Dear Friends,

For most investors, 2023 was year of many ups and downs. Despite some early choppiness, it closed with a flourish with US equity markets once again leading the parade in terms of gains among the major markets, albeit with a high degree of concentration among the so called magnificent 7 (Google, Amazon, Apple, Meta, Microsoft, Tesla and Nvidia), which accounted for 50% of the 24% gain recorded by the S&P 500. Returns for other US indices were less robust, with the Dow rising by 16% and smaller companies increasing by 17%. Globally, non-US stocks gained close to 16%, with both Europe and Japan up 20% in dollar terms, while China declined by 10%.

Fixed income markets were less impressive, with the broad bond market in the US ending up 5.5%. Fueled by an unprecedent rally in December, global bonds gained almost 9% for the year. On the commodities front, gold was up 14%, although the asset class as a group fell by approximately 10%, with declines in oil prices more than offsetting the gain in precious metals. Returns for other alternative strategies were mixed, with the world hedge fund index (HFRI) gaining 5%, while preliminary results for private equity investments look weak with venture capital in particular suffering as the market for IPOs dried up in the US.

For the year, our core strategy, Global Growth, gained 18%, net of fees and expenses. While we were perhaps overly conservative for much of the year, we did adjust our asset allocation towards the end of 2023, thereby benefitting from the year-end rally. As of January 1, approximately 70% of our model portfolio was invested in stocks, with 15% in fixed income securities (all dollar denominated) and 15% in alternative strategies. We were significantly overweight US equites, which represented 45% of the portfolio, while Europe accounted for 9%. Japan was a little under 7% and emerging markets were 10%. In addition, we held 4% in two global index funds, one of which focused on small cap value stocks.

In terms of individual returns (NB performance numbers only show changes in stock prices and do not include dividends), we had some significant successes in the US with Blackstone (2.3% of the portfolio) up 83%, Salesforce (2.9%) gaining 98%, and Google (2.3%) rising by 58%. On the negative side, following the decline in COVID treatments, Pfizer fell by 44% and Albemarle, the major lithium producer, was off by 43%, as over production and concerns about declining sales of electric vehicles (EVs) impacted its stock. Fortunately, our weightings in the latter two positions were relatively small, at a little over 1% each.

Outside of the US, the picture was more mixed. In Europe BNP gained 22%, while Roche fell by 7.5%. In Japan, Sony was up 24%, while Fanuc (the world’s leading producer of robots) declined 1.6%. Pleasingly, all of our emerging markets positions were up, with Taiwan Semiconductor gaining 40%, while the South Korean ETF was up 16% and HSBC rose by 30%. BYD, the Chinese EV manufacturer, climbed 13%.

Results on the fixed income side were also positive, as the short duration bond position was up 3% and the intermediate core piece rose by 6%. Our alternatives exposure added value, with the market neutral fund up 12%, the gold position gaining 13%, Pershing Square rising by 27%, while Energy Transfer rose by 16%. 

In the US, the macro story continues to be dominated by two interrelated factors: the FED and its battle with inflation, and the tenacity of the consumer. While it may be premature to conclude that the struggle against inflation is completely over, based on recent data from the consumer price index in particular, the evidence is pretty compelling. Interestingly, a substantial amount of the credit for the apparent victory appears to be due to resolution of supply side bottlenecks rather than FED tightening. Regardless, it has presumably paved the way for the FED to reduce interest rates in the US, though capital markets may have gotten a little ahead of themselves in terms of pricing in three interest rate cuts in 2024.

Meanwhile, the consumer, bolstered by COVID induced government spending, has, as so often has been the case, continued to power economic growth in the US. With consumer confidence up 13% in January, and now at a 2.5 year high, this trend looks likely to continue. Massive increases in federal spending targeting domestic industry and infrastructure, estimated to total well over $1 trillion, will fuel further US economic growth. Already, over the last two years, spending on manufacturing is up 137%, expenditures on power projects are up 56%, and water and sewage spending has grown by 27%.

 Although recent GDP growth in America is running at over 3%, correlations between economic growth and stock market returns is murky at best. At the end of the day, stock markets are primarily driven by earnings. Although profits and margins for the US corporate sector remain near record highs, expectations going forward are for growth to slow. In particular, some of the recent euphoria about the potential impact of AI seems overblown.

Significantly, the total value of US stocks is close to an all-time high as a percentage of the economy. Using the so-called “Buffet Rule”, which compares market capitalization to GDP, the value of US stocks is nearly 150% the size of our economy, equivalent to a 50% premium over the long-term average. Similarly, comparing our market capitalization and the size of our economy to the rest of the world shows that while US GDP has been shrinking relative other countries (down from 40% of the world in 1960 to roughly 24% today), fueled by recent out performance, the value of US equites is at a record high and now comprises close to 60% of global stock markets.

Not surprisingly, as a result of these outsized gains, equity valuations are very high in the US. The current price to earnings ratio (PE) of stocks is close to 20, compared to the historic average of 15.6.  At present, non-US stocks are trading at a 34% discount to America’s, near an all-time high. One area of concern we would be remiss not to mention is political risk in the US. With divisions increasing in the country, and the upcoming prospect of a bitter election campaign followed by an uncertain outcome, the potential impact on our economy and capital markets cannot be ignored.

