Written by Julian Howard, Lead Director, Multi Asset Solutions, GAM Investments
Global equities, as measured by the MSCI AC World Index, fell by nearly 16% in local currency terms in 2022. This was the worst full calendar year since the global financial crisis (GFC) of 2008.
The immediate drivers of this decline were high inflation, higher interest rates, war in Ukraine and China’s zero-Covid policy.
The inflation component was especially important, as it was the one factor that prevented the US Federal Reserve (Fed) and other central banks around the world from rescuing both the global economy – and therefore investible assets – in the way that they have consistently done since the GFC.
The Fed ‘put’ – the belief that it will step in to propel markets – was reluctantly set aside in 2022 as the central bank belatedly attempted to control inflation by tightening monetary policy. In so doing, the Fed slowed down economic activity.
However, it would be inaccurate to characterise 2022 as an unremitting ‘polycrisis’. From 12 October to 31 December, the MSCI AC World gained nearly 8%.
This was a result of relief on three key fronts:
- US headline inflation softened
US headline inflation decelerated from its June peak of 9.1% to the 7.1% posted in November. 10-year US Treasury yields – the market gauge of growth and inflation – also fell from 4.3% in late October to 3.9% by the end of the year.
- Russia’s war strategy in Ukraine faltered
In Ukraine, Russia’s war strategy was dealt a severe blow by the re-taking of Kherson, giving the Ukrainians the strategic initiative.
- China loosed its zero-Covid policy
Finally, China abandoned its zero-Covid strategy under the weight of a widespread popular backlash. Caseloads inevitably spiked, but the message was clear: the priority was once again the economy.
All three factors taken together allow for 2022 to be compartmentalised into a lengthy ‘inflation and rates’ phase, book-ended by a period of meaningful reassessment.
It is however worth noting that while price action during the latter segment was positive overall, it was not one of consistent euphoria.
The cryptocurrency meltdown, along with unrealistic expectations of a complete Fed U-turn on rates that did not materialise, kept investors relatively guarded in their response.
Nonetheless, it became apparent that the relentless onslaught of bad news that had gripped markets was starting to loosen.
Chart 1: MSCI AC World in local currency terms posts worst year since the GFC
Source: Bloomberg. Past performance is not an indicator of future performance and current or future trends. Data from 31 Dec 2002 to 31 Dec 2022.
Chart 2: Why stretch for more? T-Bills offer attractive risk- and maturity-adjusted yields
Source: Bloomberg. Past performance is not an indicator of future performance and current or future trends. Data from 31 Dec 2019 to 31 Dec 2022.
So, what is the outlook for the global economy?
Our ultra-long term outlook for the global economy and markets remains broadly unchanged.
Low growth, and by inference low rates, look set to be driven by continued economic inequality, low productivity, deteriorating demographics, de-globalisation of trading, state expansion and climate change.
However, the short to medium term offers less certainty. While the fundamentals of the good news that lifted the final quarter of 2022 look set to persist into 2023, investment trends rarely play out linearly and the economic backdrop remains challenging as consumers retrench.
Five key headwinds investors should remain mindful of:
- Global GDP will likely fall
The Organisation for Economic Co-operation and Development (OECD) recently predicted GDP growth of 2.2% for 2023, down from the 3.1% that seems likely for 2022.
- Global inflation may remain volatile
Global inflation will pause and reverse as it decelerates, from a likely boost in Chinese energy demand. Furthermore, market expectations of a Fed pivot are unlikely to be met, given the central bank will be acutely conscious of its own credibility as it responds slowly to peaking inflation. This mismatch is likely to explain why indices will probably not spike euphorically on softer inflation data in the coming months, however likely it may seem to market commentators.
- Russia’s war on Ukraine war shows little signs of abating
Ukraine faces a long haul to restoring its territorial integrity, with slow progress and rising costs posing the main risks to vital continued Western commitment.
- China could re-introduce lockdowns
In China, the lifting of Covid restrictions is seeing hospitals overwhelmed. In the absence of a successful vaccination programme, localised economically disruptive lockdowns could yet be re-deployed.
- The FTX scandal may still undermine investor appetite
More broadly, the FTX scandal could have a temporarily dampening effect on investor enthusiasm. The collapse in bitcoin has been concurrent with outflows from US mutual funds and ETFs in the final quarter of the year, suggesting investors have been turned off ‘everything’.
On the bright side, there are few reasons to be despondent. Fundamentally better newsflow, with limited (initial) investor participation is arguably a formula for improved returns in the medium term.
Persistent equity engagement will remain key to capitalising on these better conditions. However, effective diversification and tactical asset allocation will be important for the inevitable soft patches and unexpected occurrences that await. We approach 2023 therefore a little wiser, but quietly optimistic too.