The final quarter of 2022 was a mixed period for equities. The US struggled whilst non-US equities started to recover from a difficult year. In terms of fixed income, assets continued the trend of 2022 by not providing the level of protection we would expect when equities deliver negative returns, as they have done historically for the past 40 years. The macro-environment continued to be mixed regionally, with Europe continuing its battle with the consequences of the war in Ukraine. Inflation has remained stubbornly high and a significant slowdown risk has arisen. Conversely, the US economy has remained resilient and there are no apparent signs of recession, although the NASDAQ has faced continued pressure. Overall, markets delivered positive returns as strong performance was seen in Emerging Markets and Asian equities, mainly due to the reopening of China’s economy after a prolonged closure due to the COVID pandemic.
In the UK, consumer sentiment continued to remain at a depressed level and the Purchasing Managers Index (PMI) remained below 50, indicating signs of a market contraction. Meanwhile, the labour market showed resilience with the unemployment rate beating expectations at 3.7%. Inflation in the UK has remained high and the Bank of England continued to raise interest rates, but we are starting to see signs of inflation easing. A recession is still expected, albeit less severe.
The situation continued to deteriorate in Europe due to the ongoing energy crisis; as a result, inflation continues to weigh heavily on monetary policy. Whilst inflation has eased from its peak in September, it remains stubbornly high and is at risk of becoming entrenched. The European Central Bank (ECB) continues to increase interest rates, but at a slower pace than previous rate hikes; the ECB president warned that interest rates will continue to be higher.
With inflation dropping, and strong employment and GDP figures from the US, the economy could potentially avoid a recession. US GDP beat expectations again, rebounding from the earlier contraction. However, the economy is sending mixed messages. On the one hand, the labour market remained robust, but on the other, business confidence continued to drop to a level consistent with a slowdown. The Federal Reserve (FED) remains committed to bringing inflation down, even if that means entering a recession as it is concerned with the strength of the US labour market.
The Japanese economy steadily improved on the back of its reopening. While inflation reached an historic high since 1991, it remained at a modest 4%. The Bank of Japan surprised the markets by announcing a significant change to its policy of yield curve control, allowing bond yields to rise more than previously.
In China, the easing of COVID restrictions saw a surge in infections, which has affected investment sentiment; fewer businesses are looking to invest during this period of disruption and uncertainty. With inflation also impacting Australia, the Reserve Bank of Australia raised its policy rate by another 0.25% and said it expects further tightening. Growth is much lower than expected based on lower consumption.
The main market issue is the re-emergence of inflation after a long hibernation. Our long-term prediction is that we are entering a structurally higher inflationary period as deglobalisation, falling working-age populations and shortages of commodities persist. To a large extent, we positioned our portfolios for this environment and this is how we managed to generate positive returns relative to our peers, during the year to date.
Transitioning from a lower predictable inflation rate to a higher and less predictable one will be problematic for asset prices; but it will also create opportunities that we can use as discretionary managers, to help our clients achieve their objectives: maintaining relative wealth in weak markets and taking opportunities as they arise.
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