Please find below our Investment Market Update as at 16th December 2022.
A reflection of the year
This is our last weekly market update for 2022 and probably like me, you’ll be glad to see the back of it.
This year has been painful in so many ways. It certainly was for the investment markets with this being one of the worst in the last fifty years, performance wise, when combining returns on equities and bonds. There has been one game in town which has derailed markets, and that’s inflation.
It was way back in the middle of 2021 when I distinctly remember a conversation with a business owner, when I suggested that we could see inflation in the UK in 2022, at about 5%… they thought I was going mad! Little did I realise that we would be looking at double digit inflation!
The excessive stimulus by governments and central banks was always going to lead to a spike in inflation. However, we didn’t anticipate severe and protracted lockdowns across cities in China, and nor did we anticipate the invasion of Ukraine!
We also did not envisage Truss and Kwasi creating somewhat of a typhoon on financial markets, meaning the cavalry (the Bank of England), had to come riding to the rescue. The manifestation of this, coupled with Brexit issues and supply chains, has elevated expectations for inflation and means that interest rates will rise for longer. Painful for some I know!
It could have been worse. In the midst of all this turmoil, the energy cap came to the rescue. Before this came into force, Goldman Sachs, were predicting that inflation could be as much as 23% here in the UK!!
Pain before the gain
In my musings over the year, my mantra has been focused around taking the pain. The harder it is, the more quickly we will see a positive response from this crisis. A prolonged and protracted situation could well mean that inflation becomes embedded within economies for years. This is not what central banks want, and nor do we!
On Wednesday in the US, the Federal Reserve (Fed) increased interest rates once again, this time by 0.5% which now places the cost of borrowing at between 4.25% and 4.5%. The rhetoric from the Fed is clear; interest rate hikes will continue and it will culminate at a higher level than markets anticipated. Jerome Powell, the Fed Chair, said “there won’t be any cuts until the Fed is confident inflation is moving towards the 2% target”.
The same stance will likely be followed by the UK, and yesterday interest rates rose by another 0.5%. It’s worth remembering that here in the UK, we are suffering from supply chain issues whereas in the US, it is mainly demand led inflation.
Many people ask why the Bank of England is increasing interest rates so aggressively and damaging our economy when inflation isn’t just a UK problem.
Inflation is elevated across most economies. The real fear is that wage rise inflation becomes embedded in the economy. An interesting dichotomy with public sector strikes going on at the moment.
The good news
- Inflation is close to peaking unless there are further nasty shocks
- In the second quarter of 2023, we expect inflation data to drop off on the year-to-year figures and the headline rate of inflation will fall
- The Bank of England is expected to slow down the rate of interest rate hikes and in the second half of 2023, we will see interest rates begin to fall gradually. Before this happens however, we need to see a series of improving inflation data.
We have experienced a crazy time since the financial crisis way back in 2008-09. There has been an eye watering amount of stimulus thrown at the economy and markets throughout the last 14 years but now we are ‘coming off the drugs’ and its painful. Supply chain issues and the energy crisis has exaggerated this pain.
The real fear in 2008-09, besides financial institutions going bust, was deflation. The fear now is high inflation which becomes embedded in economies.
- Inflation may plummet but it may be ‘sticky’ and we need to get used to inflation being at elevated levels of between 2-4%, perhaps after a rapid fall below this figure.
- Interest rates will follow a similar pattern, but we won’t go back to ultra-low interest rates. Expect 3-4% interest levels, more in line with long-term averages.
- We believe it will be a difficult winter for developed economies and expect news flow to deteriorate even more over the next couple of months.
- We are expecting increasing pressure on earnings and unemployment will become a factor. Whilst being bad for the economy in some ways, this will likely be a catalyst for an equity market recovery. We anticipate this being early in the second quarter of 2023.
- The economy and indeed capital markets are resetting for what is a new paradigm. Uncertainty has occurred on many fronts. This reset has nearly finished and the uncertainty this paradigm shift has caused, is plain to see. Get ready for the new normal.
- From an investment viewpoint, currently, we are expecting bonds, after a devastating year, to deliver returns of circa 5% per annum without too much risk. After an anticipated ‘bounce’ in equity prices we are expecting, over the medium term, to achieve between 6-8% per annum moving forward.
It’s so important to remember that economic data is backward looking and by the time we are in recession, there is a good chance that investment markets will already be showing signs of strengthening.
It’s important to also realise that our investment portfolios aren’t UK centric and have a global reach. Whilst it’s difficult not to see the world through a UK lens with the news flow we are served, our emphasis is on what is happening globally.
It’s also worth recognising that the type of companies that have delivered extremely strong growth in the past may not be those that do well in the future. We shouldn’t forget that some of the most successful companies were born in recession.
Many analysts are expecting double digit returns from equities next year as inflation falls, interest rate hikes cease and possibly, interest rates weaken towards the end of the year. Like you, we look forward to this possibility.
Thank you for reading and thank you for your support. I hope these weekly updates throughout the year have helped give some sense of perspective in what has been a very bumpy year.
Have a lovely Christmas all and here’s to better news in 2023.
Gary and the Blue Sky Investment team
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.