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Business News/ Markets / Stock Markets/  US, China, bond yields and more: BofA lists 5 key lessons learnt in 2023 and their investment implications
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US, China, bond yields and more: BofA lists 5 key lessons learnt in 2023 and their investment implications

The year 2023 provided investors with valuable macroeconomic lessons that have significant implications on investment strategies.

As the year comes to an end, BofA discusses some key macro lessons of 2023 and their investment implications.Premium
As the year comes to an end, BofA discusses some key macro lessons of 2023 and their investment implications.

The year 2023 provided investors with valuable macroeconomic lessons that have significant implications on investment strategies.

In a recent report, Bank of America (BofA) said," We learned this year that the US economy remains the most dynamic/resilient in the world; that China needs a new playbook when it comes to driving future growth; that public sector deficits do matter, with the return of the bond vigilantes; that the global order of the past 75 years has been structurally upended—it’s different this time; and that in an era of “higher for longer" interest rates, there are legitimate and attractive alternatives to Equities."

These insights underscore the importance of maintaining a balanced, disciplined, and diversified approach to portfolio construction, noted BofA. The recognition that macro dynamics play a crucial role in shaping market outcomes, beyond traditional factors like valuations, earnings growth, and interest rates, is a key takeaway, it added.

In light of these lessons, investors are encouraged to consider the broader economic landscape and its potential impact on relative and absolute asset prices, suggested BofA. The macroeconomic trends of 2023 have far-reaching consequences, and a thoughtful and adaptive investment strategy is essential to navigate the evolving financial landscape, it advised.

Read here: Nifty at new high again! B&K sees another 10% upside in 12 months

BofA has discussed some key macro lessons of 2023 and their investment implications:

One: The US economy is still the greatest show on planet Earth 

Contrary to the unanimous consensus a year ago predicting a U.S. recession in 2023, the economy defied expectations and continued its robust performance. Key factors contributing to this resilience included substantial fiscal expenditures, a tight labor market driving real income and consumer spending, increased capital expenditures—especially in collaboration with public sector infrastructure spending—and the adaptability of the dynamic U.S. private sector, stated the report.

The lesson learned is the peril of ignoring or underestimating the U.S. economy, a formidable $27 trillion entity with a diverse range of strengths. The U.S. excels across numerous economic sectors, including agriculture, aerospace, energy, entertainment, technology, transportation, higher education, healthcare, finance, space, insurance, and more. This economic diversity has played a role in the U.S. outpacing the rest of the world, including China, with a remarkable increase of nearly $6 trillion in output since the beginning of the decade. The resilience and versatility of the U.S. economic landscape underscore its status as a global economic superpower, explained the report.

Investment implications: To paraphrase Warren Buffett, “don’t bet against America"— core holdings of portfolios should rest firmly on the shoulders of U.S. assets, said the brokerage.

Read here: How Is China’s Economy Doing? Not Nearly as Well as China Says It Is

Two: China needs a new growth model

A year ago, expectations were also high that China, likened to a coiled spring, would experience a robust rebound post pandemic reopening. However, this anticipation did not materialise. The Chinese economy faced challenges such as an overbuilt and overleveraged property sector, substantial local debt burdens, a declining working-age population, rising youth unemployment, and a decline in foreign direct investment. These structural issues have created a formidable "Great Wall of Worry" for China's future economic growth, signaling the need to reevaluate the existing investment-led growth model, the brokerage pointed out.

To address these challenges, there is a call for a new growth model that shifts the focus from investment to the Chinese consumer. Currently, personal consumption expenditures in China account for only 40% of GDP, significantly lower than the approximately 70% in the U.S. While potential policies aimed at driving consumption-led growth, such as healthcare reform and a more extensive social security net, have been discussed, their implementation remains uncertain. This uncertainty adds to the challenges and concerns surrounding China's future growth prospects, cautioned BofA.

Read here: Should you be worried about further rate hikes in the US?

Investment implications: China accounts for roughly 30% of the Emerging Market (EM) capitalisation, so as China has struggled this year, so has the broader EM index. That said, investors should think of Asia ex-China, where BofA expects better returns over the medium term.

