As we go into the final quarter of 2022, we review how different asset classes and stock markets have been performing, which funds and sectors have been the winners and losers over the past quarter and which key themes are driving markets.

The summer months are often a quiet time in investment markets – but that has not been the case in 2022. As the economic gloom deepened during July, paradoxically we saw investor sentiment improve. The rationale being that as economic growth showed clear signs of weakening, investors took a view that slower economic activity would dampen inflationary pressures.

However, since the middle of August, scary inflation figures and concerns over future interest rate rises have returned to spook investors. The quarter ended with significant volatility particularly in the UK where policy measures fuelled concerns of inflation and interest rate shocks which resonated around global financial markets.

Asset classes

The past quarter has once again demonstrated how unpredictable short-term market movements can be. At the start of the quarter a backdrop of gloomy economic data, was highlighted by a slowdown in US economic growth which saw the world’s largest economy teetering on the edge of a recession. Yet, investors saw this as a sign that central banks would be more reluctant to aggressively increase interest rates. Both equity and bond markets rallied strongly in July.

But this optimism has proven to be short-lived. Inflation figures have showed little sign of abating and the US Federal Reserve has been joined by other central banks in reinforcing the view that controlling inflation is the key priority even if it leads to short-term economic pain along the way. As a result, despite having been up over 11% at one point during the quarter, the MSCI World benchmark index for global stock markets finished down by -3.5%.

Such dramatic price swings were replicated in bond markets. Government bonds have certainly not proven to be a safe-haven this year. They saw some respite during July as investor sought refuge from the slowing economic growth. But recent weeks have seen a renewed sharp sell-off in bonds due to concerns that interest rates are going to rise much more sharply than previously expected.

The Bloomberg Global Aggregate bond index has fallen -7.2% during the third quarter of 2022. UK bonds fared even worse, and the promise of unfunded tax cuts announced by the new chancellor were viewed by investors as both inflationary and destabilising to the UK economy. UK Government bond prices were in free fall before the Bank of England had to step in to support prices by buying back gilts. But, despite the late intervention the benchmark index for gilts was down more than -13%¹ over the quarter and the fallout hit bond prices globally.

However, a crisis can often provide opportunities for investors. Remember, there is an inverse relationship between bond prices and the yields offered. The dramatic price falls has resulted in a significant rise in yields across many areas of bond markets – the asset class is looking interesting again.

It has been challenging to find anywhere to hide during the past quarter, asset classes such as property and infrastructure have also sold off as the backdrop of stagflation has taken hold. Gold has been another area that has failed to provide a safe-haven as the price fell back by -7.9%. With interest rates rising, the opportunity cost of holding gold increases (given it provides no yield) so the backdrop for the precious metal is proving challenging.

The one investment area that had bucked the downward trend in the first half of 2022 was commodities (with the exception of gold), particularly energy with prices driven higher due to the Ukraine war. But this trend reversed over the summer months as the global economy slowed. The oil price fell heavily during the third quarter and the Bloomberg WTI Oil Price index plummeted by -19.3%.

A key theme that cannot be ignored is the dramatic fluctuations in currencies over the past quarter. In particular, the strength of the dollar and in recent weeks a volatile pound. The dollar appreciated by 8.8% versus sterling during the past three months. For investors with a global outlook this has provided some respite, with funds that invest in dollar-based assets proving positive for UK investors.

Regions

It is no surprise that a perfect storm of geopolitical tensions, rising interest rates and inflation alongside slowing global growth has not provided an easy environment for stock market investors. But at the start of the quarter a lot of gloom and doom was already being priced into stock market valuations and this has helped temper the falls. We have even seen some positive returns in sectors such as technology and biotech which had been particularly beaten up earlier in the year. The strengthening dollar has also meant that holding funds focused on US equities has proved beneficial for UK investors. Whilst the S&P 500 index fell by -3.6% this translated into a rise of 6.2% in sterling terms due to the strong greenback.

Although concerns over the UK economy have been causing market turbulence, the UK stock market only saw modest falls with the CBOE UK All Share down by -2.1% in the third quarter. For UK based multinational exporters a weak pound can prove beneficial in making them more competitive. However, UK smaller companies are proving more challenged, with greater sensitivity to an economic slowdown and more of a focus on the domestic economy. The Numis UK Small Cap index fell by -8% over the three month-period.

European stock markets have continued to have a torrid time with their economies at the epicentre of the energy crisis caused by the Russian war in Ukraine. There is little sign of resolution in the conflict, which showed signs of escalating towards the end of the quarter with Russia annexing occupied regions of Ukraine. The benchmark MSCI Europe ex UK index fell by -5.8%.

Asian markets have been a mixed bag. For the second quarter in a row, Japan proved to be the pick of the major developed markets with the Topix index eking out a gain of 0.8%. However, following a strong bounce back for Chinese equities in the previous quarter, signs of green shoots of recovery in China were dashed. Investors became spooked by a re-emergence of political tensions over Taiwan, their zero COVID policy and regulatory concerns in the technology and property sector. This saw the MSCI China index falling by -21.6%. The woes in China had a knock-on effect for wider Asian and emerging markets, but there were some bright spots over the quarter, such as India where the MSCI India index was up by 9.7% boosted by falling oil prices and strong economic growth.

