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A Positive Start to the Year
- The global stock market (MSCI World Index) rose 6.5% in January, following a 16% decline in 2022
- The bond market (Bloomberg Global Aggregate Index) rose 2% in January, following a 12% decline in 2022
- Central banks are slowing their interest rate hikes and are expected to stop raising rates soon
Key Themes
The market thinks inflation is yesterday’s news, at least for now. Since October, inflation has been declining and markets have been rising. We still see higher prices on the shelves and strike action in the news, but markets care about the rate of change and that is improving. Focus is now on recession: if it will come, when it will come, and how big it might be. With no clear evidence of a major recession right now, markets feel free to march higher.
UK
The FTSE 100 index of the largest UK stocks was one of the few markets to generate a positive return in 2022 and it had a solid January (+3%). However, smaller stocks performed best (+4.5%) due to returning risk appetite. UK small caps were among the first to decline, peaking in September 2021, and still have a long road ahead to make up their losses. If the Small Cap Index, AIM Index and FTSE 250 Index can pull themselves up off the floor, it would be a positive indicator for the prospects of a sustainable market recovery throughout the rest of this year.
United States
The US stock market had its best January return (+6%) since 2019 and the growth-focused Nasdaq index had its best January (+11%) since 2001. Earnings season is in full-swing and company profits have held up better than expected so far. This may have taken one potential downside catalyst out of play for the time being – although most companies are still to report at the time of writing.
In the five previous instances where US stocks rose 5% or more in January following a negative prior year, the average full-year return has been a barnstorming 29%. Such an outcome would certainly be welcome this time around. However, the market remains acutely aware of heightened recession risk for the remainder of this year.
Europe
The French and German stock markets rose 6.5% to start the year but the big winner was Spain (+8.25%). Europe isn’t used to taking the lead but it has become one of the most popular investment ideas for professional managers recently: especially those in the US who are looking to move money into the overseas ‘value’ trade. The European Central Bank remains committed to raising interest rates.
Emerging Markets
Emerging markets are also a popular theme currently, as the US Dollar continues to decline following its spike last year. China has finally committed to a full reopening after almost three years of rolling covid lockdowns. This is seen as a boon for emerging markets in particular, and global markets to boot. China is now by far the biggest trade partner to the vast majority of South America, Africa and South-East Asia.
The MSCI Emerging Markets stock market index is back at 2007 levels, having suffered a sharp decline since June 2021. Can a Chinese reopening, weak dollar and strong commodity prices fuel a decade of outperformance – or is this another false dawn?
Bonds
Bond yields rose to such an extent in 2022 that it created ‘once-in-a-generation’ capital losses statistically. Note that bond yields move inversely to their prices. Yields have declined recently as the initial inflation pulse has begun to pass. UK 10yr Government Bond yields spiked to 4.5% during the Liz Truss debacle, but now sit at a rather more comfortable 3.2%. It is a similar pattern for all developed markets, which are closely correlated.
Government bonds are seen as offering an element of safety if a recession does arrive. However, credit spreads – the difference in yield between government bonds and riskier corporate bonds – have remained very narrow. This suggests the bond market is not pricing risk as though a hard recession is imminent. Declining yields have mostly been due to declining inflation.
Points of Interest
Bitcoin rebounded 40% for its best month since 2021 and its best January performance since 2013 – showing tentative signs of recovery following the crypto crash of 2022. Bitcoin’s perceived diversification benefit has reduced greatly in recent years, with it now acting as a high-beta play on risk assets in general. The market has started 2023 in an optimistic mood and this is where it shows up most. Bitcoin still remains 64% below its all-time high.
The property market is intriguing and may prove key to the future direction of the economy and financial markets. Most developed nations experienced a property boom during 2021-22 as mortgage rates became historically cheap and covid stimulus measures pumped money into the economy. UK housing activity has stalled since August and prices have declined by 3.2% since then. Housing activity has also stalled in the USA and other developed markets. In Sweden and New Zealand house prices have already declined by 20% and 11%, respectively. These are open economies with a high proportion of variable rate mortgages, similar to the UK. Can mortgage rates decline fast enough to prop up the domestic property market, or is it too late?
Summary
January has certainly been a very positive month, which has extended a very positive rebound since October. However, stock and bond markets declined slightly towards the end of the month. House prices are down and recession is a real possibility. Will 2023 mark the beginning of a new bull market, or an extension of the 2022 bear market? Nobody can tell for sure, but for those investors willing to take a long-term approach, valuations and yields appear more attractive now than they have been in recent years.
