Commentary on December 2022
Market Overview
Following an initial set back at the start of December, markets have resumed their recovery from September lows, starting the New Year on a particularly strong note. The more upbeat tone has, not surprisingly, coincided with a peak in the growth rate of inflation. In the US, core CPI has now fallen for each of the past three months to the current level of 6.5%. While interest rates have continued to move higher, the magnitude of the December hikes in both the UK and US was downgraded from 0.75% to 0.5%. The accompanying statement from Fed Chair Powell continued to pour cold water on any idea that they are close to a policy pivot, but did concede that there would be a ‘slowing down of rate hikes’ going forward. Equities and bonds rallied alike.
The global recession drumbeat has continued to grow louder, with a range of leading economic indicators warning of a slowdown in growth across the globe. The hard data however has remained remarkably resilient. In the UK the much-anticipated recession has so far failed to appear. GDP growth in November rose by 0.1% and subsequent Christmas trading statements have also been generally ahead of expectations. While consumers are clearly feeling the pinch from the sharp rise in the cost of living, the economy is supported by full employment and rising wages. There are signs in the US that the trend in overall wage growth is finally starting to decelerate, although this has yet to occur in the UK.
Bright Spots are Starting to Emerge
While markets were busy waiting for signs of a policy pivot by the US Fed, a major change in strategy came from the east instead. Chinese authorities finally threw in the towel on zero covid, releasing the economy from a draconian policy that has greatly suppressed growth for the past three years. While the initial reopening is likely to be constrained by an inevitable acceleration of cases, the medium term outlook could see 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 the 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 have benefit from both of these trends.
Looking Forward
2022 has been 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 enter 2023 this narrative is finally changing. Markets are much more concerned with the direction of travel and are gradually gaining confidence that the rate of inflation will see a notable decline during 2023. Further rate hikes are expected during the first half, but the size and pace of these should continue to moderate and the end of this process is finally coming into sight.
Most economists see developed economies falling into a mild recession in 2023. However this is now widely anticipated and markets have priced in a lot of bad news. The valuation of both bonds and equities are finally approaching attractive levels having unwound much of the speculative excesses built up during years of excessively loose monetary policy. The UK, Japan, Asia and emerging markets now offer strong value in historic terms.
Our Strategy
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 has led a return to a more traditional approach favouring companies that generate strong cash flow with attractive yields and valuation multiples. This trend is likely to continue, as a return to the secular backdrop of falling interest rates is unlikely for the foreseeable future. Moreover traditional value areas have been long forgotten: value managers have recently been likened to the Jedi in terms of their scarcity! The extent to which this area has fallen out of favour is 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 look particularly compelling at current levels. We are proceeding with caution while the macro outlook remains unclear, but on the alert to take advantages of these opportunities and gradually increase exposure as the clouds start to clear.
