21st December 2022

We wrote in last year’s review that the exceptional returns seen in 2021 were not sustainable. Against a backdrop of very low yields in bond markets, lofty valuations in stock markets and risk of policy error by central banks, we warned that returns in 2022 were likely to be much more subdued.

We certainly didn’t anticipate that 2022 would turn out to be so painful for investors in almost all asset classes. Fixed income markets have suffered their worst year since 1788 (we are told) and most equity markets have fallen significantly. Shares of medium and smaller sized companies have been particularly badly hit. In the UK, the underperformance of smaller company shares compared with their larger counterparts is the widest it has been in any recession in the last 50 years. Sectors such as energy have outperformed and companies with the strongest growth prospects have been punished, mainly because their future profit streams are deemed less valuable with higher interest and discount rates.

The rout in bond markets has continued through much of the year and even accelerated in the third quarter as central banks signalled that interest rates would continue to rise until inflation is tamed. The re-pricing of bond markets from the absurdly low yields, caused by years of distortion from negligible interest rates and continuous bond buying by central banks, has been brutal in both speed and scale. However, in the last few weeks, there has finally been some respite for investors in bond markets as signs have emerged that inflation may have peaked, prompting investors to hope that interest rates might not have to rise by as much as previously feared.

The UK gilt market was also sent into a tailspin at the end of September after new Chancellor Kwasi Kwarteng announced a raft of tax cuts which appeared to be unfunded, and which would need to be paid for by yet more government borrowing. The Bank of England was forced to step in to stabilise the gilt market after a meltdown in prices threatened the liquidity of many defined benefit pension funds. Mercifully, the fiscally reckless Truss/Kwarteng partnership was short-lived and the efforts of the new team of Sunak and Hunt to restore fiscal credibility has so far been rewarded with the welcome return of stability in the gilt market.

Global stock market indices have fallen sharply this year, with many down by more than 20% at their low points. The UK stock market has been amongst the most resilient, thanks to its heavy weightings in energy and other multinational companies which benefit from a weak pound. It also has a low weighting in highly valued growth stocks which have suffered most as bond yields have risen.

The US dollar has appreciated significantly against all other major currencies as the US Federal Reserve has raised interest rates more aggressively than other central banks.

With many goods, such as oil, priced in dollars, the strength of the US currency is making the battle against inflation in other countries even harder.

It remains Groundhog Day for daily dealing UK property funds, with the Regulator still yet to make and deliver any decision about the future of the sector. This stems from the obvious mismatch between funds which offer daily dealing and pricing to investors, and the illiquidity and frequency of pricing of the bricks-and-mortar properties in which the funds invest. Both issues could be laid bare if the UK enters a severe recession.