2022 market commentary

December was a month of largely negative returns to end what was a challenging 2022 for investment markets. The FTSE World Index fell 4.8% over the course of the month, to bring losses to 17.0% for 2022 as a whole. The US market, represented by the S&P 500 index, dropped 6.1% in December, culminating in a 19.4% decline over the year – the worst annual performance for the index since 2008. European markets were also weak, with the Euro STOXX 50 falling 2.4% on the month to end the year down 11.7%. The FTSE 100 Index was the only major equity index to finish 2022 in positive territory, up 0.9% for the year after a 1.3% fall in December. Its all-cap equivalent, the FTSE All Share Index, closed the year down 3.2%. The FTSE Emerging Market Equity Index finished the year with losses of 17.0%. 

(All returns are sourced from FactSet and are reported as total return for the period 01/10/2022 – 31/12/2022 and 1/12/2022 – 31/12/2022 respectively) 

Central bank decisions and China Covid cases dominate December   

The year ended with both the US Federal Reserve (Fed) and European Central Bank (ECB) moderating the pace of interest rate hikes to 50 basis points in December, as inflation continued to be reported lower than expected. Both Central Banks however signalled further rate hikes for 2023. Twelve months ago, investors expected rate rises of c.1%, but they are now close to four times this figure, with the Fed increase to 4.25% the sharpest 12-month hike since the 1980s. The Bank of Japan also announced a surprise move, adjusting their yield curve control policy to allow the 10-year yield to rise 0.5% (having previously been limited to 0.25%).  

Following the easing of Covid rules in China, there has been a surge in cases, although the death toll is obscured by Beijing’s recently narrowed definition of Covid-19 fatalities. Countries have implemented new testing requirements for travellers coming from China amid worries there may be new variants. Domestically, China’s factory output has struggled since the rules were lifted as it battles nationwide waves of infections. Investors will be keeping a close eye on economic data as the world’s second largest economy re-opens.  

Historic biodiversity deal reached at COP15 

The first ever United Nations Biodiversity Conference (COP15) in Montreal took place from 7-19 December 2022 and was attended by representatives from 188 governments. The summit closed with a historic deal being made to halt the destruction of the Earth’s ecosystems. Delegates pledged that at least 30% of the world’s land, inland and coastal waters and oceans will come under conservation in the next eight years (by 2030). The ‘30 by 30 target’ will pay particular focus to areas important for biodiversity such as tropical rainforests.  

This target provides all parties with a clear roadmap to follow, and the next step is for countries to develop plans on how they will achieve the goals. It is widely recognised that achieving the target will involve action at an exponentially faster rate than we have seen to date. 

Sophie Lawrence, Stewardship and Engagement Lead at Rathbone Greenbank attended the summit and summarises her five key reflections here. The COP15 deal provides a supportive policy backdrop to the ongoing work Greenbank have been championing for several years on biodiversity.  

Other good news is the release of the final consultation draft of the Task Force on Nature-related Financial Disclosures (TFND) framework - a risk management and disclosure framework for organisations to report and act on evolving nature-related risks. The final framework will be released in June enabling companies and financial institutions to integrate nature into decision making.  

Nowhere to hide in 2022  

The shocks of 2022 came from war in Ukraine, soaring energy prices and out of control inflation caused by persistent constraints in the supply of goods and services. Inflation reached 40-year highs across major economies, causing central banks to embark on steep rate hikes. In the UK, the gilt crisis prompted higher yields and the devaluation of the Pound. These market shocks resulted in sharp double digit sell-offs in both stocks and bonds.  

By the end of Q1, equity markets were weak, but in Q2 it was even worse. Persistently high inflation combined with the US Consumer Price Index (CPI) reading for May saw a big sell-off in June. Prospects of the Fed ratcheting up US interest rates by 75 basis point hikes caused the S&P500 to fall by more than 10% in a week. There were hopes by the summer that the Fed may have begun to ease back their rate increases, with falling energy prices and weaker US inflation in July helping to support that view. However, these hopes were dashed when Fed Chair Jay Powell announced that the Fed would be “maintaining a restrictive stance for some time”. The European Central bank also hiked rates for the first time in over a decade with a 50-basis point rise in July and a 75-basis point increase in September.  

