Market Analysis Dec 2022

At the year's outset, the global economy was emerging from the pandemic-induced recession, ushering in labor and supply chain constraints that raised expectations of heightened inflation. Central banks gradually commenced raising interest rates from historically low levels to mirror the improving economic outlook.

However, the situation took a dramatic turn with Russia's invasion of Ukraine in early 2022. This event reverberated throughout the year with profound consequences. Commodity markets witnessed immediate effects, as energy and agricultural prices surged due to supply disruptions. Ukraine's inability to export vital agricultural crops and ensuing sanctions on Russia propelled inflation to levels not witnessed in decades.

All asset classes bore the impact of these developments, with commodities being the exception as they experienced positive performance. Trends initiated in 2021, such as declining bond prices and the outperformance of value-oriented investment styles over growth strategies, were magnified. Central banks, caught off guard by the surge in inflation, accelerated interest rate hikes, further influencing consumption and mortgage rates. Economic forecasts were significantly downgraded, with many anticipating a widespread recession in 2023.

In the UK, these challenges were compounded by political upheaval, featuring three prime ministers, echoes of 1970s industrial action, and a disastrous mini-budget introduced by the Truss administration. This initially prompted investors to shed sterling, rendering it the weakest major currency for much of the year. The gilt market also faced pronounced selling pressure, leading to surging bond yields as global investors absorbed the implications of an underfunded budget. A swift change in prime minister and chancellor, coupled with a complete reversal of the budget, reinstated stability to UK assets in the fourth quarter.

As the year advanced, some pressures abated as the aftermath of Russia's invasion waned, particularly in energy markets. Europe swiftly reduced its dependence on Russian energy supplies, and a milder early winter season along with resumed grain exports helped stabilize the situation. Additionally, China relaxed COVID-19 restrictions driven by populist sentiment, which bolstered its economic prospects.

Interestingly, despite the UK's political tumult and its post-Brexit unpopularity among global investors, the UK stock market outperformed other major markets in 2022. The market managed a slight positive return while others declined by nearly 10%. The UK market's substantial exposure to the energy sector, which surged by nearly 50% due to the impact of the Russian invasion, significantly contributed to this superior performance. Conversely, the US market performed poorly, primarily due to declines in the technology sector. This pattern was echoed globally, with growth-oriented sectors facing more selling pressure than economically sensitive value sectors.

Divergence among different sectors within global stock markets was pronounced. Economically sensitive and defensive industries fared well, whereas highly valued sectors and those heavily reliant on consumer spending experienced notable selling pressure. The standout performer was the energy sector, followed by utilities, consumer defensive, and pharmaceutical sectors, which display relative immunity to economic slowdowns.

Within the fixed-income bond markets, all major segments witnessed weakness. Bond prices, both government and corporate, plummeted sharply as investors reacted to escalating inflation and its ramifications on fixed-income coupon payments. UK government bonds and index-linked gilts endured the poorest performance, primarily due to the political upheaval and the poorly received mini-budget introduced by the Truss administration.

Energy and agricultural commodities stole the spotlight, driven by the supply shock triggered by the Russian invasion and the resulting inflation. Gold also functioned as a safe haven with positive returns, owing to its properties as an inflation hedge.

Real estate encountered selling pressure as concerns escalated regarding the economic fallout from inflation and interest rate hikes. Alternative asset managers encountered a challenging environment but also identified opportunities through astute positioning amidst the divergent performance of assets.

All in all, 2022 proved a turbulent year for investors, with few asset classes delivering positive returns and substantial fluctuations throughout. Success in generating positive returns necessitated agile decision-making.