Investment market participants will be keen to see the back of what has been a difficult year for investors. Whilst it may seem a long time ago, 2022 began with markets in a buoyant mood. The restrictions imposed due to Covid-19 were finally ending, and with central banks and Governments continuing the support put in place at the start of the pandemic, global Equities markets peaked around the turn of the new year.
Inflationary pressures were already starting to build at the end of last year, although it would have taken a very brave economist to predict inflation reaching double-digit levels in most Western economies by the third quarter of the year. Whilst some of the blame for the heightened inflation can be placed firmly at the door of Vladimir Putin, the shake-off of the Covid excess and a tight labour market also contributed to the rapid rise in inflation. Central banks have predictably moved to raise interest rates to try and dampen the inflationary fire, but the combination of restrictive central bank policy and concerns over the conflict in Ukraine pushed most asset classes lower over the first half of the year.
The summer saw markets rebound, amidst very tentative indications that inflation was being tamed, although the renewed optimism was dashed by hawkish words by the Federal Reserve and the ill-fated Mini-Budget announced by Kwasi Kwarteng. This forced the Bank of England into the very uncomfortable position of firing up the printing presses once again, to provide liquidity to the Gilt market and caused Sterling to plummet against major currencies.
By early November, the mood finally began to lift, as market participants cheered lower than expected inflation data in the US, and closer to home, a second Budget statement was received more positively. Whilst central banks may not be at the end of the rate hiking cycle just yet, markets are hopeful that the first quarter of 2023 will see the end of this painful period where interest rates have realigned to reflect the prevailing and expected conditions.
Nowhere to hide
One of the key takeaways from 2022 has been the negative impact of higher inflation on most asset classes, and how this has reduced the benefits of diversification. An important component of a well-diversified portfolio is to include exposure to different asset classes that tend to produce a variance in performance, with the aim of balancing weak performance from one particular class or sector, with an improved performance elsewhere.
This year has seen very different conditions emerge, and as the year progressed, the performance of different asset classes began to correlate more closely than they have done for many years. The rapid spike in inflation heralded conditions that are not friendly to fixed interest securities, such as Government and Corporate Bonds, and this has undermined the traditional role Bonds play in reducing volatility, at least for the time being. Equities, which should see less of an impact from the inflationary conditions, also retreated, as sentiment towards risk asset faded in light of the ongoing conflict and worsening economic outlook.
The result has been that 2022 has been a disappointing period for investors in most asset classes, with a high degree of correlation across the board. We do, however, see a return to more normal market behaviour over coming months as our expectation is for inflation to fall back towards mid-single figures by this time next year. We therefore believe that the benefits of diversification, which were rather hidden during this year, will make a return next year.
Taking the medicine
Stock markets are often referred to as “discounting mechanisms”, which work on the notion that the current price of a market or asset takes into consideration all available information at the time, including present and potential future events. Whilst this theory is nowhere near perfect, and short-term sentiment is often dictated by market fear and greed, it is clear that markets do take into account expected economic data within prices we see today.
As a result, the difficult market conditions experienced over the last 12 months can be viewed as being a period of readjustment in asset prices, from the positive outlook many held at the start of the year, to the reality of slower growth, and possible recessionary conditions, as a result of the conflict and the spike in energy, food and fuel prices. We feel that investors should not, therefore, be alarmed by the expected gloomy reports in the media about the state of the economy over coming months, as markets have, at least to some extent, factored this into the current market value.
Brighter prospects ahead?
As 2022 draws to a close, investors will reflect on a bruising year and will be hoping for a return to less volatile conditions over the course of the next year. We certainly feel that current valuations are attractive for many asset classes, and we will explain the reasons behind our optimism for the coming 12 months in our market outlook to be released in January.
As this is the last Wealth Matters for 2022, we would like to take this opportunity of wishing all of our readers a peaceful Christmas, and good health and happiness for 2023.
If you are interested in discussing the above further, please speak to one of our experienced advisers here.
The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.