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2022 Q3 Market Notes

2022 Q3 Market Notes
Lizz Truss giving a speech outside Number 10.

Markets seemed to start stabilising somewhat after such a dismal first half, but 2022 remains woeful for investors with both equities and government bonds posting negative returns so far this year.

Year to date, the S&P 500 is down more than 23%; emerging markets are down almost 28%; and the Nasdaq is off more than 31%. Investors remain worried about high inflation, slowing growth and the potential for an aggressive Federal Reserve to cause a recession.

Source: Refinitiv

In the U.S. there are some signs of encouragement: retail gasoline prices fell by more than 20% from mid-June, supply chains are tentatively healing, and some of the most volatile drivers of U.S. inflation, such as durable goods prices, are moderating.

Inflation may be peaking, however it is doing so at a much higher level than the Fed is willing to accept. The Fed has signalled that more large interest rate increases are likely, showing it is willing to tolerate a period of higher unemployment and slower economic growth in order to get inflation under control.

When the Federal Reserve expanded its balance sheet and reduced interest rates during the post-2008 monetary environment, you probably missed out on years of stellar gains if you didn't buy the market. But we should remember that the market goes both ways, and just as you don't want to fight the Fed when it's easing, you also don't want a fight with the Fed when it's tightening interest rates, as it is doing now. This is a lesson investors have learnt over the past few months, and the lesson may not be over. There's a high probability that we will see another 75 basis point increase at the November FOMC meeting and should see the benchmark at about 4% going into year-end.

Central banks around the world also continue to tighten monetary policy to combat stubbornly high inflation. The Council on Foreign Relations publishes a Global Monetary Policy Tracker which, as of August 2022, shows tightening among most of the 54 central banks that they track.

While there are many unanswered questions (as there always are) about the potential for a recession — including when it might start and how severe it might be — investors have come to fear that it is increasingly likely. In the U.S. it’s probably too early to predict that a recession is the most likely outcome. However, for the Eurozone and the UK, a recession seems unavoidable, where surging prices for natural gas are hitting hard.

In the UK, Lizz Truss' depressing new government announced a badly designed plan aimed at stimulating growth and investment. Unfunded tax cuts are the last thing the UK should be doing. The changes are likely to increase public borrowing by some 5% of GDP. It looks like she and her finance minister got it all wrong as many (not least Rishi Sunak) had predicted, and investors handed her a slap in the face. Interest rates soared and sterling slumped to a 37-year low — a combination clearly expressing zero confidence in the programme. The UK economic downturn is already underway.

Source: Refinitiv Note: all times BST. X-axis is condensed where the market closed from 23 Sep 22:00 until 24 Sep 20:00
The U.K. is behaving a bit like an emerging market turning itself into a submerging market. - Larry Summers

No surprise there though, Liz has a reputation for recklessness and her trickle-down economics could continue to hurt an already battered UK economy. Ironically, Biden tweeted this as she was speaking last week:

It doesn't help that Putin announced a partial mobilisation of 300,000 reservists, which shows he has no intention of withdrawing from Ukraine. The UK does not have any natural gas storage, so it is forced to buy natural gas on the open market, which is driven by the same dynamics as that in the EU, which means it is prone to further spikes as the winter approaches. A cold winter it will be.

As for China, it is on the opposite side of the monetary cycle. Whilst the Fed and other central banks are tightening, the People's Bank of China is easing, but China's economy remains weak on the back of ongoing Covid lockdowns and the property sector slump. Stimulus is happening, gradually, with rate cuts and infrastructure spending, but they have proven to be inadequate to reinvigorate growth. An end to resurgent lockdowns should allow growth to recover, but no end is in sight for a change of policy.

U.S. and China on Different Cycles: 1-Yr Govt Treasury Yield:

This week, the World Bank downgraded its 2022 China growth outlook to 2.8%, meaning China’s growth will be weaker than the rest of the Asian-Pacific region for the first time in three decades. There is also the potential for sedated growth to bleed into 2023 as a slowing developed market consumer may begin to weigh on the tradeable goods sector.

The Politburo meeting in October will be an important watch point for investors. Covid restrictions will likely continue into 2023 as prioritisation of political control over economic growth remains. China's focus on "high quality" growth is likely to be the ongoing narrative rather than a push for shorter term performance, as President Xi consolidates power for a third term.  

A global slump will probably not be as calamitous as the 2008 financial crisis, but could certainly be worse than the minor cycles we’ve seen since. Worst case, if guns go blazing over Taiwan, then economic disaster will probably befall the world for a few years, although this is highly unlikely.

It’s hard to find much good news, but one source of comfort is that investor sentiment is very negative right now, which perhaps provides some reassurance that markets have already accounted for all the bad news. Those who take a more balanced view that not all is doom and gloom will do well to invest progressively over time. We can look at times like this as incredible buying opportunities, a time to seek alternatives, or a time to run. Shorter term investors have good reason to be fearful.

For longer term investors, the current market environment is better now than it was a year ago. With today’s lower prices and falling valuations, we are laying the foundation for tomorrow’s success. It may not feel that way in the current moment, but that’s why not everyone gets to succeed. In ten years time, 2022 will be a minor blip on long-term performance charts, just like every other global slump in history.