Three: The bond vigilantes have awakened—deficits do matter

The bond vigilantes, investors opposed to excessive government spending, have re-emerged after a prolonged period of inactivity. Their awakening is prompted by the sizable U.S. budget deficit, necessitating additional servicing of U.S. government debt. The lesson learned by investors is that deficits indeed matter, rendering the Modern Monetary Theory (MMT), which posits that a high debt-to-GDP ratio does not limit deficit spending, obsolete, said the brokerage.

While federal budget deficits are not unprecedented, the magnitude (a $1.7 trillion gap in fiscal year 2023), the rapid increase (a 23% jump from the prior year), and the projected deficit outlook are causing investor apprehension. Elevated interest rates led to a nearly 40% surge in interest costs last year, coinciding with expanding mandatory spending programs like Medicare, Medicaid, Social Security, and defense expenditures. With government debt-to-GDP reaching historic highs, there is limited room for substantial fiscal expansion in the coming years. This constraint could potentially impact overall economic growth in the short and medium terms, it warned.

Read here: A bull market is coming: This is how you should prepare for it

Investment implications: In an era when deficits do matter, investors have become very attuned to the borrowing needs and attendant costs of U.S. government debt, injecting more volatility into the U.S. credit markets this year. In terms of assets, BofA continues to suggest a Treasury allocation for liquidity, principal preservation and diversification.

Four: It’s different this time—ignore geopolitics at your own peril

While the phrase "It's different this time" is often met with caution, a survey of the current geopolitical landscape suggests that indeed, things are different. Ongoing events such as Russia's invasion of Ukraine, conflicts in the Middle East and Africa, and heightened tensions between the U.S. and China over Taiwan indicate a state of multipolar disorder, introducing increased geopolitical risks to investment decisions. Adding to the complexity is the formation of an alliance comprising China, Russia, Iran, and North Korea, openly challenging the American-led international order established over the past 75 years, stated BofA.

The geopolitical unrest of the 2020s has led to a surge in global military expenditures, surpassing $2 trillion annually for the first time in 2021. The United States, with a record-high defense budget of $858 billion in fiscal year 2023, is at the forefront of this escalation. . China's military expenditures have seen a remarkable increase, exceeding $293 billion in 2021—more than 25 times the 1990 level of roughly $12 billion, according to World Bank figures. The overarching trend is a secular rise in global defense spending, poised to reach $3 trillion annually in the foreseeable future, driven by the persistent geopolitical uncertainties and conflicts of the present era, it added.

Read here: The economic consequences of the Gaza War

Investment implications: In an era more fraught with geopolitical risks, BofA has been and remains constructive on large-cap U.S. defense contractors and continues to favor cybersecurity leaders.

Five: TINA has left the building—there are alternatives to Equities

The brokerage pointed out that the investment landscape has shifted, marking a departure from the era of There Is No Alternative (TINA) to Equities. Low-risk assets like cash and bonds now offer real returns, presenting flexible and liquid opportunities for investors. The prevailing environment of "higher for longer" interest rates has transformed cash from a historically low-risk, negative-yielding asset into a viable option, dispelling the notion that it is "trash" or a drag on portfolio returns. Money market funds are regaining popularity, but investors should be mindful of the potential swift decline in cash rates, making bonds relatively more attractive as they allow for locking in higher rates for an extended period, it noted.

Equities, once enjoying secular tailwinds from stable, non-inflationary growth, globalisation, and deregulation, now face headwinds such as an elevated cost of capital, large budget deficits, and higher-cost supply chains. The conclusion is that Equities now have competition in asset allocation, it added.

Read here: Stock rally: India’s youth bulge could support higher valuations

Investment implications: BofA advocates for a successful investment strategy grounded in a balanced, disciplined, and diversified approach across all asset classes. While the U.S. equity market continues its secular bull run, driven by the robust U.S. economy, the current investment landscape offers tangible alternatives with real returns, such as cash and bonds alongside equities.

Looking ahead to 2024, macroeconomic factors will once again play a significant role. The present era is characterised by impactful macro forces, including a war in Europe and the Middle East, a Cold War between the world's largest economies, unpredictable climate change, and substantial public sector deficits. In navigating this landscape, investors are urged to not only consider traditional investment metrics but also closely monitor these mega macro forces. While the past doesn't always predict the future, the lessons learned from the preceding year should remain in the forefront of investors' minds.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decision

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Published: 07 Dec 2023, 02:25 PM IST
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