Nonetheless, as Warren Buffet says, it is never a good idea to bet against America. In addition to the core strength of the economy and the resilience of the consumer, there are several pockets of opportunity in the US. Examples include: beaten down smaller companies which are trading at close to a 40% discount to their larger brethren, value-oriented stocks like the pharmaceutical companies, which should benefit from both the demographics of an aging population combined with a wave of innovation, and banks, which offer a pleasing combination of low cost and high dividends. Lastly, we see an opportunity to take advantage of the extreme concentration of equity gains among the magnificent 7 (see above) and are allocating to an equally weighted S&P fund in anticipation of a broadening of market gains. For the time being, we anticipate maintaining our overweight position in US stocks, but will alter it slightly to try to take advantage of mispricing in out of favor markets like Japan and potentially the UK.

Speaking of which, Japan, which has long been ignored by international investors, is having a moment. Foreign capital inflows were at a near record last year at $ 43 billion. Pretax profit margins are at an all-time high, as more companies are starting US style buyback programs, and governance reforms are gathering pace. In fact, the stock market now has a formal policy of de-listing companies which do not use capital effectively. Currently, half of all listed companies in Japan trade at below book value.

Most importantly, Japanese investors, who historically have had relatively little exposure to equities (24% own stocks as opposed to 75% in the US), are being offered tax incentives to invest more in equities. With over $7 trillion in cash, if retail investors make even a small re-allocation to stocks, it will have a major impact on the stock market. At the moment, 7% of the portfolio is invested in Japanese stocks. In an effort to seize the potential opportunity, we plan to increase this allocation.

Like Japan, stock markets in Europe have been in the relative doldrums for a number of years. They continue to trade at substantial discount to the US, with PE’s averaging around 13 compared to close to 20 in America. Headwinds include Europe’s dependency on world trade, which accounts for 50% of the GNP of some countries, and which is being pressured by both global decoupling and increased onshoring in places like the US. Another impediment is the European Community’s over reliance on the public sector.  For instance, in the US (by no means an exemplar), the public sector accounts for just over 35% of total expenditures. In France the number is 58%, in Italy 56%, and in Sweden 47%. In a similar vein, the government accounts for 13% of employment in the US, but averages about 20% in the European Union. 

Another challenge for Europe is the lack of technology-oriented business. For instance, only 2% of listed companies in the UK are focused on IT, while in developed markets globally the average is closer to 20%. This under exposure to one of the primary drivers of recent market gains is clearly a handicap. Nonetheless, the British market, which many have written off following Brexit, is incredibly cheap, with a current PE ratio of 10. Even its lack of technology exposure is an interesting contrarian factor, resulting in a disproportionate percentage of its listed companies being devoted to real assets. In addition, average dividend streams are above those of most other developed markets. As noted above, during the course of 2024 we intend to look selectively for investments in the UK.

There are clearly some great businesses to invest in in Europe, and we think we own some of them. However, for the time being, the overall landscape is not compelling and there is little in the way of an immediate catalyst to move things forward. Consequently, we do not expect to increase our exposure to the continent above the current level.

Emerging markets represent a mixed bag, with the two most important economies moving in opposite directions. China is struggling with political and economic problems as it tries to transition from being a developing country to becoming a global superpower. In the medium term, it also has to contend with a growing demographic burden as its population ages and the size of its workforce declines. Estimates are that the number of Chinese workers will fall by over 40 million over the course of the next decade. While there will doubtless continue to be excellent Chinese business like BYD (which we own), now the largest producer of electric vehicles in the world, a highly leveraged economy with massive capital out flows is hardly the ideal environment for long term investors. Compounding domestic economic concerns are growing political pressures from the West in terms of tariffs, and restrictions regarding technology transfer. 

In contrast, the prospects for India are steadily improving. Although its stock market is not cheap, a pro-business government, combined with a huge demographic dividend due to its young population, should provide a foundation for future growth. Like Vietnam, India should be the beneficiary as more companies looking for cheap labor relocate away from China. With a compound average growth rate of 10% over the last decade, and its economy expected to grow by 6%-7% this year, India looks to be in good shape for the long haul.

Lastly, our alternative and fixed income positions, which together constitute 30% of the portfolio, are generally doing their job in terms of providing diversification and downside protection. In light of the recent rally in US fixed income markets, I think the easy money has been made, but current yields in the 5% range remain attractive. Given our relatively conservative views regarding the timing of additional interest rate cuts, we are positioned in the middle of the yield curve, with an emphasis on short to intermediate maturity issues.

The alternatives allocation remains a hedge both against the overall volatility and potential declines in stock markets. Although we had the good fortune to see gains in most of these positions in 2023, especially in gold and the hedged equity strategy, an important part of their value added is in their low correlation with equity markets. While alternative strategies may be of limited utility in a buoyant market like last year’s, going forward, not every year will be so positive. Hence, they will remain part of our long-term strategic core as we continue to seek to add value while controlling risk.

I hope the above will provide at least some understanding of how our portfolios are positioned and how we see markets evolving.  As always, we would be delighted to try to answer any questions or queries you might have.

All the best,

Philip Winder