Despite the upbeat sentiment in 2023, it is important to remain vigilant.

Mindaugas Mažeikis

The year 2023 was an excellent one for financial markets. The main equity indices rose by 15%–25% over the year, recovering what had been lost during the 2022 correction. US company shares performed best, followed by Europe, while the emerging markets equity index delivered the “weakest” result with an annual return of “only” 10%. Investment-grade government and corporate bonds in euros generated returns of 4%–6% last year. After a negative start to the year, the final two months turned out to be some of the best for bonds in the past twenty years. The only weaker segment was commodities, where balancing supply and demand led to market normalization.

Solid market performance was supported by stronger-than-expected economic growth in the US and Europe. Low unemployment and declining inflation boosted real incomes and stimulated consumption. Another key factor was the end of the monetary tightening cycle by central banks. In early November, financial market participants reached a consensus that interest rates had peaked, which triggered a sharp rally in both bond and equity markets as expectations shifted.

Within alternative asset classes, private debt funds stood out. Higher base interest rates and a low number of bankruptcies resulted in riskier lending generating double-digit annual returns. Due to the deteriorating geopolitical environment and the withdrawal of foreign investors, the capital shortage was especially evident in the Baltic markets, significantly increasing borrowing costs for higher-risk investment projects. As offered interest rates rose, the local private debt market also gained momentum.

A somewhat unusual situation unfolded in the real estate fund market. According to standard valuation models, rising interest rates negatively affect real estate values. As a result, many US real estate funds saw their valuations decline for the third consecutive year. Western Europe experienced similar, albeit milder, trends. Meanwhile, most real estate funds operating in the Baltic States reported asset value growth last year. This discrepancy likely stemmed from the lower number of commercial real estate transactions in our region.

Looking ahead to 2024, it is worth focusing on several aspects important for building an investment portfolio. First, ensuring diversification across asset classes, sectors, and geographies is crucial. Record-high global equity indices conceal a significant concentration risk in Technology sector companies. From a geographical perspective, global geopolitical tensions remain high, so it is important to consider how specific investments would perform under extreme scenarios.

Second, despite optimistic forecasts, Europe’s economic outlook remains challenging. Poor demographics, high public debt levels, stagnant export markets, and an unfavorable geopolitical environment are all constraints that reduce the region’s long-term business growth potential. It is worth monitoring the political landscape and acknowledging the long-term risks to the euro as a single currency.

Third, even after the expected rate cuts, base interest rates will remain relatively high. More than a decade of negative interest rates in the eurozone has created a situation in which some high-risk borrowers will be unable to meet their obligations in the coming years. Therefore, when assessing expected returns, it is essential to understand the risks being taken on.

In summary, we enter 2024 in a period where managing investment risks becomes particularly important.