At the onset of 2022, our first Weekly News Flash was entitled “The year of the Fed”. Even though we could not have anticipated events such as the war in Ukraine and prolonged Covid-19 lockdowns in China, it was indeed the case that spiralling inflation and interest rate hikes around the world were the key factors that shaped the direction of investment markets during the past year.
After enjoying strong returns for many years, most global investors experienced a sharp drop in their equity portfolios by year-end: The MSCI World index had fallen 26% for the year to date by 12 October, before bouncing back by 9.8% in the fourth quarter. Nonetheless, the index ended the year 18% down. Energy was the only industry sector on the S&P 500 that ended 2022 in positive territory.
Noteworthy was the convergence of risk in 2022, with not even global bonds being spared from financial market carnage. US 10-year treasuries fell by nearly 17% in US dollars, their worst calendar year performance in history. All eyes are now on how markets will perform with global growth expected to slow down as inflation starts to subside and the rate tightening cycle draws to an end.
Taming the inflation beast – the oil price is now only 3.4% higher than at the onset of 2022
In the US, inflation peaked in June 2022 at 9.1% year-on-year. While inflation at 6.5% for December remains well above the Fed’s 2% target, there are already some signs that the inflation beast has been tamed. Food price pressures continue to ease, falling 1.9% from November’s number, and inflation-linked bonds are now pricing in a sub-2% level by the end of 2023.
Energy was the main culprit for inflation becoming persistent rather than transitory in 2022 – both before and in the immediate aftermath of the Russian invasion of Ukraine. But the effects of the global energy crisis were less severe than anticipated as the year unfolded, thanks in part to a mild European winter and various vulnerable countries having accumulated healthy gas stockpiles.
Brent crude oil is now only 3.4% higher than it was at the beginning of 2022, 19% lower than the day of the invasion, and 38% lower than the March peak. The question now is whether central banks can engineer a soft landing in their economies by continuing with tight monetary policy to break the inflation cycle, without causing recessionary environments. Signs in the US are positive, with employment figures remaining constant even as inflation tapers off.
Equities are already discounted for a global slowdown. Attention should now shift to corporate earnings
The market is already pricing in lower inflation, as evidenced by a modest 0.3% gain on the S&P 500 when the December inflation numbers were released this past Thursday afternoon. While economists have reached broad consensus that there will be a global slowdown this year, our research shows that this has also been factored into equity prices.
As such, we believe that the key driver for equities this year will be the extent to which corporate earnings hold up relative to consensus forecasts. Markets tend to be forward-looking, peaking before growth reaches its pinnacle and bottoming before it troughs. In the absence of any new risks or events, we expect markets to grind higher during 2023 and recover a meaningful portion of 2022’s losses.
During the last quarter of 2022, we finally saw China reverse its zero-Covid policy. This should be broadly positive for the global economy, given that frequent lockdowns in China dampened global growth, disrupted supply chains and contributed to supply-side inflation. The Chinese government has indicated that it will focus on growth in 2023 and this stimulus could also provide global support.
On the global political front, this is the first year since 2000 that there will be no general or presidential elections in any G7 country, barring potential snap elections in the UK. At the same time, we can expect to see existing geopolitical tensions to continue as countries use trade as a weapon and seek increased energy security.
South Africa—Eskom is the millstone
Our newsletter has a separate article about why we are not bullish about the JSE. We believe persistent, ever-worsening load shedding will mean that South Africa will continue to underperform and remain an unattractive destination for inbound fixed investment. However, one big positive on the domestic front should be the reopening of the Chinese economy, which will stimulate demand for our commodities.
In a review of our portfolio building blocks, we are monitoring the US dollar as a barometer for risk appetite, as well as S&P 500 earnings, to better understand where the global economy is going. We may well see the rand strengthen as the US dollar begins to weaken in the year to come.
In line with RW Johnson’s insights in the video included in this quarterly, we remain sceptical about the ANC’s political will, ability and capacity to implement the necessary policy reforms to support and grow the economy at the required levels, especially as the country draws closer to the 2024 general election. As such, we recommend that clients continue to externalise wealth in an appropriate manner.
