Endowus Q4 2022 Market Update and Outlook — A Game of Chicken
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Endowus Q4 2022 Market Update and Outlook — A Game of Chicken

28 Apr
19 Jan
  • Investors are betting that the Fed will cut interest rates as early as the second half of the year; the US central bank says it’s simply too early to say how significant the decline in inflation will be.
  • In October and November 2022, equity markets broadly recovered from the sharp losses in September, before flattening out at the end of the year.
  • 2022 was marked by the failure of bonds to compensate for the equity downturn. The positive correlation remained in place during Q4 — all major bond indices posted solid positive returns.

A game of chicken

As the Wall Street Journal put it this month, the markets are locked in a game of chicken with the US Federal Reserve (Fed). While investors are already betting that the Fed will cut interest rates as early as the second half of the year, the US central bank is staying pat on its guidance that it’s simply too early to say. The bet comes down to this: Has inflation peaked? Investors think so — WSJ quotes CME Group data showing traders see a 90% chance that the Fed lifts rates two more times this year, to around 4.9% by March, followed by a 60% chance that they then cut rates at least once by December. 

The Fed says investors are pricing for perfection. Inflation is likely to continue falling this year as Covid-prompted supply-chain pains ease and housing demand cools, but the labour market’s strength could keep wage growth up.

A longer inflation fight?

Going by December’s consumer price index (CPI), there just might be cause for optimism that price pressures could be coming down from decade highs. The US overall inflation rate eased again in December 2022 — for the sixth straight month — to 6.5% on a year-on-year basis. That’s a gentler price increase than November's 7.1% and well below the June 2022 peak of 9.1%.

Core CPI, which strips out energy and food prices due to their volatility, rose 5.7% in December last year, slower than the 6% gain in November. For the last quarter of 2022, core prices increased at a 3.1% annualised rate — the slowest pace in more than a year, and down from 7.9% in the second quarter of 2022.

These numbers provide relief for households that have been grappling with surging energy and food prices, and are another hopeful indication that inflation may be turning the corner. 

Fed policymakers have said that the December inflation data would help them decide whether they could reduce the size of interest rate hikes to just 0.25 percentage point at their first meeting of 2023 on 1 Feb. That would be a smaller increase than the 0.75-point hikes seen at the previous four straight meetings. 

All officials at the December Federal Open Market Committee (FOMC) meeting of 2022 had agreed that the US central bank should slow the pace of its aggressive interest rate hikes. This would still mean further increasing the cost of credit to temper inflation — but doing so gradually, to avoid slowing the economy too much and causing higher-than-necessary unemployment.

It comes as the world’s largest economy already showed signs of cooling in late 2022. There have been declines in US imports and exports, retail sales, sales of existing homes, and manufacturing output.

The Fed policymakers were also concerned about any “misperception” in the financial markets that their commitment to control inflation was weakening, according to the minutes of the 13-14 Dec FOMC meeting, which were released on 4 Jan this year. They “reaffirmed their strong commitment” to bringing inflation back to the Fed’s 2% target, the minutes added.

Some commentators have suggested that the Fed may now be overshooting on inflationary expectations, after undershooting on the previously held belief that inflation was transitory.

Chart: Prevailing downside risks; risk of excessive Fed tightening seen as top risk for 2023.
Source: Amundi poll. Data as of 23 Sept 2022.

Potentially excessive Fed tightening that triggers a recession is seen as a major risk for 2023. But it may not be as dire as some fear — commentators generally think a shallow recession is likely this year.

The consensus view sees the US and developed economies falling into a mild recession in 2023. The surge in mortgage rates will crimp new housing demand, and the impact — including weaker construction activity and less spending — will be felt across the global economy. Consumer spending may also be dampened for the next few quarters by the higher mortgage payments and the wealth impact from falling house prices. Taken together, these should have the intended effect of slowing growth.

However, the overall balance sheets of both households and corporations remain strong.  While we may not know when the Fed pivot will happen, we know that eventually it will come and the central banks combined with stronger balance-sheet positions in developed markets could cushion the shock of a growth slowdown and recession and prevent it from a severe downturn.

The year of yield

Bonds are back. Yields have surged globally, reaching attractive levels not seen in years. Investors are now getting excited about bonds again, after years of being starved for yield. The Bloomberg Global Aggregate Index and other major fixed income indices have all bounced back double digits from October lows.

The fastest rise in interest rates in decades caused a dramatic fall in bond prices in a short period of time last year, but the countereffect is that yields are at the highest levels in a long time and at very attractive levels. 

Particularly for holders of bond funds for income, payouts should increase, and when the bonds in the portfolios mature, the funds are reinvested by fixed income managers into higher-yielding bonds as they take advantage of the rise in interest rates. 

