The 12 months to 31 December 2022
A quick summary
- Investor optimism over the reopening of the global economy after Covid-19 has been replaced by concerns about its health.
- This is mainly down to high inflation and rising interest rates across the world.
- Prices were already climbing before Russia invaded Ukraine in February and this major event sent energy and food prices soaring.
- Stock and bond markets fell considerably during 2022. However, the UK fared better than many other nations.
Inflation issues
Inflation was initially stoked by labour shortages, supply chain problems and rebounding demand after the Covid-19 lockdowns. These pressures were then added to by Russia's invasion of Ukraine. Reduced supply and strict sanctions against Russia caused energy and food prices to rise even further.
Central banks responded to multi-decade high inflation levels in Western economies by raising interest rates throughout the year. The US Federal Reserve increased its key interest rate by 0.25% in March (its first rate hike since 2018). It followed this up with a series of increases through the year, capped off with a 0.50% rise in December, taking rates to 4.25% by the end of the year.
The Bank of England (BoE) also raised interest rates to tackle inflation starting gradually in the first half of the year with several 0.25% increases and more aggressive 0.50% and 0.75% increases in the second half of the year. The year ended with rates at 3.50%, with the rate of ascent over the year not seen since the late 1980s. However, UK annual consumer price inflation (CPI) peaked at 11.1% in October and has since started to decrease with 10.5% reported in December 2022. This suggests that measures are starting to work and markets expect interest rates to peak between 4% and 4.5% in the first half of 2023.
The European Central Bank kept its key interest rates unchanged at emergency low levels, before finally raising them by 0.50% in July, and with further increases taking rates to 2% by the end of the year. Inflation in the EU zone rose to 10.6% in October but began to stabilise and fall at the back end of 2022.
Higher energy prices have been a key reason for inflation and a major cause of the current cost-of-living crisis. Oil prices rose steadily in the first half of the year, peaking at over US $120 per barrel in early May in the wake of Russia’s invasion. The war led to partial bans on imports of the country’s oil and coal but on a positive note, oil prices have dropped off in recent months. The cost of natural gas also surged before cooling off towards the end of the year. The spike in price was down to European countries building up gas reserves for the winter and Russia reducing supplies to Western Europe.
How did stock markets do?
It’s been a tough time for global stock markets, with a 17% fall over the last 12 months before the effects of currency. Investors have been unnerved by high inflation, surging energy prices and rising interest rates and Russia's invasion of Ukraine added to a worsening global economy. However, the UK stock market has shown some resilience, with a modest decline of 3% over the period. It’s home to many energy and mining companies and their share prices have benefited from high commodity prices. Oil and gas companies returned over 30% (average across the sector) over the last 12 months, with their high profits raising demands for further windfall taxes on their profits.
US share prices fell in dollar terms (-19%) but a strong US currency mitigated some of the loss (-9%) for UK investors when converted into GBP (pound sterling). A combination of higher interest rates and surging inflation – due in part to a booming jobs market – caused US share prices to fall sharply at the beginning of the year. There was a brief recovery in the third quarter, but November and December saw further declines. Growth-focused stocks, such as technology companies - which are especially sensitive to higher interest rates - have been among the biggest losers.
It was a similar story for the Asia-Pacific region and emerging market stocks, with declines mitigated somewhat when converted back into GBP. Equity markets in the Asia-Pacific region (not including Japan) fell by 13% over the 12-month period in local currency terms but by less in sterling terms (7%). Asian stock markets were negatively impacted by ongoing post-pandemic supply chain issues, the growing inflation problem and fears the world economy may enter a recession due to interest rate hikes. Chinese stocks were hurt by the regulatory crackdown and a slowing economy, caused in part by the Chinese Government's strict 'zero-Covid' policy. Elsewhere, the export-heavy South Korean market sold off heavily.
Overall, emerging market stocks fell 20% in dollar terms, 9% when converted into GBP over the period. Some emerging markets performed better, with the Indian and Indonesian markets enjoying gains. Most Latin American stock markets did relatively better than other regions, although the sizeable Brazilian market was also notably weak. This was partially caused by political unrest during presidential elections.
European shares, as measured by the FTSE World Europe Ex UK Index, fell by 14% over the period, with again the loss lower when converted into GBP. The region's stock markets were buffeted by surging inflation, the prospect (and now reality) of higher interest rates and the shock of the Ukraine war and its hit to European energy supplies.
Inflation and rising rates hit bond markets
Global government bonds have had a challenging 12 months. After years of ultra-low interest rates, central bank rate rises (to combat inflation) caused a historic fall in the global bond markets. The winding up of bond-buying stimulus programmes added to the downward pressure on bonds. The same inflationary and interest rate pressures also drove down corporate bonds. GBP investment grade (AAA ratings through to BBB ratings) corporate bonds declined just over 22% during the period.
Bond prices are particularly susceptible to rising interest rates, as it directly affects the relative value of the fixed income payments. Bonds have reacted not only to the interest rate rises that have already happened, but also to the expected future direction of rates. UK rates are expected to rise more slowly in 2023 compared to last year, now inflation has started to taper and there are signs of a recession.
UK Government Bonds (gilts) were also pushed down further by the new (and now ex) Chancellor's mini budget in late September. This announced unfunded tax cuts hot on the heels of the energy price guarantee. The actions of the Government (in part forced by energy prices outside of their control) forced the BoE to start buying gilts again to prop up the market. The total return from UK gilts over the last 12 months was -22%. This was one of the worst 12-month periods for gilts on record.
