By Jan Faure
Global markets made a positive start to the year as investors were encouraged by signs that the anticipated economic downturn may not be as harsh as feared. Bullish themes centred around disinflation momentum, the Fed leaning more dovish, and a further easing in supply chain pressures on China’s reopening following a prolonged period of strict zero-Covid controls. China’s reopening should spur global growth and relieve supply chain constraints, but it has also raised concern that increased domestic Chinese demand will exert upward pressure on global inflation.
Interest rate sensitive technology stocks gained most in January as investors looked across the valley at easing inflation pressures. Recent inflation and GDP data support the view that major economies will have a soft landing, avoiding any major recessions. In the US, the tech-heavy Nasdaq Composite index surged 10.7% for the month, posting the best January since 2001, while the S&P 500 index gained 6.2%. In Europe, the Euro Stoxx 50 index added 9.7% while the UK’s FTSE 100 index increased by 4.3% for the month. In Asia, Japan’s Nikkei 225 index gained 5.1% while Hong Kong’s Hang Seng index climbed 10.4%.
Listed companies are currently reporting earnings results for the fourth quarter (Q4) of 2022. Approximately a third of companies in the S&P 500 have reported results so far, with 69% having reported positive earnings surprises. For Q4 2022, the blended earnings decline for the S&P 500 is -5.0% year on year (YoY). As inflation and higher interest rates place upward pressure on input costs and downward pressure on consumer demand, companies are unsurprisingly placing more focus on cost-cutting and expense control.
Inflation readings in the US and Europe have come in lower than expectations, supporting the view that central banks may start pausing further rate hikes by the second half of 2023. Eurozone headline inflation has fallen from a record high of 10.6% in October, dropping to 8.5% YoY in January (preliminary reading) from 9.2% YoY in December, giving some relief to consumers.
Food and energy prices are the persistent factors driving European inflation. The war in Ukraine severely disrupted food and energy markets, and while commodity prices have fallen from all-time highs, consumers are only gradually seeing relief on their utility and grocery bills. Natural gas prices have dropped 70% from record levels last year as milder winter weather eased energy demand for heating.
The US has been less affected by the energy crisis than Europe and the UK, and hence the inflation shock has been less severe. US inflation slowed to 6.5% YoY in December from 7.1% YoY the previous month, the lowest inflation print since September 2021. US core inflation, which excludes food and energy prices, declined to 5.7% YoY from 6.0% the previous month.
After reaching multidecade highs in 2022, global inflation will moderate this year in response to tightening financial conditions, softening demand, and easing supply chain constraints. However, persistent labour shortages and stickier inflation within the services sectors should see inflation remain above central bank target levels in the medium term. This is positive for short duration bonds where yields are offering investors attractive returns for their lower relative risk.
A prominent theme that has emerged is the impact of Covid and the war in Ukraine on geopolitical co-operation. The war in Ukraine is reshaping strategic alliances and international trade as a new East versus West dynamic takes shape, with US-EU leading one side and China-Russia the other. The reshoring of key manufacturing in pursuit of economic self-sufficiency is underway. The cost of this shift is global economic efficiency, increasing the likelihood that inflation will settle significantly above pre-Covid levels.
Gold advanced to a nine month-high, ending January at $1930 an ounce. Gold’s fortunes have been boosted by the prospect of a more dovish Fed, while inflation and geopolitical concerns continue to linger. Gold tends to benefit in a low to negative real-interest-rate environment, as it reduces the opportunity cost of holding gold vis-à-vis other yielding assets. Current geopolitical tensions as well as a major pick-up in gold investment in Russia (from retail, state entities and federal reserves) is helping boost the yellow metal.
Investors had to contend with major volatility throughout last year. Risks to the economic outlook remain with inflation well above central bank targets, higher interest rates dampening consumer spending and the war in Ukraine having the potential to escalate further. Looking ahead however, we are constructive on investment returns for 2023.
The end to the zero-Covid policy in China has ignited optimism of a rebound in Chinese growth and a boost to global economic growth, which should be supportive for corporate earnings. General market sentiment has improved as the worst seems behind us from a peak-inflation perspective. Further interest rate hikes will be far more measured as we approach the end of this rate hiking cycle. These factors should combine to create a far more favourable backdrop for investors.
Table 1: Global Indicators – Local reporting currencies