Potential recessions became more of a worry in Q3. The Nord Stream gas pipeline from Russia to Europe was suspended leading to energy prices rocketing. European governments stepped in to protect customers and businesses from the impact of high energy costs. Later in the quarter there was more turmoil in the UK, after the short-lived Truss cabinet announced a mini-budget containing the largest tax cuts in 50 years. Sterling plunged against all major currencies and hit an all time low against the dollar. Gilt yields spiked causing the Bank of England to intervene and offer support to the bond market. The government reversed the bulk of the announcements, with Rishi Sunak replacing Liz Truss as the new Prime Minister. Despite the support from the UK government, gilts finished 2022 down 25%.  

The final quarter of the year was the only quarter with some positive broad equity market performance. US and Euro Area inflation were lower than expected leading to hopes that “peak inflation” had been reached. The Fed and ECB stepped down their rate hikes to 50 basis points in December although both central banks have signalled further rate increases in 2023.  

Within equity markets in 2022 we saw ‘value’ (cheaper) companies such as financials, energy and healthcare companies outperform their ‘growth’ counterparts (particularly unprofitable technology companies). This was largely due to high starting valuations for growth stocks as we entered 2022 and the effects of rapidly rising inflation and interest rates.  

Outlook  

What will happen with market performance over 2023 is likely to be determined by two key factors:  

- Will the world’s major economies fall into a deep recession?  

- How high will interest rates go?  

Taking the first question, the UK is estimated to have entered a recession in the third quarter of 2022, with the Bank of England believing the contraction of the economy marks the start of a prolonged recession that will last through 2023. In fact, economists are predicting the UK will have the worst and longest recession of the G7 countries. The Eurozone has also entered a recession, although it may not be as deep as originally expected, with business activity contracting less than initially thought at the end of last year. The US is in a better position, with forecasts currently for a 2023 with zero growth, although there is a risk that the US will also fall into recession.  

Turning to the second question surrounding interest rate rises, we know that it takes time for rate rises to be felt in the real economy. We may only be at a point now where the first Fed rate rise from March 2022 is being felt, with another 4% still to feed through. Whilst recent US inflation data has been encouraging, Fed officials want to see more evidence of inflation falling back persistently for core services and wages. Markets continue to price in a US rate cut for the first half of 2023, which seems over-optimistic. In the UK rates are forecast to be 4.5% by June 2023.  

We do see a path to a more stable equity market in the second half of 2023, although we expect the first half of this year to be volatile and challenging. The outlook for energy, price and wage inflation is still uncertain, as is the prospect of global profit growth.  

Our positioning is tilted towards defensive parts of the market and we are limiting our exposure to cyclical sectors which typically do not do well when there is an economic downturn. In any case, we naturally have lower exposures to cyclical sectors (such as mining and fossil fuel companies) as they do not align with Greenbank’s mission to invest in companies that are positively benefitting people and the planet. We are keeping a close eye on the valuations and earnings forecasts for our preferred names – companies with strong balance sheets in sustainable industries with long-term structural growth trends.  

"...we naturally have lower exposures to cyclical sectors (such as mining and fossil fuel companies) as they do not align with Greenbank’s mission to invest in companies that are positively benefitting people and the planet."

We continue to see a strong investment case for renewable energy infrastructure and technology, as governments are rethinking their attitudes to fossil fuels and energy security following the Ukraine war. Furthermore, there is an even greater imperative to meet carbon reduction goals by investment into technology that supports the transition away from fossil fuels and promotes energy efficiency and a circular economy. The COP27 and COP15 summits last year reiterated the holistic approach needed to create a more sustainable future while emphasising the scale of the challenge ahead. The long-term investment case for sustainability is as strong as ever before, with companies providing solutions for these systemic challenges supported by regulation, changing consumer preferences and an urgent need to halt the climate crisis and to protect and enhance our natural habitats.