Commentary on November 2022
FESTIVE GREETINGS FROM CHARLWOOD’S
Markets have extended their recovery from the September lows, as we enter what has generally been a seasonally strong period and while some of the negative factors overhanging sentiment have started to ease.
November began with further widely anticipated rate hikes in the US and the UK, to 4% and 3% respectively. However the policy statements accompanying these moves noticeably diverged. While the US Fed remained hawkish in its outlook, the Bank of England was at pains to guide market expectations for the future level of rates lower. This softer monetary stance is partly a result of new Chancellor Jeremy Hunt’s move back to fiscal austerity, unveiled in his Autumn Statement. It is also an acknowledgment that the UK economy has officially entered a mild recession.
As the month progressed data in the US also weakened, providing further evidence that multiple rate hikes were starting to take effect across the pond. There was finally some good news on the inflation front. The US core CPI print of 6.3% for October was well below market expectations. Markets greeted this news with a euphoric sigh of relief.
There were further signs that even lagging indicators such as the labour market are also starting to cool, with tech giants including Meta Platforms, Amazon, Twitter and Lyft announcing large-scale layoffs, following weaker than expected Q3 earnings. This suggests that overall economic data will continue to soften going forward, reversing many of the factors driving inflation. The biggest single contributor in this regard has been the earlier surge in energy prices. Price volatility has since evaporated; the oil price has continued to drift lower and is now trading broadly in line with where it started the year.
Markets rallied as this series of weaker data finally prompted Fed Chair Powell to soften his hawkish stance, stating that, “the time for moderating the pace of rate increases may come as soon as the December meeting”. Both equity and bond markets surged alike. Having started the year at 1.1% and rising to a peak of 5%, the yield on UK 30-year gilts fell back to 3.5%.
In other events, the anticipated Republican “Red Wave” failed to materialise. The US mid-term elections saw the Democrats retain control of the Senate but lose their majority in Congress by a slim margin, with increased political stalemate the most likely outcome during the Biden administration’s remaining term in office.
Global equity and bond markets as a whole rose 3% in sterling terms, led by gains in Asia. Equities in Europe and the UK recorded gains of 7%, while 2% gains in the US were muted by US dollar weakness. Chinese equities surged by an historic 25%, as authorities signalled a potential shift away from strict “covid-zero” policies following a wave of protests that have swept the nation in a rare and unified display of public anger.
2022 has been a challenging year for investors across the risk spectrum. With equities and bonds declining in tandem there have been few places to hide. Our portfolios have weathered these tough conditions well.
We are pleased to share that all of our standard portfolios have significantly outperformed their respective benchmarks for the year to date. While portfolio values have fallen, they have declined by considerably less than their corresponding benchmarks and in doing so have achieved first quartile performance. Our focus on capital preservation has cushioned our exposure to market falls.
While these periods can be unsettling, dealing with uncertainty is an integral part of our remit. We have navigated through many such events over the years. History has shown that despite periodic corrections markets trend up over time. Our focus is on building robust all-weather portfolios that can deliver strong returns over the long-term and help smooth volatility along the way. As an example, our flagship low-medium risk income portfolio has gained 85.2% since the start of 2012, a period that has included a number of negative events. It has achieved first quartile performance, outperforming its benchmark by a significant margin of 29.3% (31/12/11 – 30/11/22).
This leaves us in good shape going into 2023, when many of the current issues clouding the market should hopefully begin to ease.
Hope of a peak in the rate of inflation has driven a resurgence in animal spirits that has seen US equities rally by 17% from trough to peak in the space of six weeks. However we have been here before; markets staged a similar rally during the summer, only for expectations to be dashed. We are cautiously optimistic that we are indeed nearing the end of policy tightening, but would like to see inflation on a more established downward path to confirm the trend. A lasting recovery will most likely have to wait until central banks begin to cut rates.
Looking forward, the narrative will likely shift to predicting the length and magnitude of a global recession. There are clear downside risks to growth, but so far the data is not that bad. Most economists are expecting a relatively mild recession through 2023. While the overall macro environment remains unclear, valuations are much less demanding than when we entered 2022. The US price/earnings multiple is a full 3 points lower at 17X, while the UK is an historic bargain on a mere 9X. Bonds are also looking better value for the first time in many years. At the start of the year, yields on 10-year government bonds in the US, UK and Germany were 1.5%, 1.0% and -0.1%, respectively. These same bonds are now yielding 3.5%, 3.1% and 1.9%.
Going into 2023, lower valuations have significantly improved the risk versus reward outlook compared to 12 months ago. Economic data will likely get worse before it gets better, but markets are already pricing in a lot of bad news and will likely move to discount a recovery in advance. Rebounds can happen swiftly and there’s little point in trying to get the market timing exactly right. Buying assets when valuations are cheap is the best way to generate superior long-term returns. Our portfolios have raised cash in order to capitalise on such opportunities.