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Following the market euphoria of the swift post-pandemic recovery in the economy in 2021, 2022 has been anything but plain sailing for investors, who have had to grapple with multi-decade high inflation, rising interest rates and European energy insecurity, with speculation over all of the above weighing on the global economy throughout the last 9 months. It’s clear that market conditions remain exceptionally challenging in the short term, with more volatility seemingly inevitable at this stage, however as interest rates move closer to peak expectations and economic data trickles through into labour markets and inflation figures, data is beginning to suggest that things may be starting to look up for investors. As we move into the final quarter of the year, we consider what the next few months may have in store for investors and discuss why we are taking a cautiously optimistic stance on market expectations this quarter.

Unprecedented Market Conditions

As inflationary concerns, monetary tightening and geopolitical tensions continue to weigh on market sentiment, multi asset investors have been faced with an unprecedented challenge this year, with rising interest rates tarnishing the safe haven status of government bonds, decoupling their historical negative correlation to equities. Both equity and bond markets have experienced their worst 3 quarters in 40 years, however it is our view that the data is beginning to suggest that a brighter future lies ahead.

Multi-decade high inflation

Rising inflation has not only weighed on market valuations in recent months, but also the consumer’s pocket. Driven by a rapid re-opening from the pandemic and fuelled further by surging commodity prices as a result of Putin’s war in Ukraine, inflation remains one of the biggest headwinds investors face in 2022. Domestically, labour markets have applied upward pressure on inflation through persistent wage growth, unemployment rates remaining resilient and a strong demand for workers. The robustness of labour markets alongside solid consumer balance sheets in comparison to previous economic slowdowns has paved the way for central banks to begin the most aggressive tightening cycles seen in recent times.

Rising Interest Rates

The US remains somewhat of a bright spot in the global economy, given the haste at which the Fed began to tackle inflation when compared to other developed markets, but the key task will be bringing inflation back to target, without causing a sharp downturn in the economy. In the US, consumer demand represents around 70% of the economy and demand destruction through a rise in unemployment is crucial to the slowing of the economy. The difficulty for the Fed is that unemployment acts as a lagging indicator, therefore raising the risk of the central bank over-tightening and ‘engineering’ a recession. Should the Fed over-tighten significantly, a substantial rise in unemployment and a sizable drop in consumer spending could tip the economy into recession, with this feeding through to the UK and European nations, worsening the global economic growth outlook further, however recent data has pointed to a slight easing of labour market pressures. When combined with cooling commodity prices, headline inflation levels have begun to cool in the US, potentially offering the Fed room to manoeuvre going forward.

Energy Insecurity

Headwinds remain in place in the UK and Eurozone economies, with natural gas supplies via the Nord Stream pipeline ceased for the foreseeable future. In addition, Russia has continued to escalate its war in Ukraine with the illegal annexation of territory, a move which has seen Europe respond with an 8th sanctions package including an oil price cap, posing further risk to energy supply. Questions remain over how Europe will refill their natural gas reserves in early 2023, with limited supply alternatives pushing wholesale prices up further, weighing on inflationary pressures. In the UK, political uncertainty and a tug-of-war between monetary tightening and fiscal loosening continues to fuel volatility in government bond markets and the pound. Whilst recent inventions from the Bank of England have provided some stability to markets in the near term, the Central Bank are likely to have to raise rates more aggressively as they look to tame inflation.

What to Watch This Quarter

Q2 corporate earnings in the US largely surprised albeit very low analysts’ estimates, and the upcoming US earnings season is likely to provide an insight into how businesses are coping with rising input costs alongside consistent wage growth. Early signs have emerged of better-than-expected performance from companies which have passed on rising costs to the consumer, a trend which if continues through this quarter, will likely raise risk appetite. The risks facing multi-national businesses remains the overwhelming strength of the US dollar which has outperformed significantly throughout 2022, with investors rushing to safety following the conflict in Ukraine alongside interest rate differentials as the Fed continues to fight to bring inflation back towards its 2% target.

As markets remain sensitive to economic data releases, recent data shows 3 straight months of declines in US inflation, as key drivers such as energy and food prices cool amid recessionary concerns. As such, traders continue to bet on a Fed pivot in 2023 as interest rates move closer to the 4.75% expected peak, and despite Fed officials confirming their intent to leave rates elevated, it is our view that a Fed pivot is likely and will provide a significant boost for risk assets. Whilst the timing of this pivot is uncertain, investors will be looking for clues within data releases throughout Q4 to signal that rate hikes are taking effect in slowing down the economy, giving central banks room to breathe.

Cautious Optimism

Overall, it is our view that as we see asset valuations more accurately reflect economic headwinds moving forward, investors are presented with an opportunity to deploy cash more efficiently with a long-term investment horizon. Whilst markets remain sensitive to economic data in the near term, providing volatility and risks for investors with a short-term outlook, we believe that key drivers of inflation will cool into next year, giving central banks room to apply the brakes on their tightening cycles. It is therefore our view that a brightening economic outlook and current market valuations provide an attractive long-term opportunity. Whilst our flagship OBI portfolios continue to remain somewhat cautious in nature to manage near term risk, we expect investors to enjoy a brighter future as economic headwinds ease moving into 2023, with renewed sense of optimism and risk appetite likely to provide a welcome boost to investor’s portfolios.

Important Information:

Past performance cannot be used as a guide to future performance and the value of your investment will fall as well as rise in value.  You may not get back all of your investment and the final value of your investment will depend on the performance of your portfolio.  The actual performance of an individual client’s portfolio may differ due to different funds being used and being restricted in relation to certain asset allocations.  Performance figures quoted include fund manager charges but exclude adviser, discretionary, custodian and switch charges.  Unless stated, income is reinvested into the portfolio.  The information contained in in this document is for information purposes only.  It does not constitute advice or a recommendation or an offer or solicitation for investment.


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