Inflation concerns abating as recession fears mount

Having declined for three consecutive quarters, global equity markets ended 2022 on a positive note as the MSCI All Country World Index returned 9.8% during the fourth quarter. Gains in global stocks can largely be ascribed to participants in the equity markets anticipating a more subdued hawkish approach by central banks as we head into 2023. Despite the renewed ebullience within stock markets, bond yields edged higher during the quarter with the US 10-year benchmark yield increasing 8 basis points to close the year at 3.88% and the European 10-year benchmark yield gained 40 basis points during the quarter as it closed at 2.53%.

As exceedingly high levels of inflation continue to be the scourge of central bankers, particularly those in the developed markets, the pattern of rate hiking persisted during the final quarter. The most influential central bank of them all, the US Federal Reserve (“Fed”), increased its lending rate twice during the quarter, firstly by an increment of 75 basis points and later by a smaller increment of 50 basis points. The 25-basis point reduction in its most recent rate hike combined with what appears to be a plateauing of inflation elevated hope among some that the Fed might reduce its hawkish stance, possibly even pivot towards the doves, resulting in a renewal in confidence for stocks. For others, this may have just been a bear market rally, only time will tell.

November’s annualised consumer price growth in the US slowed to 7.1% compared to October’s read of 7.7% and the month-on-month inflation growth rate for November was only 0.1%, lower than the 0.3% increase seen in October. Core inflation, which strips out price increases related to food and energy, rose 0.2%, a deceleration when compared against the October read of 0.3%. Despite recent inflation data providing support for a more accommodating interest rate environment, the outlook for rates remains unusually opaque. Wording from the Fed suggests that the central bank remains concerned over inflation noting that further evidence would still be required to support the idea that inflation is headed back down and that additional rate increases would still be appropriate. Positive reads from the most recent economic data points added further murkiness to the interest rate picture. US third quarter GDP was revised upwards and the US labour market continues to show signs of resilience as recent jobless claims came in lower than expected. Both data points would count against the Fed pausing, let alone reversing its process of hiking interest rates.

While the Fed will remain concerned over tackling inflation with higher interest rates, markets appear to have moved onto what the implications may be under an increasingly restrictive interest rate environment. The “R-word” is likely to be the hot topic in 2023 as recession fears loom large. Corporate earnings and household balance sheets will be closely monitored for signs of deterioration, particularly in an environment of higher interest rates.

What is noteworthy about global stock returns during the final quarter of 2022 is the gulf in performance between growth¹ and value¹ stocks. The MSCI All Country World Value Index increased 14.2% compared to the 5.3% increase in the MSCI All Country World Growth Index.

Gains across the value cohort were broad-based during the quarter. Stocks within the materials sector benefitted from higher industrial metal prices which rose during the quarter against a backdrop of a weakening US dollar and China relaxing the country’s lockdown restrictions. Notable commodity price gains during the period include aluminium (+8%), copper (+10%), iron ore (+13%), lead (+24%), nickel (+36%), platinum (+25%) and tin (+20%).

Strong earnings momentum continued to support investor sentiment towards the energy sector. Energy counters climbed higher during the quarter despite the prices of Brent crude and WTI ending the period relatively unchanged. The pair closed December at $86 and $80 a barrel respectively. The increasing likelihood of a global recession has dampened the outlook for oil demand placing downward pressure on oil prices but the relaxation of lockdown restrictions in China and a weaker US dollar have provided pillars of price support.

Much of the relative underperformance during the quarter from growth stocks can be attributed to “big tech” names such as Apple, Alphabet, Amazon, Meta, Microsoft and Tesla (some may argue that Tesla does not belong in this particular cohort). Sentiment towards these more richly valued counters continued to fade during the final three months of the year owing to a variety of concerns. Challenges facing the US tech giants include production issues stemming from China as a result on intense lockdown conditions, regulatory concerns that include antitrust investigations as well as penalties and fines but perhaps the biggest worry for investors and traders alike has been the recent slowdown in sales growth which may persist during a recessionary period. A certain CEO’s $44 billion acquisition of Twitter has raised concern among certain Tesla acolytes that he may be losing focus on what matters, at least to them.

