New Year, new rally?

Wednesday 18 January, 2023

In summary

• Markets start strongly after a difficult 2022

• Improving news on inflation has spurred the rally across the US and Eurozone

• China’s reopening has brought positive sentiment globally 

 Last year was the first time both the S&P 500 and the 10-year Treasury Bond fell by more than 10% in a calendar year[1]. So far this year, investors have seemingly closed that chapter and are embracing the New Year with upbeat optimism, which has been driving a broad-based rally. At the time of writing, the S&P 500 is up over 4%, the FTSE 100 is up around 4% and European shares are nearing a nine-month high, with the STOXX Europe 600 up around 6% YTD[2]. Elsewhere, 10-year US bonds are up nearly 3%, gold, in dollar terms, is up around 5% while the US dollar has softened. Cryptocurrency is riding the coattails of the rally and Bitcoin is up nearly 30% so far this year[3]. With both risk assets and safe haven assets rallying, the question is what is driving asset prices higher, and can this be sustained, or is this another in a series of bear market rallies?

Much like those embarking on their New Year resolutions, investors have entered into the New Year with newfound enthusiasm. However, it is imperative not to be swayed by momentum, especially when almost all asset classes have benefitted from the recent rally. Risks remain and there is still a long way to go this year, with some recessions predicted during the second half of the year. The main drivers for the positivity in markets this year have been the string of positive data points and China’s reopening. 

Positive news on inflation 

To start the month off, we had lower than expected CPI data from Germany showing that inflation appears to be rolling over on the continent, albeit at a slower pace than that of the US. Further in the Eurozone, despite speculation in 2022 of winter blackouts and collapsing growth, economic indicators for December 2022, whilst weak, surprised to the upside. The Eurozone has also been aided by a mild winter, which has meant that gas storage remained elevated despite having to seek supplies outside of Russia.

Then it was the turn of the US to report their CPI figures and, whilst too early to declare victory, the release provided additional evidence that inflation is cooling off and the Federal Reserve (Fed) may be able to ease off their monetary tightening sooner than expected. Markets are now pricing in a 0.25% rate hike at the Fed meeting in February after lowering to a 0.5% hike in December from the four consecutive 0.75% hikes. We have had numerous bear market rallies recently, the most notable during the summer months of last year centring around the Fed pivot narrative, but they have been short-lived by central bankers reaffirming to investors that they will continue on their mission until inflation is subdued. The labour market remains strong and so there could still be some way to go for the Fed to meet its longer run objective of 2% inflation.   

China reopening 

The Chinese economy expanded by 2.9% year-on-year in Q4 of 2022[4]. This means that for the full year, the economy grew by 3%, well below the official target of 5.5% and signalling the second slowest growth since 1976. Whilst we have likely seen the back of the stringent Covid-19 restrictions, the impact this has had on growth is evident. However, as touched upon in the LGT Snapshot last week, China’s reopening has brought positive sentiment globally. Following a potential peak in Covid-19 cases, with a close focus on Lunar New Year, supply chains should normalise, which is likely to boost global growth and economic activity. On the flipside, China’s reopening could raise prices for commodities resulting in less room to manoeuvre for developed market central banks with regard to monetary policy. 

Summary

The rally witnessed this year has been welcomed by all after a difficult 2022. We are past the peak of inflation concerns, and China reopening its doors to the world should boost global growth. 

Although a recession is still a major concern going into the second half of this year, for now, the picture looks less gloomy than previously thought. Overall, we anticipate market volatility to remain elevated. Hence, we believe that retaining a selective approach to high-quality companies with solid balance sheets and pricing power should offer the best security against this backdrop in the medium to long-term.

[1] Factset

[2] Factset as at 17/1/23

[3] Factset

[4] Factset

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