7 Minutes on Markets - Q4 2022 Market Update
In our latest 7 Minutes on Markets podcast, Senior Investment Strategists Ahmer Tirmizi and Ben Kumar take a look back at what has been a rather eventful last quarter before discussing the ongoing uncertainty around inflation, growth and interest rates - and what that all means for portfolios that have been set up for that last ten years, rather than the next ten years.
Hello everyone and welcome to 7 minutes with seven. I'm Ahmer Tirmizi, a senior investment strategist at 7. And I'm joined by my colleague Ben Kumar, who's also a senior investment strategist.
Now it’s been a pretty eventful quarter, I think we'll all agree. We could talk about the UK but by the time this comes out, I guess it'll probably be out of date. And I guess besides there's been a lot going on in the world.
You've had China's party Congress and its reaffirmation of its Zero COVID policies which is likely to lead to slower growth than we'd otherwise like to see from China.
You've also closer to home, got Europe and the uncertainty going on there. The Russia/Ukraine situation continues to weigh down on the European consumer and it looks like we're heading into a recession there.
The US, on the other hand, what traditionally is the locomotive of the global economy, appears to be holding on. The growth is still holding up there.
Ben, what is going on here? Can the US economy drag the rest of the world with it? Can it be that traditional locomotive that it has been in the past, or is it going to go the way of the others, the way that China and the way that Europe has gone?
In the past, we've seen the US do just that, manage to save the world as it were, through consumer spending.
The reason it's holding up so well is that energy prices are a bit more controlled. In the US, they're not exposed to Russia and they control their own supply. They've got a really strong dollar, which means they can keep buying stuff and they've had a load of savings. Consumers have had a load of savings because of the COVID stimulus in their bank accounts. But that is running out. That was a one-off payment. People have run it down living their best lives as the world opened up.
Can it keep going? It is not certain that it can. There are just too many things that people are struggling with, whether it's, the rising cost of living or whether it's just the fact that they haven't got any money left. The US is it's not guaranteed to slow down but it's heading in that direction.
You know, added to these growth concerns, we've also got these inflation uncertainties still continuing. And when you look at all parts of the inflation basket, they've all been pretty strong, not just across the world, but in the US as well.
Now, what we're seeing next year is that there's a decent chance that some of those numbers are going to start to come down. If we break it down into the component parts, you can see how this is the case. Let's take goods inflation as an example. Now, during COVID, everyone was stuck at home. We bought lots of stuff. We bought too much stuff. This led to all of these global supply chain issues that everyone was concerned about.
But what we're seeing now is that as the economy has opened up again, people stopped spending on goods and they ended up spending on services. But here was the problem. Lots of companies, that extrapolated out what people were going to demand, they've ended up producing too much stuff.
And a lot of that stuff is essentially sitting in warehouses right now. And in order to shift that stuff, they're going to have to discount those prices. And so you're going to start to see that in the inflation numbers. Similarly, if you look at energy prices, and I know it doesn't feel like this right now, but energy prices are going to start to level off over the next year or so. You're already seeing it in some of the oil price numbers and in some of their natural gas price numbers. The things that have really hurt this year are going to hurt less next year, let's say.
Then finally there is this big component of inflation in the US, which is driven by services. This is the stuff that actually didn't do so well in COVID. Now what we're seeing here is you've got a situation where unemployment is really low. People are able to demand the wages that they haven't been able to demand before and that is pushing up services inflation.
However, the central banks are telling us they want to do one thing. They want to bring that services inflation down. They want to bring wages down. And the way that they're going to do that, and this is the bit they don't talk about, is by creating unemployment by essentially forcing companies to maybe have to lay off a few people. And that is again, adding to that growth concern that we see right now. So I guess over the course of the next year, this link between higher inflation which will eventually lead to lower inflation – now that lower inflation is only going to come about because you're going to have slower growth - and I guess how do markets navigate this connection between these two major economic forces?
I think almost regardless of asset class, whether you're looking at equity or bonds or credit, there will be, and we've been calling this since the start of the summer, sideways with volatility.
We don't know quite how long this is going to last. Is it six months? Is it a year? Asset prices are reacting, and overreacting arguably, quickly to new bits of information as they try and build up a picture of a world. And I think there is something interesting. We haven't seen inflation in the market for a long, long time. So people are having to remember sort of how to behave around inflation. They're sort of trying to remember and reprice assets, reprice equities and bonds in ways they haven't had to for over a decade. So things are a bit rusty. Things are jerky. And there's no particular sign of anything that's going to smooth that out, at least on a 6-to-12-month horizon. Sideways with volatility, with volatility being the key factor.
Yeah, I mean, that sounds pretty challenging. It's an interesting point, right? When you have, as you've just described, a recession, you have these disruptions to markets and what we've seen this year is disruptions to asset classes that don't usually get disrupted. You look at bond markets, the traditional safe asset, the traditional low volatility asset classes lost as much as equities, or you look at some of the big tech stocks companies which have been delivering huge returns over the last decade or so have lost in some cases half their returns.
And this is the challenge for investors. Lots of managers, lots of portfolio managers have set up their portfolios to succeed in the world that we saw over the last ten years or so.
But as you've described, higher inflation, uncertainty around growth, uncertainty around interest rates, that's going to challenge all of those portfolios that have been set up for that last ten years or so.
But at 7, we've been running money for 20 years or so. We've been running money not just over the last 10 years, but previous to those ten years as well. And so we we've developed portfolios, we constructed portfolios in a way that's not just ready for what we saw in the last decade, but also for the following decade as well, where you do have higher inflation, where you do have higher interest rates and you do have uncertainty around growth. And we think that we're, through the diversification, set up to navigate the uncertainty we see coming.
That's it from us at seven minutes from 7. I’m Ahmer Tirmizi and thank you, Ben.