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Market update January 2023

Retrocessions
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Written on 2 January 2023 by Peter Garnry, Head of Equity Strategy at Saxo Bank

Inflation surprise fuelled equities in Q4

Global equities rallied 9.8% in USD terms in Q4 as inflation surprises drove bets that inflation is coming down and faster than expected, leading central banks to move to a neutral stance on monetary policy. This narrative drove equities considerably higher in October and November before comments from several central bankers suggested that policy rates must remain tight throughout 2023 to tame inflation to satisfactory levels. 

Services inflation excluding energy remains very elevated in the US, so there’s still a lot of uncertainty around inflation and wage dynamics and this will determine how inflation evolves from here but also the operating margin of companies. 

Global equities ended 2022 lower by 18.1%, the worst year for equities since 2008. The move lower has predominantly been an adjustment to higher interest rates pushing up the cost of capital and thus 2023 performance in equities will be dominated by whether companies can continue to grow earnings or not amid increasing headwinds on operating margins.
Market update January 2023 1
The fourth quarter of 2022 was also a tale of the US and European economy diverging. The US economy accelerated a bit in Q4 while in Europe, economic activity fell considerably. Financial conditions in the US have also moved from being tighter than the historical average to being looser than the long-term average.

While the US economy remains incredibly resilient amid the ongoing inflationary pressures, the global composite PMI slowed from 49.3 to 48.0 in Q4, suggesting an overall contraction in the global economy or at a bare minimum just no growth.

This is also evident in South Korean exports, a global leading indicator, which deteriorated significantly in Q4 but may bounce back in Q1 as China is reopening its economy after being in Covid lockdowns for almost three years.
Market update January 2023 2
The US inflation rate fell to 7.1% in Q4 from 8.3% in our Q3 update and the broadest measure of the US unemployment rate fell to 6.7% from 7.0%. The Fed continued to hike its policy rate taking the effective Fed Funds Rate to 4.33% from 3.08%.

China’s way out of lockdowns drives commodities

The last quarter was shaped not only by the positive surprise to US inflation but also China’s decision to finally let go of its very restrictive Covid policies which had kept the country in on-and-off lockdowns for almost three years. 

The change in Covid policy was immediately priced in industrial metals which rose 15.5% in Q4 as China’s reopening will help fill out the gap from the lower growth elsewhere in the global economy. Energy-related commodities declined 14.7% thanks to improving supplies and mild weather in Europe, but with the US expected to end releasing more of its strategic petroleum reserves, headwinds could easily come back in energy markets haunting economic activity again. 

Agricultural spot prices were once again well-behaved for the second straight quarter, alleviating some of the pressures on households, especially in developing countries.

While global equities generally reacted positively in Q4 to the lower than estimated inflation figures, US technology stocks were still under pressure, ending the quarter lower by 0.3%. Chinese equities were not seeing the rebound investors had hoped for as the Chinese government changed its Covid policy, recognising the headwinds in the short-term.

The strong USD has been a theme throughout this entire inflation cycle, with the USD Index rising 26% from early 2021 to the peak in mid-October last year. In the fourth quarter, the USD Index was down 7.4% helping to ease financial conditions, improving sentiment not only in equities but especially with precious metals increasing 13.1% in Q4. 

In the fixed-income market, the US 10-year yield rose 12 basis points in the fourth quarter and the US 10-year inflation swap also rose 12 basis points, leading to an unchanged real yield. The yield curve measured by the 5-year over the 30-year increased 17 basis points but remained in negative territory, suggesting that the market is expecting growth to slow while the Fed maintains its tight policy rate.

Will the commodity supercycle continue?

Two equity themes stood out last year, with our commodities and defence baskets gaining 24.4% and 22.3% respectively. Commodity prices were strong, and Russia’s invasion of Ukraine led to significant increases in demand for military equipment. The EU has proclaimed that it will double its military spending in the years to come in order to mitigate the increased threat from Russia. Energy-related theme baskets such as nuclear power and renewable energy also had a relatively good year, as elevated electricity prices drove up profitability of power generation. As the new year starts, the big question is whether we will see investors positioning themselves in new equity themes or continuing with what has worked in 2022.
Market update January 2023 3

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