Market performance in Q4 2022

The final quarter of 2022 was a positive one for most major equity markets. A softer dollar pushed US equities to the bottom of the pack for sterling-based investors, while European equities led the way. The general narrative surrounding inflation and interest rates remained largely unchanged throughout the period, though there were signs that 2023 could be the year this starts to change.

Positive US inflation news

Official US data showed what could be a key turning point in the battle against inflation. The quarter brought two consecutive prints where both core and headline inflation were below expectations. November’s consumer price index (CPI) print caught investors by surprise, showing a ‘miss’ of 0.3% coming in at 7.7%, but perhaps more importantly, core inflation also showed encouraging signs of slowing, coming in 0.2% below expectations at 6.3%. This core figure strips out the more volatile food and energy components of inflation and is the measure that the US Federal Reserve (Fed) is focused on, given it is more closely related to domestic economic activity.

Off the back of this, markets, particularly in the US, rallied strongly in the hope that inflation had peaked and was beginning its long road back down. While one print below expectations was never going to drastically change the Fed’s roadmap for interest rates, it was a step in the right direction and attention quickly turned to December’s print. This also did not disappoint, with both headline and core numbers below expectations by 0.2% and 0.1% respectively. Of note, December’s print also marked a fifth straight month of an inflationary slowdown in the US.

The Fed continued its rate hiking journey throughout the period, but importantly, December saw a hike of 0.5% rather than the 0.75% investors were becoming used to. While the smaller rate hike had been widely anticipated, it put an end, at least temporarily, to the previous four consecutive 0.75% hikes.

UK market indicators

On home shores, in October the UK had its third Prime Minister in as many months, but from an investment perspective, markets gained comfort that Sunak and Hunt were the team to deliver stability with their more conventional political and economic strategy. It should also be noted that the international focus of FTSE 100 companies meant the index was sheltered to a large degree from domestic political turmoil.

UK house prices recorded their fastest fall since early 2021, retreating by 0.4%, the third fall in four months, with many economists predicting more falls ahead. Data from the Organisation for Economic Co-operation and Development (OECD) suggested Britain was suffering the worst cost-of-living crisis among G7 countries, with the housing market an undeniable victim. Inflation continued to run rampant through the UK, and while the Chancellor’s Autumn Statement was never likely to have any great effect, it at least provided some comfort that the government was committed to erasing the disastrous mini-budget from memory, as best it could.
While the UK’s most recent CPI inflation print offered a much uglier overall inflation number versus the US, it too offered signs of slowdown through the quarter. The final print of 2022 showed UK inflation eased from 11.1% in November to 10.7% in December, and while inflation continues to damage the economy, a fall from the previous peak raised hopes that the UK may follow a similar downward trajectory to the US.

The Bank of England closely mirrored the decisions from the Fed, with December’s interest rate hike of 0.5%, down from the previous hike of 0.75%. The base rate currently stands at 3.5% with expectations of further, but shallower, rate rises to come.

Eurozone cooling

The story was the same across the Eurozone, with inflation again showing signs of cooling in certain areas. The European Central Bank also stepped away from recent 0.75% hikes, announcing an increase of 0.5% at its most recent meeting.

Chinese turnaround 

It was a remarkable quarter for Chinese equities. October began with deep negative sentiment toward the region in light of President Xi cementing his hold on power for a record-breaking third term. Investors rushed for the exit after there were no signs the zero-COVID policy would be relaxed, and also no pledges of significant stimulus to prop up the slowing economy. However, as the quarter progressed, cracks started to show in the zero-COVID policy, with rumours abound that the country’s leadership was considering loosening the tight restrictions. While little was officially confirmed small amendments were enough for investors to get excited and push markets higher. Eventually, and in response to widespread protests, the Chinese government finally relaxed its stance. This was particularly well-received by investors, having positive spill-over effects for broader Asian and Emerging Markets too. Sentiment improved further as much needed stimulus from China’s central bank was expected to drive an even faster economic recovery.

Central Banks response

While lower inflation numbers are undeniably welcome, there is a sting in the tail. The narrative from major central banks signposted that, in light of their changing inflation expectations, rates were likely to stay at a higher level for longer than originally expected. This means central banks – and investors – must continue to weigh up the delicate balance between slowing inflation and a crashing of the global economy. Restrictive policy being in place for a longer time elevates recessionary risks.

A further complication is the persistently strong jobs market, particularly in the UK and US. In the UK, the Office for National Statistics reported that 32% of UK companies with ten or more employees were experiencing a shortage of workers, while in the US, the unemployment rate remained at just 3.7%, close to a 50-year low, as average hourly earnings continued to grow above expectations. Factors such as these have ultimately led to a feeding of wage inflation. This, unfortunately, gives further justification for central banks to maintain aggressive rate policies, given the threat it presents to the longer-term inflation challenge.