Risk assets rallied through November as 2022, the annus horribilis for bonds and equities, nears its conclusion

Challenges remain but Q3 earnings for companies were relatively robust in the face of weakening consumer confidence and higher input costs. Quality companies are beginning to flex their muscles through bulk buying, cost saving and pricing power to offset the impact of inflation and there are early signs that some have taken opportunities to increase market share by picking through the assets of stricken competitors. Next being a prime example of this after buying Joules out of administration and acquiring Made.com branding and intellectual property.

Tech stocks have rallied after acting to cut costs and reposition businesses. News of big layoffs at Facebook owner Meta and Amazon with new Twitter owner Elon Musk shedding almost half of the social media giant’s global workforce made the headlines in this respect.

What is happening in the US?

At a macroeconomic level, the actions of both the US Fed and Chinese authorities have helped lift investor spirits in recent weeks, softening their stances on interest rate hikes and Zero Covid policy respectively, hinting that brighter times may lie ahead for markets. The latest jobs data from the US however suggests that the fight against inflation is far from over. 

The most eye-popping November data was average hourly earnings, which rose by 5.1% year-on-year, well above consensus estimates of 4.6% with wages also up 0.6% on a monthly basis, the fastest pace of growth since January. Labour participation continued to fall, meaning the supply of labour is not rising sufficiently to help cool that strong wage growth. Taken in the round, this suggests the labour market is not cooling as much as hoped and that means core inflation may stay higher for longer.

So, what does it all mean for Federal Reserve policy? Taking what Fed Chair, Jerome Powell said in his speech to the Brookings Institution at the end of November at face value, the Fed will raise interest rates by 50 basis points this month, a retreat from the previous four consecutive 75 basis point rate hikes. This provides further confirmation to the markets that upcoming rate rises will be moderated in terms of size and pace.

Importantly, Mr Powell said that goods inflation has decelerated and that shelter inflation, by far the biggest component of headline US inflation, was also slowing. This suggests it is appropriate for the Federal Reserve to pause soon and observe the lagged impact of higher rates. That is why despite the jobs report, traders’ expectations for the peak in the US Fed funds rate are pretty much unchanged and stable at just below 5%.

What is happening in the UK?

Meanwhile, business activity in the UK contracted for the fourth month in a row in November. New orders decreased at the fastest pace for almost two years though, on a more positive note, business expectations for the year ahead rebounded from the 30-month low seen in October. Many survey respondents commented on recession worries and increasingly challenging economic conditions, but there were fewer comments citing domestic political uncertainty.

Rishi Sunak and Jeremy Hunt’s long awaited Autumn Statement confirmed a range of tax increases and spending cuts to help narrow the gap between the government’s income and outgoings and demonstrate fiscal responsibility to the markets. The raft of tax hikes included slashing the capital gains tax exemption, dividend allowance and additional-rate income tax threshold, and extending the freeze on the personal allowance, higher-rate income tax threshold and inheritance tax nil-rate band.

The Chancellor also announced that public spending would rise by just 1% a year in real terms in the next parliament. The energy price cap will increase from April 2023, meaning the average household will see their bills rise from £2,500 to £3,000 a year.

The autumn statement was accompanied by the Office for Budget Responsibility’s economic and fiscal outlook, which warned that a squeeze on real incomes, rise in interest rates and fall in house prices would see the economy fall into a year-long recession from the third quarter of 2022. GDP is forecast to contract by 1.4% in 2023 before rising by 1.3% in 2024 as energy prices and inflation fall. Despite the slowdown, Bank of England chief economist Huw Pill said last week that more interest rate hikes will likely be needed to return inflation to the bank’s 2% target.

What is happening in China?

Elsewhere all eyes remain on China where there continues to be mixed messages about COVID and potential reopening of the economy, and also political engagement and wider policy. It seems likely that progress here will take a little time but it should act as a positive for market sentiment and economic influences in time.

As we close out 2022

With recessions looming or already under way in major economies across the world, it is easy to be downbeat, but stock markets tend to look beyond the bad news once the damage has been assessed and with inflation beginning to stabilise, attention can once again turn to company fundamental and there is hope that 2022 may not end as badly as it began.

Written and prepared for Crowe Financial Planning UK Limited by John Moore (Senior Investment Manager at Brewin Dolphin).