TILLIT Universe

Despite such a challenging investment backdrop over the summer months it has been encouraging to see several funds in the TILLIT Universe produce double digit returns during the third quarter of 2022.

Biotechnology funds were the best performers with the sector seeing a strong recovery during the period. This needs to put in the context of heavy falls previously when investors shied away from the sector due to concerns over US drug pricing reform and the broad sell-off in higher risk Growth areas. But recent price rises suggest that despite high levels of risk aversion, investors are taking advantage of depressed valuations to exploit exciting long-term growth opportunities that this sector provides. The Biotech Growth trust share price rallied by 23.6% and the managers have been actively looking to exploit what they believe to be mispricing of small-cap biotech companies that are trading at low valuations. The AXA Framlington Biotech fund which has more of a focus on large-cap biotech stocks was up by 15.9%.

Another area that is likely to be at the higher-risk-end of a portfolio, is India and the Alquity India Subcontinent fund rallied by 13.8% in a positive backdrop for the Indian stock market. Boasting attractive demographics and a strong agenda of economic reform this fund provides the opportunity to tap into exciting long-term growth opportunities in India. During the quarter India was reported to have overtaken the UK to become the world’s fifth largest economy and is currently the world’s fastest growing major economy². Investing in a single emerging market will not be without its challenges but the past quarter has shown how it can provide diversification in a portfolio when developed markets are struggling. A significant weighting in India also contributed to a 10.3% quarterly return for the Pacific Assets Trust.

A possible mistake many UK investors seem to make is to overlook the opportunities in the world’s biggest market. Investing in the US is not all about a handful of global leading tech behemoths. The Artemis US Smaller Companies looks further down the market cap spectrum for growth opportunities and rallied strongly early in the summer months on the belief that US Growth stocks had become oversold, despite giving up some of the gains later in the quarter it still returned 10.8% over the three-month period, boosted by the currency moves.

At the other end of the spectrum, Chinese funds which were amongst the best performers in the previous quarter had a horrid time. Fidelity China Special Situations trust and Matthews China both saw heavy falls (-21.2% and -13.9% respectively) as investor sentiment was hit by the ongoing negative economic impact of the Zero COVID policy and geopolitical concerns over Taiwan. Both factors need to be resolved before investors have confidence to return to investing in Chinese equities.

Property acts as a good barometer of an economy and TR Property fell by -20.0% as concerns for the outlook for UK economic health deteriorated. Investors in the UK property sector have become alarmed by the impact that rising gilt yields, rising interest rates and a fall in the currency will have on residential and commercial assets, whilst recession would hit rents for commercial property.

Concerns over the UK economy has also been instrumental in UK smaller companies selling off, which hit the Montanaro UK Income fund hard, falling back by -11.9% over the quarter. There are probably few areas of investment markets where sentiment is more negative at present, so funds investing in UK small-caps could present opportunities for contrarian investors with a long-term horizon.

Finally, as discussed, rising interest rate expectations have seen a dramatic sell-off across bond markets and the AXA Carbon Transition Sterling Buy and Maintain Credit which focuses on sterling investment grade corporate bonds fell by -11.2%. With yields having risen to levels not seen since the global financial crisis, the rewards for bond investors are beginning to look more appealing.

Looking ahead

There is little doubt that we are in for an ongoing torrent of gloomy economic news flow going into the autumn and a winter of discontent in politics and economics seems to be on the cards.

The conflicting economic policies of central banks having their foot on the brakes by raising interest rates and governments with their foot on the accelerator through expansionary fiscal policies is not a healthy situation to be in. It is likely that markets will remain volatile with asset prices driven by how hawkish (pushing for rising rates) or dovish (keeping rates lower) central banks feel the need to control inflation.

But the significant falls across markets so far this year are creating opportunities. For the first time in over 70 years, global bonds are in bear market territory³ (having seen a decline of more than -20% from their peak). With aggressive interest rate rises already priced and the offer of yields at levels not seen since the global financial crisis, the risk-reward profile for fixed interest markets is looking much more attractive. And whilst there is no point trying to call the bottom of a stock market cycle, valuations in many areas are beginning to look like distressed levels. It is important to remember that markets look ahead and when the economic picture feels darkest and this has traditionally been a good time to buy, not sell!

Sources: FE Analytics (quarterly performance figures for funds and market 30/06/22 to 30/09/22). Qualitative commentary from TILLIT meetings with fund managers.

¹https://www.spglobal.com/spdji... (accessed 30/09/22)

²https://www.ft.com/content/4732995f-bf44-4138-9b6a-787d1048ba41

³https://www.ubs.com/us/en/wealth-management/insights/market-news/article.1575587.html

Date of publication: 7 October 2022