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Even the very beginning of the year of 2022 was hinting at numerous difficulties for market participants ahead. In addition to military actions, politics and international relations, sanctions and counter-sanctions, the tiresome pandemic and rising inflation, the market turned out to be absolutely unprepared for record increases in interest rates and resulting price movements. Investors were hit by falling equity indices, huge losses on the venture capital market, capitulation of cryptocurrencies, sharp jumps in credit spreads in emerging markets and high-yield bonds, and even by a mess in the government debt market of some developed countries.
A few words about many things
The S&P 500 lost 19.5% for the year, while the Nasdaq 100 fell by 33%. Companies are starting to cut jobs, and financial results are deteriorating. Expensive capital makes equities less attractive, and we see no grounds for optimism here. Investment bankers are not in their rosiest of moods either. Recent years have been record-breaking in terms of the number of IPOs and bond issues, and now, for objective reasons, the number of those is decreasing, so large investment banks have reported a drop in income by 30-50% for the year.
In the first half of the year, we saw a surge in prices for oil, gas, grain and fertilizers, however, at the end of the year, Brent crude added a rather modest 10%, while the price of grain barely changed (+2.76% y-o-y). Bitcoin has lost about 65% of its value over the past year. At the moment, the thesis of crypto-enthusiasts, who consider digital currencies as a protection against inflation, looks way out of line.
Liz Truss will be remembered as the shortest-serving (former) Prime Minister in UK history – her reign lasted just 44 days. This precedent can be seen as an important signal to many governments – it is better to keep public finances in order. Those who do not understand this are cut down by the market.
European and US equity markets
The return of the bond market
In the first days of 2023, we can quite confidently say that era of negative bond yields, which lasted for the last eight years, has come to an end. The European sovereign bond market was practically “uninvestable” for almost 10 years, but in 2022 it has returned with a bang. The German 2-year bund yield has risen from -0.65% to 2.65% over the year, perfectly illustrating the remarkable changes that have taken place in the market in just 11 months.
Still, when not taking into account currently attractive 2.5-3.0% yields in low-risk bonds, the past year has been historically the worst year for fixed income investors.
According to Bloomberg indices, debt securities of the Eurozone countries lost 11-17% of their value, the investment grade corporate bond index was down 15%, while the high-yield bond index gave away “only” 11%. A truly unprecedented year, during which the risk of rising interest rates was clearly manifested, having had the heaviest consequences for low-risk instruments.
Central banks were careful to bring no surprises to investors in December, though bond markets saw mixed reaction – European debt made new lows while Treasuries did not. At the moment, it looks like the toughest times are behind us, that is, the rise in inflation is starting to lose its strength. Yes, market participants expect higher interest rates in February with the only question being “how much higher”? However, the longer-term expectations suggest only a couple of rate hikes in the minds of the central banks. A look at the sovereign bond charts shows that the rise in yields has stalled and more likely points to a decline over the next couple of months. Our tactics meanwhile stay the same – we would keep buying 2-3 year US treasuries at 4.50-4.75% yield level and same maturity EU government paper at around 2.75-3.00%.
Benchmark 10-year bond yields
Is the bull market in precious metals just around the corner?
Forex market did not see much of an action during last weeks of the year, though dollar did get weaker. The EUR/USD pair tested 1.0600 area (almost hitting 1.0700 mark) and now January is important in defining possible route for the whole year. Generally, we want to see dollar turning higher from nearby levels, but market needs to show us that it wants to follow this path.
Similar observations were made in the commodities market. Oil prices did not move a lot in December and although overall picture still tells us that there is a decent probability of oil moving higher, we prefer to be careful during the first weeks of the year. Short-term reasons for downward pressure are falling natural gas prices, which are now back to pre-war levels, thus taking some pressure off energy markets, and rising risks of the global recession, with yield curve still being deeply inverted.
Precious metals had second good month in a row with silver gaining 13%. Both metals that we carefully track rose above levels we consider “comfortable” – gold finished the year over 1800 dollars per troy ounce, while silver closed well above 22 dollars resistance mark. We believe we are getting closer and closer to that bull run in precious metals we have been buzzing for years now and one must be prepared for that. There is a high-probability chance that XAG/USD runs into a resistance zone around 25 mark and if that happens we could see prices correct all the way back to 21-22 zone, which should be a good area to add to existing long positions. XAU/USD charts also hint at 1750-1800 level being a constructive support zone for the metal.
High Yield bond Indexes
Let us not forget about the economy
China’s service sector shrank for the fourth straight month in December impacted by a sharp increase in Covid-19 cases after government eased several lockdown measures. The rate of contraction was slightly lower than in previous month though, indicating that the ease of several lockdown measures was allowing for some operational improvements. Chinese factory activity also extended losses. Official PMI survey showed a sharp decline, with index falling by one point to a near three-year low of 47.0, according to the National Bureau of Statistics.
Data from the United States was also disappointing with manufacturing sector contracting for the second consecutive month and companies facing pressure from elevated borrowing costs and lower consumer spending. Although raw material prices continue to decline, signaling that the inflation outlook is improving, the ISM’s forward-looking new orders sub-index decreased to the reading of 45.2, remaining below 50 for the fourth straight month.
Manufacturing activity in the Eurozone showed improvement in December with S&P Global final manufacturing PMI increasing to 47.8 points compared to 47.1 a month ago. Factory output increased even sharper, marking its highest reading since June. The strength of the economic downturn in the Eurozone moderated for the second consecutive month, indicating that contraction may be milder than many anticipated – S&P Global final composite Purchasing Managers’ Index, seen as a good gauge of economic health, increased by 1.5 points in December to the 49.3 mark.
Gold price, USD/oz
Excessively loose monetary policy of the 2020-2021, supply problems, sharp increase in demand and spending, supported during the pandemic by fiscal actions, first caused significant inflation of the financial assets, and then (“fortunately”, there were enough additional factors to reinforce this) rising prices in the real economy followed. After that, we saw a significant drop in the prices of risky assets, and, in our opinion, there is enough room for further declines in 2023. Current situation can be viewed as the stabilization of the market for high-risk assets after a long cycle of elevated prices, provoked by excess liquidity, and the very mood of central banks suggests a restrained market dynamics.
The commodity market threatens to remain highly volatile throughout the year. Pricing will be strongly influenced by climate conditions (gas prices), stabilization measures, as well as expected recession (primarily oil and base metals prices).
For most of the year, China implemented a policy of zero tolerance for Covid-19, which negatively affected main economic processes. The aggravation of relations with Taiwan also brought nervousness to the Chinese markets. The lifting of restrictions, the opening of borders, as well as the ongoing implementation of various economic stimulus programs, served as a good motivation for the growth of the Chinese stock market at the end of the year. The drop in tech sector in 2022 was significant, making it particularly attractive. If the factor of worsening relations between China and Taiwan (USA) is not taken into account, then the Chinese market looks quite attractive for investments in the medium term, although fundamentally we still prefer Indian stock market.