Merry Christmas from the Montgomery team
As we approach the end of the year let’s briefly reflect on the major developments of the year and share some thoughts about what may transpire in 2024.
At the end of 2022, my overriding prediction was that 2023 would not see a recession in the U.S. or Australia and that it would be a broadly positive year for equities, especially innovative companies with growth or pricing power. This view was not a widely shared one. Looking back, with the S&P 500 Total Return Index up 20.80 per cent in calendar 2023 (from 1 January 2023 to 30 November 2023) and the S&P/ASX 300 Accumulation Index up 4.58 per cent for the same period, the non-consensus view has proven useful, if not prescient.
The one deficiency in my forecast was that smaller innovative companies would also do well. They didn’t. Not in aggregate, anyway. The S&P/ ASX Small Ordinaries Index has only returned 0.56 per cent from 1 January 2023 to 30 November 2023.
This leads me to contemplate the outlook for 2024. Last month, in November 2023, U.S. 10-year and two-year Treasury bond yields plunged amid optimism that the U.S. Federal Reserve has concluded its interest rate hiking cycle and may cut rates next year.
In the meantime, according to the CME’s FedWatch Tool (a tool which measures market expectations for Fed fund rate changes), markets are pricing in a greater-than 50 per cent chance that benchmark interest rates will fall more than 125 basis points by December 2024. Most recently that view was backed by none other than the Federal Reserve’s Chair, Jerome Powell.
I don’t know if rate cuts are a certainty but I remain convinced that even expectations of interest rate cuts will be positive for the market valuation of smaller companies, especially those high-quality issues our managers tend to acquire.
The gap in performance between large-cap innovative companies – the Magnificent Seven, for example – and their smaller peers, and the narrowness of the rally in large-cap stocks this year, suggests to me many quality small caps will be on professional investors’ radars.
They could ‘catch up’, especially if the macroeconomic background includes positive economic growth and disinflation. In any case, if one remembers that buying and selling a stock on the same P/E delivers the same annual return as the earnings per share growth rate that the company produces, investors should do well given small cap P/Es remain at historically compressed levels.
The Montgomery team will all be taking a break from blogging over the Christmas and new Year period, so you can too. We’ll be back from the beginning of February with a fresh raft of insights and investment ideas.
From all of the team here at Montgomery we wish you and your families a safe and happy Christmas and we hope that 2024 delivers you and your loved one’s immeasurable joy.
If you would like to catch up on some holiday reading, you can re-visit our top ten articles from 2023 via the links below: