Inflation continues to trend down, investors have taken heart and equities are on the up – but with China emerging from lockdown, how long will this last?
After all the grim tidings of 2022, we’ve seen an encouraging start to 2023 – at least in terms of market performance. Shares have made a solid start to the year, with equity indices rising in most major markets. In January, higher-risk and procyclical sectors and countries have led the way as investors rediscover their appetite for risk. Consumer discretionary has been a standout, and eurozone and emerging markets have done particularly well.
The bond markets appear to be in better health too. So far this year, government and corporate bond yields have generally fallen across the developed world. And with risk back on the menu and higher yields looking more attractive, corporate bond spreads have narrowed. In the currency markets, the dollar has weakened against most of its peers, especially the more procyclical currencies like sterling and the Australian dollar.
A mixed picture
Commodity prices have been mixed, however. Overall, broad commodity indices are little changed this year, but this disguises the quite divergent performances of energy and metals. Energy prices have fallen, most notably that of natural gas, helped by a warmer-than-usual winter that has helped to offset the removal of Russian supply. But the prices of metals such as copper and zinc have risen sharply.
The main factor in the surge in metals is China’s abandonment of its zero-Covid policy. This has led to anticipation of renewed demand for commodities in general and metals in particular as investors look to the enormous engine of the Chinese economy roaring back into gear.
Consumption and confidence contract
But while markets have been buoyant, economic news has been much less encouraging. Consumption data has been weak, with retail sales down in both the US and the UK in December. And as the chart below shows, US business output surveys have been consistent with contraction. This indicates a lack of corporate confidence about the coming months.
Central banks, most notably the US Federal Reserve and the European Central Bank, are maintaining their hawkish tone. They’ve been decidedly non-committal about any peak in interest rates and have pushed back on expectations that they’ll cut rate cuts any time soon. And, as we’ll discuss on the next page, China’s emergence from constant Covid lockdowns isn’t
an unalloyed positive for developed economies.
So, despite an upbeat start to 2023, we’re not by any meansout of the woods. Investors should reflect this in their portfolios’ positioning, ensuring that they are appropriately diversified and braced for further bumps.
"Central banks are in reactive mode - which is a polite way of saying they're making it up as they go along"
Haig Bathgate, Head of Investments
Investment view: why all the optimism?
As we enter the Year of the Rabbit, investors have their tails up. But we think that there are still good reasons to be twitchy.
As we noted on the previous page, economic data has been a bit grim. So why have equity and bond investors been so upbeat? Well, first, the economic news hasn’t been all bad. One important bit of good news has been the falling rate of inflation in the US. Investors have been excited by this, and speculation has been rife that US
interest rates might soon reach their peak. And if inflation continues to fall, the Fed and other central banks could even have room to cut rates later this year. That has certainly been the market’s expectation in recent weeks – and that’s why share indices have followed a well-worn path. Historically, when a tightening cycle is about to turn, equities have tended to rally. But things aren’t quite so simple this time. Central banks are at pains to stress that inflation is still stubbornly high. In many countries, that’s because there’s a shortage of workers, which is contributing to persistently high wage growth. Tight labour markets aren’t easy to fix, and central banks are clearly cautious about the time this will take.
It’s a gas, gas, gas …
More good news has come in the form of lower energy prices in Europe – especially that of natural gas. As energy prices have continued to fall, they have eased the market’s worries about the effects on the economy. This winter has been unusually mild, which has resulted in lower-than-expected demand and thus higher supply
of liquefied natural gas. The fall in the price of gas has reduced the pressure on energy-intensive manufacturers and consumers. As a consequence, a major recession in Europe is no longer a certainty.
All eyes east
The biggest positive impact on global growth should come from China. When the Chinese authorities abandoned their much trumpeted zero-Covid policy in December, just about everyone was taken by surprise. The sharp about-turn seems to have been caused by a combination of popular protests and the realisation that the dominant variants of the virus were spreading rapidly in any case. After millions of people returned to their hometowns to welcome the Year of the Rabbit, the virus will now have penetrated deep into rural areas, adding to the huge wave of infections that China is currently facing.
But the experience from other countries is that this will subside relatively soon – at least in terms of its impact on the economy. But besides the removal of Covid restrictions, the Chinese government has also switched to a decidedly pro-growth stance. Measures have been introduced to support the ailing property market – which in turn will support people’s wealth and hence growth in consumption. These measures will also boost constructionrelated investment, which is an important driver of growth in China. Meanwhile, the political crackdown on internet platforms seems to be over, which could allow a dynamic part of the economy to start flourishing once more.
Growth versus gloom
If Chinese growth bounces back, it will certainly improve the growth prospects for the rest of Asia. But it’s not all good news for economic conditions further west. Global commodities are still in short supply, and stronger Asian demand could push up prices around the globe and exacerbate inflationary pressures. And this would come at a time when European and US economies are still weak – as evidenced by weak retail sales and output surveys. On top of that, the full effects of 2022’s rate hikes are probably still to be felt. This massive monetary tightening is likely to put further downward pressure on growth – and we think that markets haven’t yet factored this in.
So while markets have been cheerful in January, there are still soun reasons for gloom. For now, we’re reserving judgement. The Year of the Rabbit isn’t guaranteed to be all fluffy for investors, and we think they would be unwise to assume that central bankers will soon pull something nice out of the hat.