Following a traumatic 2022, the first Lowdown of the year finally brings some good news for investors. Global equity markets rallied strongly at the end of December and have continued to do so in the first week of 2023. Those which rallied most impressively from the 2022 lows are Chinese H-shares (listed in Hong Kong). Indeed, at the time of writing, they are up around 43%. Asian high-yield bonds, meanwhile, are up around 26%. And even long-duration fixed-income assets around the developed world have rallied – despite ongoing increases in central bank interest rates.
In the UK, the FTSE 100 Index hit its highest level for nearly five years. And the mid and small caps have rallied strongly since trading resumed. Given the challenging economic backdrop that the UK is currently contending with, such a sprightly start to the new year is more than welcome.
Financial markets appear to have taken a turn for the better. Yet a couple of major factors are still very much in play. The Ukraine war continues, keeping energy prices relatively high; this in turn has led to stubborn consumer price inflation, with the leading central banks responding with aggressive monetary tightening.
After nearly 12 months of conflict, we have a clear overview of all the ways in which Russia's invasion of Ukraine has impacted the global economy and the financial markets. People rarely extol the virtues of war, but the timing of this one has been particularly bad, coming just as the global economy was recovering from a pandemic. It has not been without geopolitical turmoil either. So the markets remain under threat as we enter 2023.
The markets are, however, a good indicator of investor sentiment. It now appears that the initial shock created by the war, rising inflation and subsequent monetary tightening is behind us. Indeed, asset allocators and fund managers are beginning to take some selective positions in both equities and bonds.
Nobody is saying that this is not going to be a difficult year for the global economy. But the evidence so far suggests that it will be a better one for the financial markets – just as global growth is slowing and recession is starting to bite: the stock markets will have already made some provision for this. Indeed, barely a week into 2023, certain themes are already taking shape. That is not to say that we can completely rule out some early disappointments. If, for example, we were to see a weaker macro trend reflected in US corporate earnings or any hint of balance sheet weakness in the coming months, this could create a quick retracement in the markets.
Interestingly, the US has seen a strong start to the year in terms of corporate bond issuance. This would suggest that investors are not overly concerned about credit. And fixed income has become more attractive now that we have higher yields and high-quality credit providing a risk-adjusted return alternative. But of course, the recent impressive rally in bond markets has already seen yields fall from their recent highs. So if you have not been part of it, it might be wiser to watch from the sidelines and see what the next batch of inflation data provides over the coming months.
The recent jobs data in the US showed that 223,000 jobs had been added in December, slightly less than the 256,000 added the previous month. The unemployment rate, meanwhile, slipped to 3.5% – a fraction under the predicted 3.6%.
Wall Street economists had expected the figure to be nearer 200,000 new jobs for December and for the jobless rate to hold steady. The slightly higher figure will keep the Federal Reserve Bank on its toes and do little to ease its concerns. And in the recently published minutes of the Fed’s December meeting, it emphasised its determination to overcome inflation whatever the cost.
From a more positive perspective, news from the Eurozone that inflation for December had fallen back to single figures was greeted positively. This helped to push European bourses higher.
Although recent reaction in the markets has been mostly positive, there have been pockets of disappointment. In the technology sector, for example, South Korean company Samsung reported a quarterly fall in profits of nearly 70% as consumers started to shun purchases of electronic gadgets. Meanwhile, a significant number of businesses have announced swathes of redundancies to help them through the forthcoming recession. US homeware retailer Bed Bath & Beyond has even warned investors that it may be on the verge of becoming one of the country's largest retail bankruptcies since the start of the pandemic.
We remain cautiously optimistic about 2023. Inflation still needs to be tamed, but realistically, the central banks will probably not succeed in bringing it back down to their target levels. At least, not in the short term. At the same time, we desperately need the situation in Ukraine to improve. Any further escalation in hostilities will inevitably lead to higher energy costs and create additional inflationary pressures.
Then there is the Federal Reserve Bank: it is particularly important that future monetary policy decisions be made wisely. It will need to consider whether or not it has done enough to tackle inflation. Simply put, it should not seek a perfect inflationary or economic backdrop before deciding whether or not it should ease up on its monetary tightening policy. Indeed, central banks need to accept that they will need to run their economies amid the threat of inflation and higher interest rates for the foreseeable future.
From an asset allocation perspective, many well-established “old economy” companies that fall into the value category and boast both strong balance sheets and attractive dividend payouts will continue to do well. Regarding regional allocations, the UK stock market offers exactly that combination – thanks to its exposure to energy, basic resources, financials, pharmaceuticals and consumer services.
From a global perspective, further dollar weakness could provide investors with some interesting opportunities in Asia and emerging markets. Meanwhile, any meaningful recovery in the US is likely to see further inflows into sensitive sectors, such as industrials and materials, along with other favoured segments – such as energy, bulk commodities, precious metals and financials, as well as – obviously – technology.
Just as footballers can only play the ball in front of them, we as investors can only invest in what is in front of us. So what we have to do, as another year of volatility and uncertainty gets underway, is assess value and risk… and decide whether or not the expected returns are likely to meet our financial goals.
