In their final meetings of 2022, the Federal Reserve, the Bank of England and the European Central Bank all raised their interest rates by 50 basis points. In the US, Fed chair Jerome Powell maintained his hawkish stance, dispelling any notion that the central bank might back down in its fight against inflation in 2023. In Europe, Christine Lagarde followed suit, declaring that further rate hikes would be necessary, but would be data-dependent.
In the UK, interest rates now stand at 3.5% – their highest level in 14 years. Bank of England Governor Andrew Bailey expressed concern over the possibility that UK companies might continue to raise prices – despite the fact that inflation had likely peaked (it edged down to 10.7% in November).
Surprisingly, November’s retail sales fell – despite Black Friday and Cyber Monday. Although online transactions were particularly weak, food sales were higher (most likely due to people shopping for Christmas earlier than normal).
The recent pullback in crude oil prices has helped lower petrol prices at the pump (this contributed to November’s slight fall in the rate of inflation). This is unlikely to help with the cost-of-living crisis, however: more favourable data will take time to feed into the UK economy and the consumer prices index. So there will be no immediate end to the squeeze that UK households are suffering.
Inflation may have eased ever so slightly on both sides of the Atlantic, but it is still well above the leading central banks’ 2% target.
The conflict between Russia and Ukraine rumbles on. Earlier this month, oil tankers carrying Russian crude oil were prohibited from accessing western maritime insurance – unless the crude oil they carried was sold under the G7’s price cap of US$60 a barrel. The cap was introduced to keep oil flowing while still crimping Moscow’s revenues and defunding the war machine. In a retaliatory move, the Russian authorities have drafted a decree banning the sale of any Russian state crude oil to buyers that are part of the “price-cap coalition”.
But this won’t be implemented for some time. The decree is expected to ban sales from Russia from July 2023 onwards, and in response Brent crude oil prices rallied after falling 10% in recent weeks. Admittedly, this can be partly attributed to a weakening US dollar. Commodity prices tend to move in the opposite direction to the greenback. A falling dollar makes oil cheaper to buy in other currencies. However, it has been reported that Moscow has reneged on its promise to block sales under the price cap: Russian crude oil has been shipped to India on tankers insured by western companies.
In China, the authorities are facing yet another dilemma – possibly the country’s biggest health challenge since the start of the pandemic three years ago. The authorities abruptly ended their Draconian “zero-Covid” policy earlier this month (putting an end to mandatory mass testing and compulsory quarantining), and Covid-19 is once again spreading like wildfire across a significant part of the country.
According to local media, last week saw the first fatalities since restrictions were lifted. China must now speed up its vaccination programme to get this recent flareup under control. And the race is on to do so before Chinese New Year in January when there will be significant population movements across the country as people return home to celebrate.
Every year brings with it new challenges. 2020 saw the start of the pandemic. Indeed, nearly three years on, many parts of the world are still grappling with fatalities and lockdowns. The global economy did start to reopen in 2021, with the hope of a steady recovery. But 2022 put paid to that – this year we have endured inflation the likes of which we have not seen for four decades.
Unfortunately, the leading central banks got it very wrong when they talked of a “transitory period of inflation”. Inflation is actually embedded in our global economy, and it is what has spooked the financial markets so markedly.
Most of the things that could have gone wrong for the markets and investors this year… have gone wrong. And now, recession looms. The data suggests that this one has already started, so the real question now is whether the economy will have a “soft”… or a “hard” landing.
Each recession is excruciating in its own way. Of the 11 cycles since the 1950s, recessions have ranged from two to eighteen months in duration. The average has been around 10 months. Worth pointing out, however, is that stock markets usually start to recover before a recession ends. In this particular cycle, equities have already led the economy on the way down – nearly all of the major stock markets had entered bear market territory by the middle of 2022.
Valuations have already crumbled under the pressure of higher inflation, an aggressive global rate hiking cycle, war in Europe, and the economic challenges facing China. And bond markets have seen their worst-ever returns – they have been struck by inflation.
But if history is anything to go by, both asset classes could rebound about six months before the economy does. So investors should hold their nerve: that way, they can leverage all the benefits of a full market recovery. And historical data shows that positive investment returns from a bull market more than makeup for the falls suffered in a bear market. The last ten bear markets have all lasted around 18 months. The current one is just under 12 months old. It is quite possible that the worst is now behind us.
There is no getting away from the fact that 2022 has been a year of heartache and anxiety for our clients and for investors. But we believe that we are slowly moving out of the mire. “How much further are interest rates likely to rise?”, “When will inflation start to significantly fall?”, “Is a recession really an inevitability?”. These are the key questions we will be seeking to answer as we head into 2023, but it is already looking as though interest rates are near peaking, inflation will fall rapidly and a mild recession will be felt in many of the world’s regions.
Financial markets are likely to remain choppy over the coming weeks. But we have already seen multiple contractions and a reset in valuations. The result is a far broader range of viable options for global investors as we move into the new year. Global equities remain the preferred route for many asset allocators – they are known to deliver strong future returns. But the idea that there is no alternative to them has been laid to rest: other asset classes (such as bonds and even cash deposits) are attractive alternatives in a diversified portfolio.
The past 12 months have been difficult. Indeed, the past 36 months have brought with them numerous challenges as we have attempted to navigate through some of the most difficult events and circumstances the world has endured in decades.
The lack of any meaningful returns this year has been a disappointment for all of us at IQ. But we are optimistic about next year: we believe that 2023 will be kinder to us, our clients and investors in general. Remember: it is always darkest before dawn.
I would like to end by wishing you all a Merry Christmas and a prosperous new year.