From a regional perspective, price weakness exhibited by the above-mentioned big tech names dampened the overall performance of US stock markets due to the relatively large weightings of these counters in the respective indices. The S&P 500 Index gained close to 8.0% during the quarter and the tech-heavy Nasdaq actually ended the quarter in the red having fallen close to 1.0%.

European equity markets, which tend to be more value orientated as opposed to growth, performed relatively better than the US. In local currency terms, there were strong quarterly gains across major indices such as the Netherland’s AEX (+7.9%), the UK’s FTSE 100 (+8.7%), the French CAC 40 (+12.5%) and the German DAX (+14.9%). In US dollar terms, the performance of European indices was even greater as sentiment towards the greenback softened during the quarter resulting in the US dollar declining close to 8% as measured by the US Dollar Index (an index that measures the US dollar’s performance against a cohort of other major currencies).  In US dollar terms, the gains made by the AEX (+17.6%), FTSE 100 (+17.5%), CAC 40 (+22.6%) and the DAX (+25.2%) were notably higher.

The Bank of Japan caught markets by surprise as it deviated from its long-held policy of maintaining ultra-low bond yields by allowing the country’s 10-year benchmark bond yield to trade as much as 0.5% above zero, an increase of 25 basis points from the previous target level. The move saw the Japanese 10-year bond yield spike higher before closing the quarter at 0.42%. In contrast, Japanese stocks fell after the announcement, dampening the quarterly performance of the Nikkei 225 Index as it returned 0.8% for the period in local currency terms. The policy change did result in the Japanese yen strengthening against the US dollar as the yen moved from ¥148 per US dollar at the start of the quarter to eventually close December at ¥132. The stronger yen meant that in US dollar terms, the quarterly return for the Nikkei 225 was 10.6%.

China’s stringent lockdowns have been a thorn in the side of Chinese stock markets acting as a quasi-gravitational force to stock prices in the region. Harsh, draconian measures put in place by authorities to contain the spread of the virus were eventually met by nationwide protests. In response, Beijing authorities have begun to relax lockdown criteria which has acted as a catalyst for Chinese stocks as well as certain commodities. Hong Kong’s Hang Seng Index rose sharply during the quarter to return 15.0% and the mainland CSI 300 Index has begun to recover lost ground as it closed the quarter 2.0% higher.

The positive developments stemming from China have also acted as a catalyst for South African stocks, especially those closely tied to China. The JSE All Share Index returned 15.2% during the quarter and a large chunk of that gain can be laid at the feet of Naspers and Prosus. Chinese tech conglomerate Tencent surged during the quarter, recovering significant lost ground, which in turn benefitted its major South African shareholders. The largest contributor to the local bourse’s gain was luxury group Richemont, as markets reacted positively to its most recent set of financial results as well as the relaxation of lockdown conditions in China, a significant market for luxury goods. The rise in commodity metal prices led to strong market performance by South African miners. Gold miners in particular had an exceptional quarter. 

The yellow metal appears to have regained some of its lustre as the price of bullion broke above the $1,800/ozt level during the quarter as it closed at $1,814/ozt, a gain of 8%. It was a different story in cryptocurrency land as the FTX scandal that has embroiled its founder, Sam Bankman-Fried, spread contagion risk among various cryptocurrencies leading to sharp falls and resultant quarterly declines for the likes of Bitcoin (-15%) and Ethereum (-10%).

Note 1:

Growth stocks can be thought of as those with a longer a duration. This implies that the bulk of their future earnings lie relatively further out in the future. In general, stocks that typically fall into this category can be found in sectors such as technology, consumer discretionary and certain segments within healthcare. Value stocks in contrast are those normally found within sectors such as financials, commodities (energy and materials), industrials, utilities and real estate. Value stocks are shorter duration in nature implying that the bulk of their earnings are more concentrated around the shorter term. Growth stocks are typically more highly valued (as referenced by a multiple on earnings, cash flows, book values etc.) than their value stock counterparts.