The
following were the economic insights for October 2022.
The
global economic outlook continued to deteriorate. Inventory rebuilding lost momentum, and end
demand weakened under high inflation, tight fiscal policy, and worsening
financial conditions. Consumer demand
shifted from goods to services, adding further pressure. The peak of the technology cycle was expected
to hit Asian exporters, excluding Japan, through the second half of 2022 and
most of 2023.
The Federal Reserve’s Trajectory, and the Dollar's Response
Risk-off
sentiment returned after a higher-than-expected CPI report. The Federal Reserve’s 75 basis point hike,
taking rates to 3 per cent, magnified that reaction, alongside a stated
commitment to reach 4.25 to 4.50 per cent by year-end. The inflation hawks were making up ground on
earlier reluctance to raise rates, and the prolonged hawkish stance across
central banks fed a growing fear of recession.
The US dollar rose against most major currencies, treated as the haven
asset it usually becomes in this environment.
China’s Divergent Path
The
People’s Bank of China kept its rate unchanged, holding an easing bias against
mild inflation and an uncertain outlook.
China could not risk a slowdown severe enough to loosen the Communist
Party’s grip on power, and this divergence from US policy fed directly into
uncertainty over the domestic property market.
Economists downgraded growth forecasts below the government's own
target, and the unclear direction of the zero-Covid policy added further risk
to the outlook.
The Portfolio Positioning at the Time
Asset
allocation remained the dominant driver of portfolio outcomes. Accelerated rate hikes, rising recession
risk, and the threat of rising unemployment across developed markets kept most
funds underweight equities and cautious on bonds, favouring lower
duration. Growth was not expected to
rebound without central bank easing, pushing many managers toward larger cash
allocations, now generating a meaningful risk-adjusted return in its own right.
Equities
were recommended underweight, given the rising risk of a hard landing and
earnings expectations still judged too optimistic. A neutral stance on Asia, excluding Japan,
was recommended for those already invested, given local central banks turning
hawkish despite improving activity.
Investment-grade credit spreads looked unattractive after their recent
rally, with default rates expected to rise and a genuine risk of cascading
sovereign bond defaults. US credit was
recommended underweight as spreads widened, with short-maturity credit treated
as the closest cash-like proxy. The Federal
Reserve’s aggressive tightening had already exacerbated liquidity constraints
for highly leveraged entities, flattening the yield curve as short rates rose
faster than long rates.
The
Federal Reserve did not stop at 4.25 to 4.50 per cent. It kept raising rates into 2023, reaching
5.25 to 5.50 per cent by July 2023, its highest level in 22 years. China abandoned zero-Covid abruptly in
December 2022, following nationwide protests the previous month, ending the
policy uncertainty this report flagged, though the property crisis it also
warned about deepened through 2023 and 2024 regardless.
The
warning about liquidity constraints for highly leveraged entities proved
prescient in a way this report could not have specified. Silicon Valley Bank and Signature Bank
collapsed in March 2023, followed within days by Credit Suisse’s forced
takeover by UBS, the first banking crisis directly traceable to the pace of
this same rate-hiking cycle. The S&P
500 finished 2022 down roughly 19 to 20 per cent, its worst year since 2008,
before recovering sharply through 2023 once the rate-hiking cycle showed signs
of ending. The underweight equity call
held for the remainder of 2022. It cost upside
for anyone who held that position too far into 2023, once the market began
pricing in the eventual pause this report could not yet see coming.
Terence Nunis | Executive Chairman, Equinox Zenith | Author,
The 1% Playbook: The Billionaire Cheat Code
