Global Economy & Markets, Weekly Roundup 17/01/23
Global equity markets enter 2023 on a strong footing as headline inflation decelerates
Key Takeaways
2022 was rough on multi-asset investors as aggressive monetary tightening, amid extremely low coupons and expensive equity valuations, contributed to an uncommon mix of bond and equity losses. The classic 60/40 portfolio recorded losses of -17% in 2022, experiencing one of the worst drawdowns on record.
Looking at 2023, valuations for risk assets have fallen, while the repricing across reference interest rates has improved prospects for medium-term returns, particularly in high-grade fixed income, compared with one year ago.
The percentage of fixed income instruments carrying negative yield has diminished due to policy interest rate increases and fewer asset purchases by central banks. As a result, an investor is likely to earn some income in bonds, after almost a decade of negative interest rate policies.
The Bank of Japan meeting on Wednesday could have repercussions not only for the JPY (+3% to ¥128 since December 20th), but for global assets as well (currencies, fixed income), assuming the BOJ provides further evidence that is shifting away from its ultra-ease policy. Following the unexpected adjustment in December of the upper range for its 10-Year JGB yield target of 0% to +0.5% from +0.25%, Japanese long-term yields have increased towards seven-year highs.
Regarding valuations, the average 12-month forward price to earnings ratio of Developed and Emerging market equities stands at the 61st percentile of valuation since 1990 from 90th one year ago, whereas valuation divergence among regions and sectors offers tactical opportunities.
In a similar vein, aggregate corporate bond spreads stand at the 37th percentile from 88th one year ago. Note, though, that valuations are no longer convincingly cheap, following the most recent rally.
Indeed, risk assets have increased in the past month on the back of decelerating inflation pressures on both sides of the Atlantic and relaxation of covid restrictions in China. US CPI slowed further in December to 6.5% (year-over-year) from a peak of 9.1% in June and euro area CPI increased by 9.2% in December from a peak of 10.6% in October.
In conjunction with signs of moderation in US wage growth, investors now price-in that the Federal Reserve will cut interest rates in H2.2023 as monetary policy will not need to be restrictive. Emerging market equities are up by +21% from their mid-October lows, with declining natural gas prices boosting euro area assets (equities, bonds, EUR).
Having said that, while medium-term return/risk prospects have improved, tactical market reaction in Q1 will continue to be a tug of war between recession and “soft-landing”, as the macroeconomic outlook (inflation evolution, central bank reaction and geopolitics) remains unusually uncertain. For central banks, is too early to declare victory in their fight against inflation, as underlying core price pressures are still strong.
Key Takeaways
2022 was rough on multi-asset investors as aggressive monetary tightening, amid extremely low coupons and expensive equity valuations, contributed to an uncommon mix of bond and equity losses. The classic 60/40 portfolio recorded losses of -17% in 2022, experiencing one of the worst drawdowns on record.
Looking at 2023, valuations for risk assets have fallen, while the repricing across reference interest rates has improved prospects for medium-term returns, particularly in high-grade fixed income, compared with one year ago.
The percentage of fixed income instruments carrying negative yield has diminished due to policy interest rate increases and fewer asset purchases by central banks. As a result, an investor is likely to earn some income in bonds, after almost a decade of negative interest rate policies.
The Bank of Japan meeting on Wednesday could have repercussions not only for the JPY (+3% to ¥128 since December 20th), but for global assets as well (currencies, fixed income), assuming the BOJ provides further evidence that is shifting away from its ultra-ease policy. Following the unexpected adjustment in December of the upper range for its 10-Year JGB yield target of 0% to +0.5% from +0.25%, Japanese long-term yields have increased towards seven-year highs.
Regarding valuations, the average 12-month forward price to earnings ratio of Developed and Emerging market equities stands at the 61st percentile of valuation since 1990 from 90th one year ago, whereas valuation divergence among regions and sectors offers tactical opportunities.
In a similar vein, aggregate corporate bond spreads stand at the 37th percentile from 88th one year ago. Note, though, that valuations are no longer convincingly cheap, following the most recent rally.
Indeed, risk assets have increased in the past month on the back of decelerating inflation pressures on both sides of the Atlantic and relaxation of covid restrictions in China. US CPI slowed further in December to 6.5% (year-over-year) from a peak of 9.1% in June and euro area CPI increased by 9.2% in December from a peak of 10.6% in October.
In conjunction with signs of moderation in US wage growth, investors now price-in that the Federal Reserve will cut interest rates in H2.2023 as monetary policy will not need to be restrictive. Emerging market equities are up by +21% from their mid-October lows, with declining natural gas prices boosting euro area assets (equities, bonds, EUR).
Having said that, while medium-term return/risk prospects have improved, tactical market reaction in Q1 will continue to be a tug of war between recession and “soft-landing”, as the macroeconomic outlook (inflation evolution, central bank reaction and geopolitics) remains unusually uncertain. For central banks, is too early to declare victory in their fight against inflation, as underlying core price pressures are still strong.