It is that time of the year when we, as market watchers, pull out our crystal balls. Just as we dust ourselves off from the past year, we look to the one ahead, either with anticipation or trepidation.

Taking a moment to look back, it has been an extraordinary year – from the tremendous gains from a handful of stocks to a synchronous increase in interest rates from Central Banks to whiplash from the bond markets. Given that towards the beginning of the year recession was the only alternative, most investors have been surprised by the resilience of developed market economies, despite persistent inflation, but buoyed by better-than-expected unemployment numbers and wage growth.

Although the cost-of-living crisis continued apace, consumers, so far, have been surprisingly resilient in the face of sustained pressure on household finances from inflation and high interest rates. This has flowed through the developed market economies, especially in the US, leading to stellar growth, with the Eurozone and UK lagging behind. Though we near the end of the year with thoughts of a well-engineered ‘soft landing’ by central banks, the situation remains far from clear – with numerous alternatives to be considered.

From a macro-economic perspective, we now enter a period of change. Since 1980 till last year, we have been in a world where interest rates have declined. More so, since the Financial Crisis of 2008, we have been through a period of low economic volatility, low inflation and low rates but high realised returns. There now appears to be a change in the wind.

We are at levels of interest rates last seen before the financial crisis, but even more challenging has been the speed with which Central Banks have ratcheted up rates. Naturally, this has caused volatility in markets – but what has been unnatural has been the fact that while volatility in equity markets has dropped, fixed income volatility has remained elevated as can be seen in Figure 1. This has wreaked havoc with low-risk portfolios which have been, traditionally, heavy in fixed income. If there is one certainty that we can speak about, it is that volatility will be our constant companion for the coming year. Were it to be constant, volatility in and as of itself would not pose a problem – it is expected that the volatility of volatility will be high, creating peaks and troughs in volatility levels.

Although inflation has declined over the recent past, the effect of the change in monetary policy is yet to be fully understood. Milton Friedman said monetary policy acts with ‘long and variable lags’. The economic resilience of the past year can partially be attributed to savings of households from the different pandemic related stimuli, as well as widening government deficits. As the level of savings decline, faced with the real reduction in disposable income (Figure 2) from the cost-of-living issues, one can expect a deterioration in consumer demand, resulting in lower growth.

This can already be seen feeding into consumer and business confidence, which are considered lead indicators of economic activity. High interest rates also affect corporates. Taking advantage of the low interest rates, most corporates increased the amount and maturity of their borrowings. This can be observed from credit spreads, which have not followed their usual widening pattern, following interest rate increases. As a result, the corporate default environment has been very benign. However, when time comes for refinancing, these companies may be faced with an increased cost of capital, which may materially alter the corporate bond market. It has only been about three quarters where the high base rates have had an opportunity to reset and have impacted company cash flows. This has resulted in a reduction of free cash flows for numerous business which have borrowings which are not aligned to maturity structure of their assets, be it tangible or non-tangible. The need for refinancing capital may make some capital structures put in place inappropriate and unreliable.

One may look back at equity markets globally and would be hard pressed to complain. However, one takeaway has been that diversification did not pay – Figure 3 shows a wide disparity between Growth and Value stocks. An equally weighted holding in the ‘Magnificent Seven’ stocks doubled in value over the recent year, while the S&P 500 gained circa 20%. This has resulted in the weight of these stocks in the S&P Index to be around 29%.

In relative terms, while growth assets did very well, defensive assets like bonds lagged. While this is not abnormal in late cycle dynamics, the egregiousness of outperformance is. This is not expected to continue going forward as cyclical pains appear to have been delayed and not eliminated outright – a typical scenario where the can has been kicked firmly down the road. While valuations in Large Cap equities appear to be stretched, the same cannot be said for Mid or Small Cap stocks. These stocks are typically more influenced by local economies rather than the more global Large Cap stocks and as a result, seem to have factored in the recession probabilities to a larger extent. As a result, one could possibly expect a rotation into stocks lower down the capitalisation ladder – which may expose portfolios to greater drawdown risks as liquidity gradually dwindles in these markets, as fiscal tightening takes hold.

