Investment Line: our current thinking on markets - December 2022

It is natural at the end of a year to not only reflect on what has been but also on what might come next. Investors remain extremely unsettled, and the uncertainty is affecting pretty much every asset class. We are going into 2023 with well diversified portfolios which reflect the opportunities available but also incorporate the necessary protections at this time. The fortunes for risk assets will depend on how several key issues resolve (or progress) and our current views on the salient issues follow.

Investors seem to think rates are very close to peaking, but central banks continue to work against complacency in their fight against inflation and rates may stay at a higher ‘terminal’ rate for longer than many believe. It does look as if progress is being made on inflation generally speaking, but the resilience of the US jobs market and the ‘stickiness’ of services inflation could mean that victory will take a while longer to declare. On top of this, the Ukraine-Russia conflict has the potential to escalate in the new year and a re-opening of the Chinese economy could inject more inflationary pressures into the global economy. If oil moves significantly over $100 on any of these or other developments, inflationary pressures will be slower to fade. This said, sovereign and high-quality bonds look a better bet than equities given they will benefit from any plateauing or reducing of interest rates, while also rewarding investors if a recession arrives.

Equities are not really looking cheap (especially in the US) and are trading on earnings multiples which look increasingly unrealistic to us. If multiples remain where they are, but earnings adjust as the economy slows, there is reason to expect further falls in share prices. If we get a harder landing than is currently expected valuation multiples may fall at the same time as corporate profits and then the drawdowns could be quite material. It is difficult to see the Federal Reserve and others not cutting rates significantly in the event of a significant economic downturn and so excellent opportunities may well present themselves in 2023.

In terms of approaches within equity investing, it looks unwise to place one’ s bets exclusively on value or growth. Arguably, the recovery in value stocks is only in its early innings but if we get a slowing of rate rises or even cuts in the face of a recession they may lose recent tailwinds. Cyclical stocks will not find the going easy in such an environment and value shares could represent a trap for the unwary. Several growth sectors like technology appear to have momentum against them and the safe haven of quality is predictably expensive. As a result, a balanced approach in equity style exposure seems sensible.

Rushing to utilise cash still looks premature and we have been patient in waiting for opportunities to add to risk assets, but it does not feel as if are there quite yet. Why embrace more market risk now, at a time when economies appear to be weakening and the effects of the considerable rate rises to date are still working their way through the system, when we have been prepared to wait? Discipline and diversification remain important attributes for those running portfolios and holding one’s nerve in these treacherous markets may well bring its rewards as 2023 develops. Better times undoubtedly lie ahead and will hopefully arrive soon.

Investment Line is written and edited by members of the Mattioli Woods Group investment committee and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.

Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority.