Anthony Willis, Investment Manager in the Multi-Manager team at Columbia Threadneedle Investments provides the team’s 2023 outlook and the key drivers behind recent market moves.
Is your money better in a piggy bank or do bonds and equities offer value?
“When we consider the bond and equity rout of 2022, a piggy bank may well have been the best place to hide after all – a safe haven for your assets but not necessarily a store of value when inflation is at its highest level in 40 years.
“2022 was dominated by inflation and how central banks reacted to it, the world’s interest rate setters were late to realise that inflation had gone well beyond the ‘transitory’ narrative. By the time they had embarked on tightening monetary policy, the situation was significantly worsened by the impact on commodity prices because of the Russian invasion of Ukraine.
“We have seen aggressive interest rate hikes from the US Federal Reserve, Bank of England, and European Central Bank; in the US inflation may well have now peaked but all three central banks still have interest rates some way below inflation as we go into 2023.
“Fixed income assets have been hardest hit from the central bank hiking cycle with longer dated bonds exhibiting some of their largest drawdowns since the 1970s.
“Equity markets struggled through 2022, as the geopolitical issues and monetary policy worries weighed on sentiment. Corporate earnings have remained surprisingly robust, but the multiple investors were willing to pay for those cash flows reduced through the year – a partial reversal of the post-COVID euphoria. We are some way above the market lows for the year, and indeed the pullback in equity markets is still historically muted than we’d expect to see in a recession.
“Speculative assets that had sucked in massive amounts of capital and garnered many ‘new era’ headlines, such as cryptocurrencies, were exposed to be nothing short of a central bank policy trade. As liquidity dried up, so did their ‘value’. We mooted back in 2020 that such enormous stimulus may well have papered over wrongdoings – maybe now we are beginning to see the results.
“Many alternatives, such as real estate and private equity, are at different stages of revaluing their assets, which will likely move somewhere much lower than their current stated values. In 2022 the Bank of England had to intervene to stabilise government bond markets, and as economies slow in 2023, and as the tide of liquidity turns, it will become clearer where the combination of higher rates and excess leverage is too much for the financial system to manage.
“Whilst the Western world have put COVID pandemic behind them China’s ‘Zero Covid’ strategy persisted, with a lack of vaccine take up now having societal and economic consequences. Political shifts in China may be most important to financial markets; with recent signs of an easing in their ‘Zero Covid’ stance and talk of a 5% growth target in 2023. It looks like China’s authorities are looking to ensure the economic, social, and political impact of COVID does not weigh too heavily on social stability. The reopening of the Chinese economy could be a positive catalyst in the short term though longer term concerns persist as both the US and China retreat from globalisation, which will see consequences for both countries as rivalries intensify.
The central bank sledgehammer
“We see this as a real inflection point for markets. Money is no longer ‘free’ – interest rates are normalising thanks to higher inflation, and this changes the backdrop for households, consumers, and governments. It’s tough to see such rapid interest rate increases as being similarly supportive of returns witnessed in the last decade.
“Undoubtedly inflation will fall from its current high levels, but we’re not convinced it will gently settle back around the central banks 2% inflation target. Soft economic landings are rare in history. And whilst interest rates may be cut to boost the economy once more, we believe the zero-interest rate era is consigned to the history books.
“Economies have already slowed, and indeed the UK and Europe are likely already in recession. With the US less impacted by the energy concerns impacting Europe its recession may well be shorter and shallower. As always, the actions of the central banks, and how far they go to counter inflation, will have a significant impact on the economic and financial market outlook.
“Our view is this will have a notable impact over time on consumers, on ‘zombie’ companies who have survived far longer than they might have in an environment of higher rates, and for governments, with the realisation that markets will not necessarily be amenable to yet more debt fuelled spending.
“Some commodity prices have fallen back to pre-invasion levels, but governments have now woken up to the fact that energy security needs to be top of their agendas. Cheap Russian gas will no longer heat the homes and keep the lights on across Europe. The clean energy transition is a multi-year, multi-decade, phenomenon and requires huge capital investment to achieve. Contrast this requirement with the austerity witnessed post the Global Financial Crisis.
Time to top up the piggy bank in 2023, not yet crack it open
“Valuations for equities have moved lower, but do not yet appear to be at levels associated with a market bottom. Hence 2023 may well see further downside – something will likely be determined by the depth of the likely recession and the impact on corporate earnings. In this environment, returns look harder to come by, but there will be more opportunities for stock picking fund managers and active fund management in the absence of the ‘rising tide’ that seemed to float all boats in the low interest rate era.
“The back up in bond yields has been so severe that now we now see a rare opportunity within fixed income, and specifically in corporate bonds. 2022 was a rare event in that during a period of equity weakness, bonds performed even worse. We believe that bond markets have gone further in pricing in the bad news around rate hikes and economic slowdown than we have seen in equities so far. For now, earning interest through the fixed income assets through certainty of cash flows seems a very opportune way to top up the piggy bank.”