By JACK PEGLAR
In what has shaped up to be one of the most challenging investment environments for decades, persistent inflation set the tone early in the year, and finally caused central banks to begin reversing ultra-loose monetary policy.
Once the decision had been made that an urgent response was required, the Federal Reserve raised rates at the fastest pace in more than three decades. With the exception of the Bank of Japan, which is still firmly yield curve control mode, all other major developed market central banks were forced to follow suit. To add to this, the war between Russia and Ukraine has been a humanitarian catastrophe, whilst further developing a perfect storm for economies and global markets.
The size and pace of the moves in rates hit risk assets hard, with stocks and bonds simultaneously seeing large detractions. The traditional 60/40 stocks and bonds portfolio has had one of its worst years on record. At a broader asset class level there were very few places to hide, with only commodities delivering positive real returns year to date.
Looking into 2023, on the surface, the nearer term outlook does not look appear much more optimistic. Central banks are likely to remain on the offence until we see a substantial moderation in inflation. Higher prices are continuing to squeeze both consumers and corporate profits, and recession is now all but inevitable in Europe, and increasingly likely in the US.
China has also continued to grapple with its zero-covid policy and according to recent data, China is experiencing their third virus outbreak. There are however, a few reasons to be positive. We go into a 2023 with a substantial amount of froth taken off equity valuations; bonds are offering a return and the ongoing conflict, inflation, and recession risk has already been factored into prices to some degree. Although more unknowns will always be on the horizon, this is a very different starting position to the beginning of 2022.
Years of supportive monetary policy has likely been guilty of encouraging complacency, forcing investors further up the risk curve and causing many to ditch fundamentals and chase the winners of yesterday. Over the past decade, having a large passive allocation to US equities and not having to think about too much else would have been a difficult strategy to beat. We now find ourselves in an environment where support has been withdrawn and volatility has returned. This is not a bad thing, as with volatility comes opportunities. It is through these periods that active managers with the discretion to be selective, identify attractive investments and hold their nerve through uncomfortable periods have the potential to plant seeds for strong future investment returns.