Review 2023 & Outlook 2024 –
R-co Valor & R-co Valor Balanced

In light of the sustained hike in key rates, the market broadly expected 2023 to be a recession year. Yet, the current environment seems quite far from such scenario.

As expected, central banks stuck to their hawkish policies with the goal of fighting inflation. Interest rates were hiked steeply on both sides of the Atlantic, by 100 basis points (bps) by the Fed, and by 200 bps by the ECB. These policies were successful in slowing inflation markedly during the year. However, as the year draws to a close, there is still some way to go in the case of core inflation⁽¹⁾ (at 4% in the US and 3.6% in Europe)⁽²⁾. These last 12 months have featured a series of factors that were rather far off the scenarios expected by consensus in late 2022. First of all, economies worldwide were surprisingly resilient. Indeed, global growth is projected at 3% by the IMF, including 0.7% in the Eurozone and 2.1% in the US⁽³⁾. Companies benefited from strong pricing power⁽⁴⁾, while consumers, particularly in the US, have been the main driver of growth in the country. Another surprise has been the impressive performance of both equity and bond markets. Indices have brushed up against their all-time highs, driven by the massive outperformance of tech companies. Share prices of US “tech megacaps”⁽⁵⁾ have soared, benefitting from sound inflows, as investors have shifted increasingly to companies offering solid earnings. Meanwhile, cost-cutting in 2022 and more stringent budget discipline contributed to margin improvement . The sector has also been driven by the theme of artificial intelligence, with the market rewarding, sometimes exuberantly, companies positioned on this trend. Lastly, China brought its share of disappointment, as the end of its zero-Covid policy did not produce a marked rebound in consumer spending, as it occurred in other countries. Chinese household confidence was hit by high unemployment, particularly among young people, thus undermining domestic consumption. Meanwhile, exports took a hit from lacklustre international demand, and the real-estate crisis, punctuated by a series of developers on the verge of bankruptcy, proved to be a large obstacle to China’s economic activity. The government has nonetheless provided support to growth, via recovery plans and credit stimulus policies. Against this backdrop, some sectors did fare well, such as education and travel.

What we did in 2023 with R-co Valor

We reduced our risk exposure throughout the year, lowering our equity allocation from 83% in January to as low as 67%⁽⁶⁾, and reducing our exposure to cyclical stocks. This translated into sales and subsequently lower weightings of financial, industrial and diversified mining stocks. We also took some profits on selected tech stocks, particularly late in the year. In parallel, we reinforced our Chinese stock holdings to prevent the dilution of our Chinese exposure. We also made some opportunistic purchases of stocks that had excessively de-rated, as well as some defensive stocks, such as goldmines. In addition to equity investments, we overweighted money-market investments. We are positioned in particular on French government bonds maturing in less than one year. The yield close to 3.7%(7), and their high liquidity, makes them an optimal holding positon .
The fund gained 13% in 2023(8). Unsurprisingly, exposure to the tech sector was the main contributor during the period, led by stocks such as Uber, Meta and Mercado Libre (the first two posting performances well in excess of 100% over the period(7)). Diversified mining companies also stood out alongside industrial stocks with strong pricing power. There was nonetheless some dispersion among these, with ABB and Airbus faring very well and Alstom and Honeywell disappointing.

What we did in 2023 with R-co Valor Balanced

Similarly to R-co Valor, we reduced our equity exposure throughout the year, to 34% by the end of December.

The fund’s bond allocation was raised gradually from 49% at the start of the year to 55% currently⁽⁸⁾. We took advantage of some opportunities, particularly in investment grade issues⁽⁹⁾. This lowered our high yield⁽¹⁰⁾ / non-rated allocation from 18% to 12.8% of the bond allocation by year-end⁽⁸⁾. The maturity wall projected for 2025-2026 is worth monitoring in 2024. Some companies will have to refinance their debt, perhaps at much higher rates. With this in mind, we have set up some hedges within the riskiest portion of the portfolio. With the monetary tightening cycle coming to an end, the portfolio’s sensitivity was gradually raised during the year. To do so while avoiding raising our credit risk, we bought 10- and 20-year Bunds. We reduced these holdings late in the year in reaction to the steep drop in interest rates.

