Cautious optimism?

Friday 3rd February 2023

The unusual aspect of 2022 (first time in 30 years) is that both fixed interest investments, such as Government Gilts, and shares fell in tandem, when usually they counteract each other.

UK Government Gilts fell 23.7% and World Shares 18% in 2022 meaning both low and high risk portfolios suffered equally as much. This is mainly due to it being a "forced" recession created by the central banks as they desperately try and bring inflation under control by increasing interest rates. Usually, as you head into recession interest rates are cut, but with so much money pumped into the western economies, (that we couldn't spend sitting at home) to beat Covid, they feel a need to make money harder to get. It's no longer a case of just shaking the money tree at the bottom of the garden!

The start to this year has been very strong for markets with investment funds performing well but is it a false dawn or will it continue? When we met with Fund Managers in December they were consistent in a positive message for 2023 but the timing was expected to be the second half of the year, once inflation started to subside and therefore interest rates hit their peak.

USA

Indeed despite the easing inflationary pressures the expected 0.25% increase in US interest rates and 0.5% in the UK went ahead in the last couple of days, but carried with it a view of rates peaking at lower levels than previously expected at the end of last year. However, as seems to be the way, it was the comments that surround the rate rises from the Central Banks that have the biggest impact. Fed Chairman Powell in the US appeared to shift his tone from the immediate need to tackle inflation to a more balanced medium term outlook, saying that he was focusing 'not on short-term moves but on sustained changes.' Markets were down until this point expecting continued negative words of caution, as done previously, in order to stop markets getting carried away. Powell did not push back against the idea of US central bank interest rate cuts later this year.

UK

Likewise in the UK it was The Bank of England statement, that counted when the Bank said, "If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.", omitting the word 'forcefully' from a similar sentence in the previous statement, so not so aggressive. It signals the great challenge of achieving a soft landing and maintaining that January achievement much heralded at the moment as the Goldilocks scenario - Not too hot and not too cold. Let's hope for all our sakes they can achieve this.

China

China's reopening has added to the optimism as supply chains should normalise, which is likely to boost global growth and economic activity. On the flipside, China's reopening could raise prices for commodities resulting in higher prices and less room to manoeuvre for developed market central banks as they fight the dreaded inflation. Overall though China's resurgence, following the scrapping of the country's zero-Covid policy, is positive. Economists in a Reuters poll projected growth of 4.9% this year versus an estimated 2.8% in 2022.

There remains uncertainty on inflation and interest rates - where will wage rises end up and will they be as inflationary as feared. Unlike the Fund Managers we are not so sure the recovery will start in the 2nd half of the year and feel it may be sooner and indeed, if waiting, would have missed the January returns. We have witnessed much greater volatility and movement in markets, highlighted as we have above based on the comments made by Central Banks rather than their action. It tells you they are looking for signs of where we will be in six, nine or even 12 months' time and react now to that current expectation. Just when it feels at its worst is when markets and hence your investment funds will start the consistent recovery that we are looking for.