Quarterly investment outlook – Q4 2022

Overview

Expectations of a change in monetary policy gathered momentum and caused a rally in global equities of over +11% in a five-week period. Alas, this proved to be a short-lived bear market rally as central banks, led by the US Federal Reserve, signalled their determination to stay the course with rate rises.

By the end of the quarter, equity markets had given up all of their gains and more, finishing with a loss of more than -5%. For a Sterling-based investor, this return was softened by the weakness of the Pound, particularly against the US Dollar, with returns being broadly flat for the period. Gilts, having suffered in the spring, continued to sell off significantly in the face of rate rises and a mini-budget which was not well received by markets.

Global inflation remained stubbornly high throughout the summer driven primarily by energy and food prices. The cost of living pressures brought about by high energy prices in particular led to a curious interaction between monetary and fiscal policy, with central banks trying to slow growth to stop inflation from becoming embedded in economies, whereas governments are stepping in to help households meet their basic bills.

As ever, the lag between interest rate rises and their impact on the economy makes it impossible to know whether central banks will over-tighten and when they should cease raising rates. The expectation, given that central bankers fear inflation more than they fear a recession, is that we will end up with more hikes than necessary and the ensuing recession may be deeper than hoped for.

For the US Federal Reserve, which lead the way with tightening policy, the strength of the US Dollar is a complicating factor which impacts many around the world, not least emerging market countries, and one which cannot be ignored despite them giving clear guidance on the domestic measures which will drive their decisions.

Despite central bank fears, markets remain optimistic that inflation will subside, and economists forecast that we are at or near the peak of price rises. These expectations are partly due to the base effect of energy price rises falling out of the calculation, but we can also look to the reopening of supply chains and Chinese producer price inflation as positives for the inflationary outlook. There are also recent indications that jobs markets, while still tight, are beginning to cool a little. Of course, the ongoing situation in Ukraine will continue to have an impact on commodity prices, and this remains an unpredictable element.

Inflation aside, there is plenty to keep market analysts busy. The UK’s new government attempted a mini-budget which was far from ‘mini’, and which was such a departure from the fiscal policy of the last 15 years that it took markets by surprise leading inevitably to a fall in Sterling and a rise in the cost of borrowing for the UK. In Europe, solidarity within the EU is once again challenged as governments pursue divergent policies for dealing with the energy crisis, with wealthier countries hesitant to fund a common approach. And finally, in China, problems around the indebtedness of property developers continue to slow growth and has knock-on effects for local government finances and the banking sector.

David Baker, Chief Investment Officer

Quarterly Outlook

In this quarter’s investment outlook, Mazars’ Chief Economist George Lagarias shares his thoughts on the impact the markets are having on businesses, and if we are reaching a tipping point. George also shares his thoughts on the Global UK and US economies.

The tipping point for Businesses

Dear Business Leaders: Forget the world you knew

The previous decade had been good for the corporate world’s leaders. Lending rates had been kept at historic lows post the 2008 Global Financial Crisis to convince corporations and individuals that they can take investment risks.

Meanwhile, unfettered monetary accommodation by central banks ensured that stock prices, a key performance indicator for many boards, would continue to climb. Technological advances prompted the rise of challengers and ample liquidity allowed incumbents to maintain a competitive advantage. Small businesses would challenge and, if successful, would be bought up by their bigger rivals at a premium.

Any mistakes, and there was no shortage of them, could be easily covered with cheap credit. Companies were flush with cash; so much so that borrowing to pay dividends was proving beneficial to their capital structures. The cornerstone of this particular house of cards was low inflation. As long as consumer prices did not rise significantly, then cheap money could continue to flow.

The pandemic disrupted businesses and the ensuing inflation threatened the global business model. As Covid subsided the corporate world hoped that imbalances would be addressed and that the world would return to at least a semblance of pre-pandemic normality. Inflation was there, to be certain, but as supply chains normalised, the consensus considered that it had peaked around last December.

The tipping point

The war in Ukraine dashed hopes of a return to 2019. Inflation soared, forcing central banks to turn off the taps of cheap money and sending financial markets into a tailspin. For the first time in over twenty-five years, corporate debt and equity prices have been concurrently de-rated by their investors.

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Economic and investment outlook

We are experiencing significant volatility as the economy remains in search of a new paradigm. Even if the old paradigm persists, we believe that once global economic growth slows down significantly, inflation will subside, giving central banks and governments more room to support the next economic rebound. For the next 3-4 months, we expect to see intensifying economic pressures, as well as persisting supply-side (cost-push) inflation. Fiscal and monetary solutions will be less available than at any time in the previous twenty years. Weaker economies and structures could come under significant pressure.

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