Quarterly market commentary - September 2022

The global economy has been buffeted by multiple challenges in 2022 and it is fast shaping as a year not many will remember fondly. During the drawn-out lockdowns and upheaval that accompanied the peaks of Covid-19, the world collectively pined for a seamless post-Covid recovery. The reality, however, has been rather bumpy.

Amidst a backdrop of sharply increasing inflation, tight labour markets, rapidly rising interest rates, and ongoing uncertainties surrounding both the war in Ukraine and the lingering pandemic, the global economy has stutter-stepped its way through 2022.

Although international food and energy prices may have eased from recent peaks, broad price increases have eroded real incomes, triggering a global cost of living crisis.

Good news is seemingly in short supply at present and these highly publicised challenges have all contributed to persistent headwinds for investment markets. However, the unforgettable lesson from all previous market corrections is that periods of weakness can often provide the best opportunities for long term investors.


Ripple effects

Even before Russian President Vladimir Putin ordered the invasion of Ukraine, the global economy was under pressure with inflation higher than markets were anticipating. The initial recovery from the pandemic recession was stronger than expected and the demand surge quickly overwhelmed factories, ports and freight yards, causing shortages, delays and pushing up prices.

In response, central banks began raising interest rates to cool economic growth and contain spiking prices. Unfortunately, it became more difficult for them to safely ‘steer the ship’. If they leant too far towards supporting economic recovery and growth, they faced a bigger fight to control mounting inflation. But if they focused too rigidly on dampening down price increases, they pushed economies much closer to possible recession. It’s an economic highwire act with a hefty consequence attached to any misstep.

Adding to the complexity, when Russia invaded Ukraine on 24 February the West responded with heavy economic sanctions which further disrupted trade in the critical areas of food and energy. Russia is the world’s third biggest petroleum producer and a leading exporter of natural gas, fertiliser and wheat, while farms in Ukraine feed millions globally.

The inflationary impacts resulting from this disruption have rippled out to the world.


Inflationary indicators easing

The fight against inflation is being waged globally. And, while it is too early to declare victory, economic data continues to point to inflation having peaked which, all things being equal, should begin to be reflected in lower average inflation readings in the future.

The general slowdown in global demand has taken pressure off commodity prices and allowed supply chains to partly normalise. Oil prices continued to recede in the recent quarter, providing some welcome relief to consumers at the petrol pump. Ending September at around US$80 per barrel, the international oil price has fallen by US$40 from its early June peak of US$120 per barrel, a 33% decline.

This is one of many indicators, along with improving delivery times, prices and inventory levels that indicate the global supply chain pressures, while still elevated, are easing.


Interest rates

Fixed interest markets continue to be highly focused on inflation, monetary policy signals from central banks and the state of the economy.

Considerations about the economy are largely centred on two competing themes:

  1. supply-based constraints leading to higher labour and goods prices
  2. forward-looking concerns about potential recession risks

In New Zealand, escalating recession fears in July, linked to the idea of potentially fewer interest rate hikes, drove New Zealand 10 year government bond yields down to their lowest levels since April. By late August, however, the focus had shifted almost entirely to the policy comments made by central banks. In synchronicity with other major central banks, the Reserve Bank of New Zealand (RBNZ) reaffirmed its absolute focus on getting inflation back down towards its target range, resulting in the New Zealand 10 year government bond yield moving back to its June highs. It was a remarkably similar story in the much larger US bond market, and elsewhere.

With interest rates rising everywhere, the degree of tightening will ultimately depend on local conditions. In New Zealand, the RBNZ’s latest projections are for the official cash rate to rise to just over 4% in 2023. With the RBNZ having recently adjusted this benchmark rate to 3.50% on 5 October, it implies we are getting closer to the end of the current round of rate rises. That’s certainly what many homeowners with mortgages will be hoping.


Farewell to Queen Elizabeth II 

The UK hit the headlines for a very different reason during the quarter - on 8 September the world was met with the sad news that Queen Elizabeth II, the UK's longest-serving monarch, had died at Balmoral aged 96, after reigning for 70 years.

The Queen ascended to the throne in 1952 and witnessed enormous social change during her reign. She also worked with 15 different prime ministers, from Winston Churchill in 1952, to Liz Truss who took office on 6 September, just two days before Queen Elizabeth’s death.


What next?

Quite apart from the ever-present challenge of living in a world that is still managing the ongoing impacts of the pandemic, grappling with a significant geopolitical conflict, and enduring a cost-of-living crisis, long term investors have also had their patience tested by these events.

Portfolio valuations have been volatile in 2022, reflecting the uncertainties surrounding these complex real world issues. Share markets have been buffeted as investor confidence has waned, and bond markets have suffered due to rapidly changing interest rate expectations.

Although it is hard to point to much obvious good news at present, one source of comfort should be that investor sentiment is currently very negative. That may sound counterintuitive, but when investor sentiment is strongly negative it means the markets have very likely factored in (and priced in) all of the existing bad news.

That’s why investors at the end of September could buy a 10 year New Zealand Government bond yielding 4.3%, when at the start of the year it was yielding just 2.4%. It’s also why the price-to-earnings ratio of the globally significant S&P 500 Index in the USA was at 19.8, down from 26.3 at the start of the year and 37.3 at the end of 2020. In the investment world, unlike in our supermarkets, almost everything is now cheaper.

In many ways, the investment discounts available today versus what investors were paying only a matter of months ago should be enough to see buyers queuing around the street. For the moment, the queues are relatively short.

But as greater clarity gradually emerges about global inflation, interest rates and economic growth rates, the prices available in financial markets today might very well look highly appealing. And one thing we do know is that forward-looking markets always have the capacity to respond (and respond quickly) to the prospect of better times ahead.

While investor patience has been tested this year, it is always important to remind ourselves that:

  • investment returns often come in spurts - making it important that we stick to our long term strategy
  • markets are volatile - meaning they can go down as well as up, so down periods should always be expected
  • critical to achieving sound long term investment outcomes is good ‘investor behaviour’ - which means holding on to quality assets that have become temporarily cheaper, rather than being tempted to sell at a discount

As always, we don’t profess to know how or when the most significant events in the world today will be resolved. However, we do expect that central bank actions to contain inflation will eventually achieve that aim. We also expect that interest rates will eventually stop their ascent and reflect a new post-Covid equilibrium. We even expect the current conflict in Ukraine to reach a conclusion.

In the meantime, in spite of prevailing uncertainties, we expect global capitalism to continue to find ways to survive and thrive and for long term investors to continue to benefit from a consistent exposure to those endeavours over time.


For a detailed review of the asset class performances for the quarter, see ‘Key market movements - September 2022’ or click here to view the full newsletter in PDF.



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