 or 2 percentage points. And this can have an impact on long-term investors.

In the long run, economies can experience vastly different interest rate environments. Following the financial crisis of 2008, interest rates went down below zero in some economies. In contrast, UK interest rates briefly rose to 16 percent in the 1980s. We currently expect interest rates to fall, but not back to zero. It’s hard to predict what the floor might be, but it could perhaps be around 3-4 percent.

Yields on government bonds and corporate bonds are back at the levels of 2008. Meanwhile technology giants such as Amazon, Microsoft and Apple have driven US and global markets upwards. Could this mean that now is the wrong time to invest in equities? Not in our view. The 10 largest stocks in the US stock market have driven the market to rise by around 10 percent this year. But the US stock market’s performance has been relatively flat once these stocks are excluded. So the rest of market isn’t looking particularly overvalued.

Around 45 percent of the global population could face elections in 2024, as the US, UK, Russia, India, Indonesia and Taiwan may go to the polls. So there is considerable political uncertainty at present.

But, as always, we remain positive on investing in line with the key SPW principles of being appropriately diversified (reducing investment risk by not having all your eggs in one basket) and willing to invest for the long term (to potentially ride out short-term market turbulence). The main thing is not to panic. We’ve been undergoing an economic and market downturn and the cost of living crisis leaves none of us untouched. Even so, this is probably the tamest economic downturn we’ve had for many years and we believe things will improve.

The peak in inflation is particularly encouraging. As we said at the start of this article, inflation is the enemy of investors, as it reduces the amount you can actually buy with your cash and savings. Falling inflation will also help with the cost of living crisis, even if there is still some way to go here.