Quarterly Investment Portfolio Update Q4 2022
by Marshall Brentnall | 25 January 2023


The December quarter was characterised by rising yields and large moves in equity markets month-to-month
2022 was one for the ages across the economic and investment environment
Changes to the model portfolios during the quarter were largely confined to re-weightings back to the benchmark allocations

The December quarter saw a weaker USD (-5.5% against the AUD), lower unemployment in Australia, higher commodity prices, higher inflation rates in Australia (and incredibly high compared to a year earlier), a positive quarter for equity markets but volatile, higher Australian 10-year government bond yields, and an inversion of the US 2Y-10Y bond yield spread.

Significant events during the last quarter of 2022:

  • A hit to UK fiscal integrity following the ‘mini budget’ in late September. The unfunded tax cuts announced caused turmoil in the UK bond market and to the sterling. The swift sell-off of 30-year bonds negatively impacted defined benefit schemes and the mortgage market. The pound fell immediately following the announcement as investors and traders had doubts about the government’s plans. The Bank of England stepped into purchase the bonds and stop the rise in yields. Prime Minister Truss duly sacked Chancellor Kwasi Kwarteng, before the new Chancellor Jeremy Hunt reversed most of the tax measures. Truss subsequently resigned on the 20th of October after only 45 days in office, the shortest-serving prime minister in history.
  • The Bank of Japan (BoJ) jolted markets in December by adjusting their yield curve control program. Since 2016, the BoJ has applied a policy framework to keep the 10-year bond yield at 0%, with an allowable range of +/- 0.25% applied from 2021. That allowable range was widened to +/- 0.50% in December, a fine-tuning of ultra-loose monetary policy. The 10-year bond yield moved higher, finishing the year at 0.4%.
  • The 20th National Party Congress meeting was held in China in October. Xi Jinping was selected for a third term, breaking the previous rule of only two consecutive terms allowed as leader. A key outcome of the meeting was likely tighter state control of the economy and markets. Towards the end of the quarter Chinese authorities signalled an easing of Covid controls and travel restrictions.

Looking at 2022 as a whole, it was one for the ages across the economic and investment environment. Etta James describes what some investors may have been feeling in 2022:

Life is bad
Gloom and misery everywhere
Stormy weather, stormy weather
And I just can’t get my poor self together
Oh, I’m weary all of the time
The time, so weary all of the time

Capital preservation through 2022 was incredibly difficult for diversified investors. There weren’t many places to hide. Of the twelve asset class returns shown in Figure 1, only commodities and cash were positive in 2022. This was the first time in about 150 years that there was a simultaneous double-digit fall in both bond and equity markets.

Figure 1: Calendar year returns for various asset classes

Source: FE Analytics

The almost forgotten phenomenon of inflation was the dominant theme and driver of markets through 2022. Annual inflation in Australia reached 7.3% by the end of September, compared to 3% a year earlier. More than double! In the US, headline inflation reached 9.1% mid-year before subsiding to 6.5% by December. UK inflation peaked at 11.1% in October but was down to 10.7% by November. Inflation in the Euro area also peaked in October, reaching 10.6%, before preliminary data showed it falling to 9.2% by December.

Global inflation was exacerbated by the Russian invasion of Ukraine in February. The negative impact to commodities and supply chains flowed through to energy and food prices. This was on the back of already strained supply chains after Covid shutdowns through 2020 and 2021. The response from central banks saw the fastest increase in rates in decades. Figure 2 compares central banks rates to a year earlier, with China being the clear outlier.

Figure 2: Central bank rates December 2021 versus December 2022

Source: Research IP, FE Analytics

Ten-year government bond yields soared accordingly on the back of elevated inflation figures. Figure 3 shows the magnitude of the yield increases, with all 10-year yields higher by at least 2-3 times compared to a year earlier.

Figure 3: 10-year government bond yields, December 2021 versus December 2022

Source: Research IP, FE Analytics

The rise in yields had a devastating effect on risk assets, particularly those with longer dated cash flows (see NASDAQ returns in Figure 1, down over 32% for the year). How did those FAANG stocks go? Meta (Facebook) -64%, Amazon -50%, Apple -27%, Netflix -51%, and Alphabet (Google) -39%. A surge in correlation between bonds and equities meant that many portfolios didn’t reap the benefits of diversification.

To summarise the outlook for 2023 in one sentence; global economies and financial markets are walking a tightrope. The most important risk will be the actual path of inflation and the response from central banks. The main question is whether central banks can increase interest rates to a point that will cool down the economy and lower consumer expenditure, whilst at the same time limiting job losses.

The US Fed is forecasting more hikes for 2023 (which is also a broader theme for other developed markets), though in smaller increments compared to last year. Inflation is forecast to fall but it is likely to stay above the target range, meaning tight monetary policy should persist through the year. History suggests that once inflation moves above 5% it can take several years to move back to 2%. Contrary to this, futures markets are pricing in cuts to the Fed funds rate. This suggests the damage to economic growth will become more apparent through the year, consequently forcing central banks to ease off the rate hikes.

A recession is on the cards in the US, though markets are not totally convinced with some expecting ‘subpar’ economic growth rather than a definite decline in growth. Europe has a higher chance of a recession due to the ongoing concerns around energy and food security. Australia and other economies around the globe are not immune, though China has the potential to provide a source of growth if the re-opening of their economy goes smoothly.

A cautious investment approach is recommended. Diversity of expert opinion and a broad overview of the global environment will be necessary to navigate the risks this year.

The following is a list of key risks (not exhaustive and not all mutually exclusive) to keep an eye on through 2023:

  1. Central bank rhetoric and action – go too high on rates and the economic damage will be too great, go too low and inflation may remain elevated alongside questionable credibility. Quantitative tightening approach is crucial
  2. Geopolitical uncertainty – Ukraine/Russian war ongoing, a more fragmented world with differing economic blocs, US-China relationship.
  3. Energy – net-zero and renewable energy, energy security, European energy crisis, another energy shock when uncertainty is already high would have more devastating consequences, energy will continue to be an economic and geopolitical pinch point
  4. Macroeconomic indicators – core inflation, wage inflation, unemployment, consumer expenditure and housing costs
  5. Corporate earnings and analyst expectations.

Today’s problem is inflation. Tomorrow’s problem is an economic slowdown. Nina Simone sang it in the 60s (or the Animals if you’re an Eric Burdon fan), and central bankers will be preaching it in the 2023:

I’m just a soul whose intentions are good
Oh Lord, please don’t let me be misunderstood

You can download the entire Quarterly Investment Update HERE


Marshall Brentnall, and the AAN Investment Committee


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Marshall Brentnall
marshall@evalesco.com.au | 0418 787 232 | 02 9232 6800


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