The fund gained 11.3% in 2023⁽⁸⁾. The bond allocation contributed about 45% to the year’s performance(8). Our exposure to the asset class played its volatility-cushioning role in full, but also served as a driver of performance itself. As for market performance, euro investment grade achieved its best performance in 10 years, at +8.2%⁽⁷⁾. In the riskier allocation, high yield performed especially well in 2023, with relatively tight spreads⁽¹¹⁾, a symptom of investors’ confidence in a soft landing scenario.

In reaction to the shift in the tone of the US Federal Reserve, opening the door to possible rate cuts as soon as the first half of next year, market participants overwhelmingly endorsed the Goldilocks scenario⁽¹²⁾.

Consensus is projecting an economic slowdown for 2024, though excluding a recession, with central banks’ lowering their rates massively over the first half of the year. Under this scenario, corporate earnings’ growth is projected at about +7.5% in Europe, and +12.5% in the US⁽¹³⁾. This win-win scenario looks a bit overdone. Core inflation is down but still at 4%⁽¹⁴⁾. The Fed, which is still set on its 2% target, would risk undermining its credibility if it acted too early. In a structurally more inflationary world, we expect inflation to return to 3%, with wage inflation remaining a major challenge. In Europe, the starting point is slightly different, as economic activity is weaker than in the US, although key rates are also lower (4% vs 5.25%)⁽¹⁵⁾. The prevailing glumness could prompt the ECB to cut rates before the Fed. Historically, this has seldom been the case – only once in the past ten easing cycles. At their latest meetings, the ECB and the Bank of England also took note of an improvement on the inflation front, while striking a more moderate tone on a possible rate cut in the near future.

Market sentiment looks excessively optimistic, with investors’ betting on massive rate cuts and a soft landing. These look hard to reconcile, and we believe that if the central banks opt for an excessively accommodative policy, it will be in reaction to a deep economic recession. With this in mind, we continue to take some profits as markets rise, with no desire to increase our risk exposure entering 2024.

However, nor are we adhering to a worst-case scenario. Public spending was a big source of support last year and will be a driver of growth in 2024. In the US, for example, the funds released under the various rescue plans are far from depleted, as just 350 billion dollars out of 1 800 billion dollars approved (i.e., about 20%) have been deployed. It is hard to say when, or if, these funds will be disbursed, but they can reasonably be expected to support economic growth. Moreover, based on a more “market-oriented” approach, inflows could provide support to equities. In the US, record amounts flowed into money-market funds in 2023, which gathered more than 1 000 billion dollars⁽¹⁶⁾. Over the same period, only 125 billion dollars⁽¹⁶⁾ flowed into US equities, whereas the Nasdaq 100 hit an all-time high and the S&P 500 came close to doing so.

China, the big loser of 2023, could make a comeback in the next few months. Signs of recovery are beginning to emerge, including an upturn in retail sales, a Caixin PMI⁽¹⁷⁾ in expansion territory, and a slower decline of real-estate prices. Moreover, the Chinese Communist Party looks more on board than ever in achieving sustained economic growth via a series of stimulus measures. Beijing seems to have begun to defuse the risks in the real-estate sector by addressing the financing needs of real-estate companies to allow them to complete current projects. Lastly, on the geopolitical front, November featured a historic meeting between the US and Chinese presidents, Joe Biden and Xi Jinping. The meeting was held in the US and was interpreted as a sign of renewed dialogue between the two countries. This has also shown up in the resumption in flights between the two countries and the signing of new trade deals. Even so, these factors still have not won over foreign investors or the Chinese population.

Lastly, 2024 will be an election year in the US, of course, but also in India, the UK and Mexico. In fact, almost two thirds of the Democratic world will be voting in 2024. Election years are generally periods in which governments try to avoid austerity measures and where central banks tend to take a neutral stance in the run-up to election cycles.

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