China, which has recently been the driver of global economic growth, has been impacted by structural issues stemming from the real estate sector. The sector has been a driver of growth in China, with it accounting for almost half the local government revenues. The recent well documented wobbles in the sector exposed the reliance of China’s financial and government sectors on real estate and its associated infrastructure development. The administration has ruled out blanket bailouts in favour of ‘remodelling’ the debt-stricken sector to further extend support to the ‘stronger’ developers whose bankruptcies could trigger wider financial contagion by encouraging bank lending, bond issuance and equity financing. The overall aim is to reduce the reliance on this sector, while maintaining a sizeable presence.

One must remember that China is a developing economy in transition from a primarily export and manufacturing oriented one to a consumer driven one. This transition is not easy given the trade restrictions in place from developed economies and the simmering tensions between itself and the developed world, primarily led by the US. If the transition is well managed and the market stabilizes, the economy will continue to grow and fuel global growth, but the path may be painful for all involved.

To cap it all, geopolitical risk is back on the horizon. While the Ukrainian war rumbles on, the Middle East is embroiled in further violence. While Europe has more or less weaned itself off Russian gas, uncertainty in the biggest oil producing region could risk creating stickier inflation through higher oil prices and potentially weighing on global asset prices. This would have a greater impact on Europe rather than US, given the latter has a larger domestic production base. Upcoming elections in the US, UK and India also creates an overhang of possibilities of global tension and uncertainty, already exacerbated in a polarised world.

To conclude, two words would define the outlook for the coming year – ‘cautious’ and ‘selective’. To give a twist to the old adage, if we manage to take care of the risks, the returns will take care of themselves. A successful navigation of the upcoming year will depend on how cautious we are in our approach and how selective we are of the risks we include within our allocations. It is clearly a case of keeping dry powder, which will be instrumental in taking advantage of material opportunities which will definitely arise once the markets readjust to the new regime.

Hear more from Abhi Chatterjee, on the Chief Investment Officer Panel, at March’s Dynamic Planner Conference.

Hear from Dr Louis Williams, Dynamic Planner’s Head of Psychology and Behavioural Insights, in candid ‘Conversation With’ Kim Dondo, of the Money Marketing Podcast. Louis talks about life before Dynamic Planner; how psychology impacts financial planning decisions, big and small, we all make; biases which creep into our decision-making process; and how weather and cash flow modelling forecasts share more common ground than you think.

[Money Marketing] What is your background Louis?

[Louis Williams] My background is in experimental psychology, different research using eye-tracking techniques, to see how people view information, for example, graphs. I began working on a joint, two-year project with the University of Reading, where I still have a visiting fellowship and Dynamic Planner, to see how we can create new tools and measurements, to understand more end clients and investors, and their behaviours. After the project ended, I joined Dynamic Planner permanently.

[Money Marketing] How does psychology play a role in shaping our financial decisions?

[Louis Williams] Many fields of psychology are relevant when it comes to shaping how clients make financial decisions, and not just important financial planning decisions, but decisions we make every day in the supermarket, for example.

One issue today is there are so many options out there when it comes to making a purchase, so much information, from so many sources – family, friends, your financial adviser, social media. We have limited time to make decisions and we are only human. We don’t have the capacity to always make the best choice, so sometimes we have to simplify the process.

For example, you’re in the supermarket and you only have a choice between two different products. In that instance you might look at all of the information available to you, like price, calories, ingredients. But if there are lots of products and you need to leave the store in two minutes, you might simply base your final decision on price, so your decision-making process changes.

Psychology, in that sense, is important for us to understand how that works, because those decisions and the shortcuts we take to sometimes make them leads to biases and ‘errors’. We make them because we’re trying to simplify the decision-making process.

[Money Marketing] What common biases today can financial planners be aware of in their clients?

[Louis Williams] Today, availability bias is important. By that we mean basing decisions on information which comes to mind quickly, or easily. Again, we can think of the example in the supermarket where you pick up a product and are instinctively shocked by its price. It’s more than you remember it being last week.

There is also recency bias, where we think what has happened recently will continue to happen in future. For example, if we make a decision on a 10, 20-year mortgage rate, based on what’s happening in the UK right now.

We can also think about anchoring bias. A client could be anchored or fixated on the value of their portfolio last year and how it is still making them feel, how optimistic they are or not, about the value of their portfolio this year.

