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Investment Outlook Q4 - 2022

The latest view from our Investment Team
Reading time: 10 mins

Each quarter, our Chief Investment Officer, Colleen McHugh, takes a detailed look at the investment markets at present, reflecting on recent events and macroeconomic factors, and looking ahead to outline our stance moving forward.

WHEN GOOD ECONOMIC NEWS IS BAD NEWS FOR CENTRAL BANKS FIGHTING INFLATION

Resilient economic conditions allow central banks to be more aggressive in tightening policy to deal with inflation. This implies that a “good news is bad news” dynamic may prevail, whereby risk assets weaken — even though economic conditions are more favourable than anticipated. Global equity and bond markets are broadly in the same dire straits as they were when we last updated you in August. US indices are in bear market territory, nearing their lowest mark for the year. Closer to home, the FTSE 100 is down over 5%, with the more domestically focused FTSE 250 down 25%, too.

Bonds – which are having their worst year since 1949 – officially entered their own bear market during the summer and continue to lurch violently. The once reliable 60/40 portfolio strategy has tanked over 20% during the course of the year —and is shaping up to rival the losses of 2008. We’ve touched on the reasons why it’s been such a challenging year for investors in our monthly updates.

War continues in Ukraine and, alongside the despicable humanitarian impact, financial markets most dependent upon Russian energy imports – Europe and, to a lesser extent, the UK – are ruffled. The UK’s ‘mini budget’ fiasco wreaked havoc for gilts and sterling, with recent reversals restoring a semblance of calm —at least for the time being. With the Communist Party of China wrapping up its 20th national congress, there is no let up in its zero-COVID policy, and trouble in its property market continues to simmer. In recent downturns, global markets have benefited from a resilient China and its ability to sustain some global growth. That is not the case this time.

 The main culprit for global markets discontent? Inflation.

And the cure being dispensed by central banks to fight it? Aggressive interest rate hikes.

If anything, inflation seems to be getting stickier; consequently, it’s likely rate hikes will continue well into 2023 (even if growth slows). Indeed, recent minutes from various central bank monetary committee meetings convey this tough stance, with policy makers fully committed to reducing inflation even if it takes its toll on growth. Realistically, the only way this hiking ends or reverses early, is with the onset of a recession — not exactly reassuring, I’m afraid.

On the economic data front, however, there are rays of light: strong labour markets – unemployment across developed markets is close to all-time lows – and impressive corporate earnings. Frustratingly, this good news is actually bad news for policy makers trying to curb inflation, as it necessitates a doubling down on their rate hike efforts. This “good news is bad news” dynamic may prevail, whereby risk assets such as stocks weaken — even though economic conditions are more favourable than anticipated. Heads or tails, and the market loses this toss, regardless.

ACTIVE ASSET ALLOCATION MANAGEMENT

Our responsibility as long-term investors, means we must focus on both what could go wrong — as well as what can go right.

We have been very active this year in making changes we believe will stabilise your Plan’s performance, whilst ensuring we are positioned for growth once the markets turn. With this dynamic at play – and market participant nerves being sufficiently jarred – we remain vigilant and alive to the uncertain investment outlook.

Risk levels continue to be actively monitored and managed — and are likely to change as the data changes. We have taken the opportunity to reduce the risk assets in your Plans multiple times this year. We remain comfortable that our current positioning offers some defence against further market declines, whilst at the same time being poised for the eventual market turn.

Given our views of growth over the longer term, our preference will favour allocating to equities in your Plans. We will therefore work to reinstate your risk weighting – particularly towards the US over time – and when the data supports this move. Your Plan is currently overweight UK equities, whilst being relatively neutral to Japan, Emerging Markets and APAC. Plans are underweight US, and European equities compared to the MSCI All Countries Index.

Regarding bond weights, Plans have an overall short duration bias to limit interest rate sensitivity i.e., the possibility of further interest rate rises, which will negatively impact bond prices in the short term. Finally, we have moved to an overweight cash position compared to our long run Strategic Asset Allocation, to have the dry powder available to redeploy into equities when the time comes.

TOP RISKS

Global Inflation 

The tightening monetary and fiscal conditions to date are beginning to have a real – and negative – impact on households. Ever-increasing price pressures for consumers tilt the probability of recession higher. The question now is likely what type of recession: shallow or deep. We are leaning towards the former.

Inflation and Policy Uncertainty
Major central banks have been quite explicit of late, calling for higher rates to quell inflation — even whilst accepting the inevitable negative impact on growth that these actions will have. Expect rates to continue to rise well into 2023.

Russia Ukraine Crisis
With no end in sight, the threat of escalations remains as the war squeezes commodity and energy markets.

New Covid-19 variants are vaccine resistant
Whilst inflation levels are the primary focus for stock markets currently, COVID-19 has not gone away, and indeed case numbers are stubbornly rising again. Markets will remain highly vigilant.

China Risks
The global economy is now coming to terms with the notion that China will not ride to the rescue in the next global slow down, as it has been able to do so previously. China is experiencing its own slowdown, which has been amplified by some self-destructive policies — not least its ongoing Zero-Covid policy, which is having a detrimental impact. on its domestic economy.

This document has been prepared by Wealthify’s Investment team and the opinions expressed here are theirs.

INVESTMENT OUTLOOK TABLE

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