Global markets to 23 January

Following a positive start to the year in the financial markets – partly driven by the latest global inflationary data – the last few days have seen something of a downturn, driven much more by regional data and ensuing investor sentiment.

Weaker US manufacturing and consumer data dampened sentiment on Wall Street. And the additional overhang from the continuing US debt-ceiling debate and the recent corporate earnings results (which have been mixed) have not exactly lifted the mood.

Towards the end of the week, the US officially exceeded its debt limit of US$31.4 trillion. This triggered the implementation of “extraordinary measures”, which included the sale of certain government securities being suspended.

Since the mid-term elections in November, political conflict in the US has been on the rise. Both parties now have small majorities (the Republicans in the House and the Democrats in the Senate), which often leads to gridlock. However, there is a tradition of “eleventh-hour” agreements being reached, typically involving concessions on both sides.

Political upheaval tends to generate negative headlines which in turn impact the markets. But such upheaval does not tend to be a long-term driver for Wall Street and overall market performance.

In the UK, positive sentiment towards the FTSE 100 Index has pushed it to a record high, surpassing its previous high of 7903.50 (May 2018). The impressive rally in the FTSE 100 can be attributed to its exposure to the mega caps and to sectors such as healthcare, energy and commodities. These have all benefited from being global businesses and dollar-earners: when the dollar appreciates against sterling, they do well.

However, medium- and smaller-sized companies seem to have fared less well in 2022. But we now believe that it is their turn to shine – both from a valuation and a consumer-related perspective.

Inflation in the UK has slowed for the second month in a row. The cost of food, however, is still rising sharply. Wages are also on the up – growing at their fastest rate in 20 years. The good news, however, is that fuel costs have eased. All of this means that the actual inflation rate for the year to December came in at 10.5% (it was 10.7% in November). It has fallen back in both the US and the eurozone as well (6.5% and 9.2%, respectively).

Although the futures markets seem to be indicating that the Federal Reserve Bank will start cutting interest rates in the second half of the year, central bank officials on both sides of the Atlantic are determined to stay on course with their monetary tightening goals; they will allow interest rates to remain higher for longer until they feel that inflation is under control.

In the US, Microsoft became the latest tech company to announce cuts to its workforce (some 10,000). Amazon, meanwhile, has started laying off workers in the US, Canada and Costa Rica. Salesforce, Meta Platforms and Twitter have also committed to redundancy plans, all in response to slowing sales and a possible recession.

Some of the week’s news has been more positive. In the UK, Marks & Spencer announced plans to create 3400 new jobs as part of its plans to revamp existing stores and open eight new ones in Liverpool, Birmingham and Leeds.

In Europe, milder temperatures have eased demand for gas and electricity, while stockpiling of both last summer and autumn has made the continent more resilient to tighter energy supply chains. The result is that wholesale energy prices have fallen, relieving some of the inflationary pressures that have built up. The European Central Bank will factor this in accordingly when reviewing its progress in tackling inflation.

In China, meanwhile, families have been meeting for bittersweet Lunar New Year reunions against a backdrop of soaring Covid death rates.

The rest of the world has hailed the reopening of the Chinese economy. With inflation low (official rates are still at 3.65%), the People's Bank of China and Jinping’s government have some flexibility to offer more stimulus (should the country's shrinking economy require it).

Although Covid continues to blight China, sectors such as travel, leisure and luxury goods are likely to be big beneficiaries as consumer spending starts to recover. Energy and commodities, meanwhile, will benefit from higher demand as factories reopen to meet recovering consumption needs. Will the year of the rabbit be more prosperous than the year of the tiger? Only time will tell, but already the Chinese market has reacted positively to the news.

Furthermore, China's desire for a return to normal levels of economic activity has led to a dialling down of hostilities in relation to technology and Taiwan. Trade disputes with the US and other nations also appear to have calmed somewhat. Although not fully withdrawing from its posture on the global stage (and over its ambitions regarding Taiwan in particular), the US is experiencing it as more cooperative.

China is also very mindful of not wanting to overtly criticise Russia over its invasion of Ukraine. At the same time, it recognises just how serious the West is about implementing sanctions and other measures against any countries which might aid Russia with its war effort.

Other good news has come from the bond markets. They now believe that inflation is set to fall further and that economic growth will be lower. Bond yields have therefore started to fall as prices rise.

More broadly, as the economy potentially enters a mild recession and the Federal Reserve Bank pauses its interest-rate hiking campaign, we would expect bonds to offer an alternative to equities and play a diversification role in global portfolios. Historically, bonds have delivered positive performances in the twelve-month periods following pauses in rate hikes. Similarly, if central banks then start to cuts rates, this will be more good news for the bond markets.

The day-to-day volatility will no doubt continue in the financial markets. This will keep global investors cautiously positioned as inflationary pressures start to ease, monetary tightening peaks and economic and earnings data bottoms out.

But stock markets tend to be forward-thinking – they usually start to recover some six months or so before the end of any economic downturn. And for investors with balanced portfolios, the revival of bond markets and attractive cash deposit rates will mean that we can start thinking about widening our allocations towards the traditional 60:40 asset allocation classes (equities, bonds and cash).

There is now a considerable amount of bad news in our wake – rising interest rates, economic slowdowns, war in Europe and Covid in China. Or at least, this is bad news that is still current, but which the markets have priced in. We can now start to focus on some better news as we gently navigate through the early months of 2023. The first three weeks of the year have generally been positive for the markets, and a number of opportunities are now emerging. “Cautiously optimistic” will be our mindset as events unfold over the coming weeks.