[Money Marketing] How can behavioural insights lead to better outcomes for investors?

[Louis Williams] Before I joined Dynamic Planner, I helped run one eye-tracking study into meteorology, nothing to do with financial planning or investing. We showed people who took part graphs of weather forecasts. And what we found was that when we showed people a median line of what weather to plan for, people fixated on it, even when we asked them questions not relevant to that median line.

When we removed that line, showing them the same forecast, we found that people viewed the whole graph much more. We have applied that learning now to Dynamic Planner, in a cash flow planning forecast, which shows a median line of how they can most likely expect their portfolio to perform in future.

An adviser and their client can click on an option to reveal possible investment paths, which go into producing that median line, and enabling the client to really visualise the volatility inherent within their portfolio, and the ups and the downs when it comes to performance. It shares the story of while you may end up in a particular place, in future with your portfolio and its value, it may not necessarily be a smooth path or journey to get there. These types of techniques and experiments can be applied in financial services, even when initial studies and findings had nothing to do with the field. We can still learn.

Hear more from Louis Williams, Dynamic Planner’s Head of Psychology and Behavioural Insights in the Money Marketing Podcast.

Should we focus on Equality or Equity?

The theme for International Women’s Day 2023 is Embrace Equity, which aligns firmly with our mission “Let’s build an equitable future”. But what do we mean by that? We have worked for more than 15 years with young people across London and beyond to help educate them, remove barriers and empower them to be the best they can be and we have done this by focusing on equity rather than equality.

What is the difference between Equality and Equity? To break it down, equality is when each person is given the same thing, or a rule is applied in the same way to everyone. But that doesn’t allow for people being individuals and having different needs. It also doesn’t consider their starting point.

Equity is when each person is given what they need to enable them to be successful. Or when rules consider the circumstances and are adapted to enable progression. The image below clearly shows if you give each person the same bike, then it only really allows one person to ride comfortably or at all. But when you consider the equitable solution in the image at the bottom, it enables everyone to able be ride comfortably.

How does Equity Work in practice?

At Urban Synergy, we understand that every young person, their circumstance, and their dreams are unique. We tailor our school programmes, mentoring and work experience opportunities to help them reach their individual potential.

We understand that our community faces many challenges, and that there is often intersectionality between the different protected characteristics of diversity, as well as the socio economic factors that we need to consider.

This year we are Embracing Equity on International Women’s Day and raising awareness of the challenges that young people face when entering the workforce.
By working with Dynamic Planner and our other partners we are removing the barriers faced by young people. We open students’ eyes through career seminars, with a network of relatable role models, showing the variety of possible job roles available, and sharing their own career journeys and providing a pathway to follow.

We guide them with 1-2-1 mentoring, teaching them business and soft skills, as well as helping them with the tools they need like a CV and an effective LinkedIn presence. And finally we connect them to opportunities that would not be accessible through their own limited networks, giving them real world experience to learn from.

Ryan who attended the Dynamic Planner internship said: “Getting to meet the senior leadership was inspiring, especially hearing from the CEO and how he built the company. During the internship, not only did I meet a great team of people, I saw that the company’s mission was very clear: support clients and make portfolio management easier for them. Everyone I met was focused on that goal. It was a privilege to be trusted to support wherever I could.”

Opportunities like this are essential to enabling the next generation to succeed.

So, what can you do to help?

The latest global gender gap report from the World Economic Forum (WEF), summarised here, shares that between 2021 and 2022 the overall global gender gap slightly narrowed. It uses four key areas to assess gender gaps, health and survival, educational attainment, economic participation & opportunity and political empowerment.

You can consider these and ‘Embrace Equity’ too. By ensuring that you consider people’s individual needs, their starting point and any intersectionality they may have, you can put in place what is needed to support the women in your teams.

Can you help young people too?

Yes! Urban Synergy can also help you to ‘Embrace Equity’ too. We’d love to help even more young people to access opportunities, so if you can open your doors to a young person, get in touch. We’d love to partner with many more companies to offer even more diverse opportunities to the talented young people we work with.

With the collaboration of our valued partners like Dynamic Planner, we are building an equitable world where everyone, regardless of their background, is empowered to write their own future.