The steepest year of policy tightening in over 40 years draws to a close
Following an initial setback at the start of December, markets resumed their recovery from September lows, starting the new year on a particularly strong note. The more upbeat tone coincided with a peak in the growth rate of inflation. In the US, core CPI fell for a third consecutive month to 6.5%. While interest rates continued to move higher, the magnitude of the December hikes in both the UK and the US was downgraded from 0.75% to 0.5%, and the accompanying statement from Fed Chair Powell conceded that there would be a "slowing down of rate hikes" going forward. Equities and bonds rallied alike.
Recession warnings grow louder, but the hard data holds up
The global recession drumbeat continued to grow louder, with a range of leading economic indicators warning of a slowdown in growth across the globe. The hard data, however, remained remarkably resilient. In the UK the much-anticipated recession had so far failed to appear: GDP growth in November rose by 0.1% and subsequent Christmas trading statements were generally ahead of expectations. While consumers were clearly feeling the pinch from the sharp rise in the cost of living, the economy was supported by full employment and rising wages. There were signs in the US that overall wage growth was finally starting to decelerate, although this had yet to occur in the UK.
Beijing abandons zero-covid and unlocks pent-up demand
While markets were busy waiting for signs of a policy pivot by the US Fed, a major change in strategy came from the east. Chinese authorities finally abandoned zero-covid, releasing the economy from a draconian policy that had greatly suppressed growth for three years. While the initial reopening was likely to be constrained by an inevitable acceleration of cases, the medium-term outlook pointed to a surge in pent-up demand for consumer goods, travel, leisure and other services.
This was seen as a welcome move for the regional economy, much of which still relies on China as an engine of growth. The recovery in Chinese equities continued and broadened to include Asia and other emerging markets that benefit from stronger Chinese demand. There was also speculation it would spur an increase in demand for commodities, along with gold, which moved up to challenge all-time highs in sterling price terms. Our standard portfolios benefited from both of these trends.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
The narrative is finally changing as we enter 2023
2022 was a challenging year for markets globally, with few places to hide as central banks, led by the US Fed, completed arguably the steepest year of policy tightening in over 40 years. As we entered 2023 this narrative was finally changing. Markets were much more concerned with the direction of travel and were gradually gaining confidence that the rate of inflation would see a notable decline during the year. Further rate hikes were expected during the first half, but the size and pace of these should continue to moderate and the end of this process was finally coming into sight.
Most economists saw developed economies falling into a mild recession in 2023. This was, however, widely anticipated and markets had priced in a great deal of bad news. The valuation of both bonds and equities was finally approaching attractive levels, having unwound much of the speculative excess built up during years of excessively loose monetary policy. The UK, Japan, Asia and emerging markets offered strong value in historic terms.
The valuation of both bonds and equities is finally approaching attractive levels, having unwound the speculative excesses of years of excessively loose monetary policy.
2022 was characterised by a "great rotation" from growth to value-style investing, following the previous heady years of chasing glamorous but high-priced stories of disruption and new technologies. This led to a return to a more traditional approach, favouring companies that generate strong cashflow with attractive yields and valuation multiples. This trend was likely to continue, as a return to the secular backdrop of falling interest rates appeared unlikely for the foreseeable future. Moreover, traditional value areas had been long forgotten: value managers had recently been likened to the Jedi in terms of their scarcity. The extent to which this area had fallen out of favour was reflected in the steep valuation discount of markets such as the UK and Japan, which are characterised by their high exposure to traditional industries. UK small caps looked particularly compelling at current levels.
We are proceeding with caution while the macro outlook remains unclear, but are alert to take advantage of opportunities and gradually increase exposure as the clouds start to clear.
Overweight value regions
We remain overweight the UK, Japan, Asia and emerging markets, where valuations look strong in historic terms. The steep discount of these markets relative to the US reflects their high exposure to traditional industries, which we believe will continue to benefit from the rotation out of growth.
Income and cashflow first
Overall equity exposure is focused on defensive areas such as income funds that own companies with strong cashflow, resilient balance sheets and attractive dividend yields. These should provide relative safety as the growth outlook softens. UK equities currently offer a dividend yield of 4.2% per annum.
Inflation protection built in
Portfolios hold assets that should prove relatively robust in, and even benefit from, a higher-inflation environment: index-linked bonds, infrastructure and renewables, along with real assets such as gold bullion and precious metal and commodity stocks.
Cash raised for opportunity
We have raised cash within portfolios in order to capitalise on the attractive entry points that are now emerging. Lower valuations have significantly improved the risk-versus-reward outlook compared to twelve months ago.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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