Commentary on January 2023
It’s been a great start to the year for financial markets. Global equities surged 5% in January with broad increases across the globe, as sentiment was buoyed by China’s reopening and better than expected inflation and economic data. Markets in the UK, the US and Japan rose 4% in sterling terms. The strongest gain came from China, where stocks jumped 9%, propelling strong gains across emerging markets. India was the notable exception to this positive trend, where the implosion of the Adani Empire following accusations of fraud had market-wide repercussions.
Commodities have also had a strong start despite slowing growth across much of the globe. The China reopening, a weaker US dollar and the search for value over growth have all contributed to this move. Gold soared to a new record high in sterling terms. UK bonds also rallied a further 3%.
In sector terms the recovery broadened to include technology stocks, which rallied from oversold levels despite the difficult operating environment for many leading companies as the prior boom has continued to unwind. This was underlined by a second consecutive poor quarterly earnings season, resulting in widespread job cuts across majors such as Microsoft, Amazon, Salesforce and Facebook’s parent Meta. Investors were prepared to look through this in expectation of lower interest rates over the coming year.
The more positive tone was fuelled by growing optimism that central banks might pull off an economic soft landing. For all the recent talk of recession, the data has remained remarkably resilient. US GDP growth decelerated to 2.9% in the final quarter of 2022, down from 3.2% in Q3. The unemployment rate has now fallen to a 50-year low following another blowout jobs number. Even the UK has narrowly avoided falling into recession. GDP was flat in Q4, having fallen 0.2% in Q3; poor rather than catastrophic. The Bank of England is now expecting a shorter and shallower recession in 2023 than previously forecast. Better data also prompted the IMF to raise its growth outlook for the first time in a year, saying it sees a “turning point” for the global economy and that while the risk of a global recession remains it is diminishing, thanks mostly to the resilience of the US consumer and China’s reopening.
Inflation meanwhile has continued to gradual trend lower, although it remains at elevated levels across the West. The annual rate of change in consumer prices is running at 6.4% in the US and 10.5% in the UK, where it’s proving particularly sticky in the face of a weaker currency. This has triggered large-scale strikes across the public sector, the latest in a series of political challenges for the UK Government.
January also saw further interest rate hikes of 0.25% to 4.5% in US, 0.5% to 4% in the UK and 0.5% to 2.5% in the Eurozone. However, for the first time this cycle US Fed chair Powell acknowledged, “a disinflationary process has started”. Equity and bond markets saw this as a pivotal moment alike.
With economic growth proving resilient and the US Fed becoming less hawkish on the outlook for further rate hikes, investors are currently enjoying the best of both worlds. This has raised hopes that central banks will be able to engineer a soft landing, where interest rates peak at a level that does not trigger a recession. This is a credible view but by no means guaranteed.
Inflation is slowing but doesn’t look like it’s going away anytime soon. And with an unexpectedly strong jobs market, the risk remains that the US central bank will continue hiking rates above current expectations to cool things down. This could create some further headwinds going forward.
It should also be noted that forecasting remains problematic. Economies are still normalising after the pandemic shifted an unnatural level of demand away from areas such as hospitality and leisure towards areas such as online entertainment and e-commerce. Consumer demand has now swung back to areas denied during lockdown, meaning that resources such as labour now need to readjust. Meanwhile, demand from goods and services that benefited from lockdowns are now dropping, as consumer spending on items such as online subscription services and garden furniture is relatively tapped out. This process is clouding the overall data, making it harder to predict the trend for 2023.
Market sentiment has once again swung from one extreme to the other. The subsequent rally has been powerful, with global equities having now retraced a significant percentage of their 2022 losses.
If central banks manage to achieve an economic soft landing, the argument that the bear market has finished makes sense. However this is not guaranteed and in the short term markets are in danger of getting ahead of themselves. While the overall outlook is clearly improving, we should expect some further bumps along the road. Markets are now betting against whether interest rates will rise as much as policymakers say they will, which leaves scope for disappointment, particularly as the fight against inflation is not yet won. The old mantra ‘don’t fight the Fed’ has been forgotten but may yet return.
Having increased exposure to equities across our standard portfolios during the recent October lows, we have made no further changes to strategy at this point. We remain patient for further opportunities to add on weakness. In the meantime our focus remains on maintaining robust portfolios that are positioned for a range of likely outcomes. The emphasis remains on value in markets such the UK, Japan and emerging markets, along with commodities, gold and other alternative assets that add diversification and uncorrelated returns while the macro environment remains uncertain.