As the end of 2022 swings into view, the financial market recovery appears to be gaining momentum. Encouragingly, global equities have just recorded their first back-to-back monthly gains in more than 12 months. Investment-grade bonds, meanwhile, have posted their biggest monthly gain since 2008. All of this is clear confirmation that a disciplined investment approach is what we need in times of uncertainty – not short-termism.
That said, there is simply no denying that the year has been challenging for global investors – they have had to endure a plethora of headwinds, all of which have hit the economy and the financial markets very hard. Four-decade-high inflation, surging borrowing costs, ongoing lockdowns in China and war in Eastern Europe have all combined, leaving strategic and tactical traders, asset allocators and professional investors feeling bearish.
Nevertheless, following last month’s amazing rally, the US Dow Jones Industrial Index is now up by nearly 20% from its September low. Indeed, it is only 7% below the all-time high that it recorded on 4 January 2022. But these figures do not reflect the broader weakness affecting technology stocks and the NASDAQ 100 index – which is down 27% year-to-date.
Another stock market indicator worth paying attention to is the VIX – the Chicago Board Options Exchange’s CBOE Volatility Index, often referred to as the fear index. It is currently at 20, down from its March peak of 36. But the picture is nuanced and trends are changing: the cost of US gasoline has fallen to its lowest price since the start of Russia’s incursion. And the US dollar has just had its worst month since 2010, falling 5% against a basket of other major currencies.
As far as global market leadership is concerned, Chinese equities led the field, with hopes that the country’s Covid restrictions would soon be lifted. This pushed Hong Kong’s main index up by a dizzying 27% in November – its biggest rally since 1998. International large caps also had a very good month, closing the gap with US stocks. That said, both are still down by some 15% for the year.
The recent strength of equities and bonds has surprised some traders and investors. They have benefited from comments made by Federal Reserve Bank Chair Jerome Powell, who recently suggested that “the time for moderating the pace of rate hikes could come as soon as this month” (meaning December). If it is indeed the case that the US inflation rate has peaked, then both the country’s equity and bond markets will benefit significantly. The Fed’s next meeting (13 and 14 December) will give us a better indication of the future direction that the US central bank might take. But many commentators are now anticipating a 0.5% hike, rather than a 0.75% one.
Nevertheless, the “lag effect” in the Fed’s interest rate policy should be borne in mind. Previous hikes are likely to continue to weigh heavily on the economy well into 2023, increasing the risks of a mild recession in the US.
Something else for the Fed to consider is the strong monthly US jobs figures – these remain resilient. This may be good news for the economy. But some see it as bad news for the markets: it implies that the US central bank is failing to slow down wage growth. Over time, this will mean wage inflation.
The US unemployment rate is currently 3.7%. Annual wage growth, meanwhile, has increased to 5.1%. This leaves the Fed very little in the way of wriggle room when it comes to formulating an interest rate policy for the next few months.
The likelihood of a soft landing for the US economy may be increasing, but the same cannot be said for the Chinese economy. This complicates matters for the wider global economy and the US dollar. Economic activity in China has been hard-hit by its zero-Covid policy: scores of cities across the country have been in lockdown for months.
But recent demonstrations and a torrent of exasperation over the government’s handling of the pandemic (including criticism of the authoritarian rule of President Xi Jinping) have led to a distinct shift in messaging from Chinese officials: the zero-Covid policy looks as though it is on its way to being relaxed.
And leaving aside Covid, Xi Jinping has reiterated his expansionist views in relation to Taiwan as a key part of his legacy. An invasion, however, remains unlikely: the US has a significant military presence stationed just off Taiwan’s coastline, which would make it difficult for Beijing to stage any kind of military exercises anywhere in the vicinity of the island.
This has created a short-term bullish backdrop for Chinese equities, and the Hong Kong market has skyrocketed over the past few days.
As we head into the final few weeks of the year, it’s worth giving some thought to what the largest risks to the financial markets might be in 2023. Stubborn inflation remains the primary threat to the global economy. And the longer it remains embedded, the greater the chances that the central banks will push us into recession.
Then there are geopolitical risks – the Russia-Ukraine war is a long way from being resolved. Meanwhile, tensions remain between Washington and Beijing… and Iran is yet another source of unpredictability as far as the world order is concerned.
In recent weeks, the markets have been ever so slightly kinder to investors, and we are currently enjoying something of a Santa Claus rally. While we remain cautiously optimistic, we are by no means out of the woods yet. Although the first few months of 2023 are likely to be volatile, we believe nevertheless that opportunity is beckoning. We remain bullish on sectors such as energy, financials, healthcare, technology, industrial and consumer staples. And as we get further into the New Year, we are optimistic about consumer discretionary – which could well provide us with further investment prospects.
In the bond markets, the bond vigilantes are back. And with US interest rates likely to hit 5%, sovereign debt yields will react accordingly. However, investment grade and high yield still offer investors some attractive opportunities.
In the equity markets – although the US is still classified by many regional analysts as too expensive (even after the multiple contractions that have recently affected numerous stocks) – there are still some selective investment opportunities for patient investors.
The UK also offers both growth and income opportunities, but the current government is still a long way from enjoying any measure of stability. As far as Asia and the emerging markets are concerned, much will depend on the direction of US interest rates and the US dollar, given their sensitivity to both of these. However, if crude oil remains elevated and commodity prices rise, then regions such as Latin America and the Middle East will benefit.
