MARKET COMMENTARY – JANUARY 2023

The final quarter of 2022 was slightly more positive for investment markets as inflation showed signs of peaking in the US and Europe, however, it was a difficult year overall with both equities and bonds declining against a surge in inflation, monetary policy tightening, slowing economic growth and geopolitical tensions.

Inflation was the dominant theme in 2022 and global economies had to contend with interest rate hikes, market volatility and recession fears. While inflation showed signs of cooling in the final quarter, it remains well above target resulting in US, UK and European central banks all increasing their interest rates by 0.50% in December. Along with clear signs of slowing growth and several negative earnings announcements, investor optimism faded in December. The impact of major central banks raising interest rates to combat inflation has led to the highest corporate borrowing costs since the 2008 global financial crisis.

Although there is still some way to go in the battle to bring inflation down, central banks are trying to minimise the collateral damage to their economies and avoid a deep recession. This has led to the expectation of a slowdown in the pace of further interest rate rises.

In equity markets, the more defensive sectors such as healthcare, consumer staples and utilities, along with energy stocks, significantly outperformed high growth stocks such as technology where rising interest rates hurt valuation levels. Alongside the general weakness in equities, investors were left with few places to shelter in 2022 as traditional safe haven assets such as government bonds suffered heavy losses, particularly UK gilts. This was caused by central banks having to raise interest rates by more than investors expected to combat high inflation and concerns over government borrowing requirements.

The FTSE UK All-Share Index outperformed other developed markets however, due to its high exposure to energy and defensive sectors and minimal exposure to technology stocks. Performance was supported by the decline in sterling given that the majority of the revenues from these companies are derived from outside the UK. The strength of the US dollar also partially protected UK investors from the fall in overseas equities. Domestically focused UK stocks however were impacted by the weak economic conditions and the cost of living crisis. Recessionary and inflationary pressures are likely to continue to weigh on the outlook for the UK however the more inflation proof defensive sectors may continue to weather the downturn.

In the US, the strength of the dollar during most of the year has been a function of higher interest rates, weak overseas growth, as well as geopolitical and macroeconomic uncertainty. The US consumer and labour market have been resilient so far despite growing recession risks, however, higher inflation has resulted in lower personal savings while higher mortgage rates have contributed to the decline in consumer spending and housing sector activity. Company profits came under pressure amidst higher costs and reduced demand.

Going forward, less wage pressure and easier monetary policy could provide a better long term environment, however, further interest rate hikes and notably the impact of a deep recession on earnings expectations and valuations remain key risks. Better positioned sectors include energy, financials and healthcare. Companies with good pricing power and a diversified manufacturing base to minimise energy disruptions may also prove more resilient.

The Chinese market was extremely weak in 2022 as policymakers pursued a very different path in tackling COVID compared to the rest of the world. China has started to loosen their zero-COVID policy restrictions to boost domestic spending and international travel, however, this resulted in a surge in the number of cases towards the end of the year. While activity is restarting, the risk to Chinese assets include lower growth and the effect of the tight state control of the economy. Emerging market economies could benefit in 2023 as US interest rates peak and the US dollar eases, however slowing global growth will weigh on emerging markets.

The investment environment remains uncertain heading into 2023, including the lingering impacts of COVID particularly in China, the war in Ukraine and fears of inflation transitioning to recession concerns. Inflation and the response of central banks is likely to remain a key factor ultimately shaping economic growth. The continued impact of the Russia-Ukraine conflict and any escalation may be a risk to global economic stability. With a moderate recession now widely expected and markets already starting to anticipate a decline in inflation and a peak in interest rates, it could be a better year ahead for both stocks and bonds. After a difficult year for investors, the move away from an extended period of low yields presents opportunities in fixed income markets making bonds now more attractive particularly as inflation, and subsequently interest rates, start to recede.

While there are reasons to be more optimistic in 2023, worse than expected economic conditions and further unpredictable events including geopolitical tensions are likely to impact the outlook.

    Total returns in GBP to 31/12/2022

           *November 2022

Source of data: FE Analytics, www.bankofengland.co.uk, www.ons.gov.uk

The content contained in this article represents the opinions of MacIntosh & James Partners Ltd. The commentary in no way constitutes a solicitation of investment advice and should not be relied upon in making investment decisions. Past performance is not a reliable indicator of future results. The value of your investments can fall as well as rise and are not guaranteed.