Let’s face it, 2022 was a terrible year for the global economy. Emerging from the pandemic (at least in the western world), there was a renewed sense of optimism. Inflation was benign, interest rates were low and almost every asset class had enjoyed positive performance in 2021… and then came 2022.
From a market perspective 2022 was the worst year for a balanced investor since 1871, with the typical 60/40 combination of stocks and bonds down an eye watering 17% on average.
The inverse relationship between bonds and equities (where one rises as the other falls) has been the foundation of low volatility portfolios since the 1980s, averaging around 7% between 1999 and 2022. But years of QE had pushed that relationship to the limit and the combination of high inflation and rising interest rates, caused both asset classes to tumble in unison. Frankly, if you (or your investment manager) were only down by 10% in 2022, you did pretty well.
With 2022 now behind us and the era of cheap money feeling like a distant memory, it has been a reassuringly positive start to 2023, with markets responding encouragingly to the latest data. Inflation now appears to have peaked in most developed nations, with US inflation now at 6.5% – its lowest level since October 2021 and whilst it is not yet near the 2% target, the direction of travel is reassuring. The re-opening of China, following its strict ‘zero-covid’ policy has also injected some much-needed support into markets and supply chain bottlenecks that wreaked havoc, are now beginning to ease. Shipping a container from Shanghai to New York has fallen from $14,000 back in January last year, to $3,600 today – representing a 75% drop in the cost of shipping freight. Further to that, wholesale gas prices are now back down at levels not seen before Russia invaded Ukraine. These are important indicators of cost pressures easing, which have been at the very heart of our recent inflationary woes.
Although the economic backdrop is undoubtedly more positive, challenges still remain. Realistically, we are already in recession and it is highly likely when more data is released, it will confirm that to be the case in the UK, Europe and the US. This economic slowdown is primarily driven by central banks aggressively tightening their grip on the economy in order to get inflation back down to more acceptable levels. Setting the correct rate is no doubt a delicate balance for central bankers to strike. Raise interest rates too high and you risk mortgage defaults, lay-off’s and plunging millions into poverty. Leave them too low, and the already high levels of inflation could get out of control, requiring an even more heavy-handed approach and even greater economic destruction further down the line. In my view, the greatest risk to market performance and economic prosperity, is policy error by central banks and this will be a key issue for the year ahead. If (and it’s a big if) they get it right, we can expect a soft landing, where inflation falls and a shallow recession ensues. Get it wrong, and the economic turmoil could continue for quite some time.
Whilst last year was no doubt painful, it has allowed the bond market to reset somewhat, sitting at what can be considered much more normal levels. Two years ago, a 10-year UK government bond would get you somewhere in the region of 0.2% p.a. (which I think we can all agree is a pretty bad deal). Fast forward to today and that same 10-year government bond will get you 3.3% p.a. As a result, the bond market – which has long been considered the low-risk aspect of a portfolio – now looks much more attractive and better positioned to provide the safety net it was known for. JP Morgan are now predicting that the typical balanced portfolio will now average annual returns of 7.2% p.a. over the next 10 years, up from their previous estimate of 4.3% p.a. in 2021.
So, for the first time in a long time, it is exciting time to be an investor again. I expect that we will see the bottom of this bear market in 2023 and whilst we can’t predict exactly when that will happen, if you have money available to invest and a sufficient time horizon, it’s certainly a good time to deploy at least a proportion of that, given the significant discounts that are now available on assets from their previous highs.
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Ben Barratt, Chartered FCSI
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