Table: Yields have soared across asset classes and in key fixed income markets.
Source: Capital Group

Read more: Five big investing questions for 2023

Global equities — ending on a positive note

In October and November 2022, equity markets broadly recovered from the sharp losses in September, before flattening out at the end of the year. In the calendar year 2022, the MSCI All Country World Index (ACWI) — the broadest global market measure of equities performance — returned -18.9%. 

US shares rose as the monthly inflation print showed lower inflation rates, which led to the hope that the Fed might not have to raise interest rates as much as feared in 2023. With indicators pointing to a tapering in inflation. After a sharp correction, energy stocks generally rebounded, while consumer discretionary names suffered as the market took a risk-on approach.

Europe started to outperform the US markets with the onset of a warmer winter than had previously been feared. Despite the overhang of the Ukraine-Russia war, we know that the market prices in all known information, and the incremental news flow has been positive at the margin for Europe. The pace of interest rate hikes earlier in the year was not maintained, which was a welcome reprieve for the stock markets. After experiencing upheaval during Liz Truss' time as prime minister, the UK market rallied as the new government has announced more measured policies.

In Asia, China surprised the world in early December with the sudden reversal of its zero-Covid policy, lifting Chinese shares but sending fears of another wave of infections throughout the rest of Asia (and the world).  Fortunately, this left the equity markets unscathed as all major Asian markets remained in positive territory in the fourth quarter. The continued reopening of Japan and its surprise increase in price levels after decades of deflation also had a positive impact on markets and its currency.

Despite that, the two-year trend of value outperforming growth stocks continued, particularly in the US where high-priced technology stocks continued to struggle. It would be interesting if the rally extends itself, as we look at what factors and sectors will be leading that next leg up. 

Global fixed income — back to black

2022 was marked by the failure of bonds to compensate for the equity downturn. The positive correlation remained in place during Q4, when all major bond indices posted solid returns, similar to equities. Corporate bonds generally outperformed government bonds, and high-yield outperformed investment grade amid tightening credit spreads. All signals pointed towards lower inflation in the Eurozone and US around year-end, but rate hikes continued in the last quarter, albeit at a slightly lower pace. 

The US dollar (USD) went from strength to strength earlier in the year, but as the inflation slowed and the long end of the yield curve came off from its highs, we have seen a reversal in the dollar strength. The surprise hike by Japan led to a spike in the Japanese yen (JPY), which further exacerbated the USD weakening. The DXY index bottomed out in early 2021, then went on a record-breaking rally to the end of September and rose 27.5% from its trough. However, since then we have seen the Dollar Index fall by 10% from the peak. 

With an attractive starting level for yields now (fixed income) and the prospect of falling interest rates in the future (capital gains), the prospects for the global fixed income market are looking rosier after a difficult year in 2022. However, it is also tempered by the concerns of credit risk cyclically as we are entering a slowing growth and potential recession scenario. Default rates have remained stable, and this will be key in the rebound in fixed income in 2023.

Commodities and gold — mixed performance

In the last quarter of 2022, commodities were a mixed bag across different hard and soft commodities, but overall enjoyed a rebound. Base and precious metals, especially nickel, posted the strongest price gains, while the prices of energy and many agricultural products fell. Within metals, silver and platinum outperformed gold. Among soft commodities, cocoa and corn outperformed coffee and wheat. Among energy, natural gas prices declined the most, helped by an unusually mild start of winter in Europe, while heating oil prices continued to rise.

Over the whole of 2022, the Russia-Ukraine conflict had an outsized impact on many commodities. Energy prices soared after the start of the invasion and eased towards the year-end. However, coal and heating oil were still the biggest winners of the year, whereas lumber, coffee, and aluminium were among the biggest losers. Wheat in particular had a tumultuous year in 2022 — the war initially disrupted supplies, but a later agreement to let wheat be shipped out of the Ukraine alleviated the situation to some degree. 

As the year progressed, we are seeing that the shock of the war and supply disruptions are now being replaced by the underlying fundamentals of demand and supply across each of the underlying commodities, which is a healthy development for the asset class.

It is often times difficult if not impossible to predict the best performing asset class of each year, our investment philosophy remain consistent — taking the long term view and sticking to your plans, investing in a discipline way in a diversified portfolio, and lower the costs as much as possible. With digital wealth platform Endowus, you can plan and manage your money — by investing in carefully curated funds, in globally diversified, intelligent and low-cost portfolios seamlessly. To join our early access list, click here.

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Risk Warnings

Investment involves risk. Past performance is not an indicator nor a guarantee of future performance. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Rates of exchange may cause the value of investments to go up or down. 

This article is not intended to be relied upon as a forecast or research or investment advice, and should not form the basis of any investment or other decisions. The information contained herein is not intended, and should not be construed, as any legal, tax, regulatory, accounting or financial advice. If you would like investment, accounting, tax or legal advice, you should consult with your own professional advisors regarding your individual circumstances and needs.

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