2022 was a tough year for both equities and for bonds. It was in fact the worst year since the 1930s for an equally-weighted portfolio of the two asset classes. The picture was slightly better for UK markets. UK shares outperformed those in the US for the first time in five years. This was driven by a small number of stocks, however.
Investors now expect inflation will head back down over the course of the year. But the real question is where it settles. Bond market pricing suggests it's heading back down to the levels we've been used to for the last decade or so. But many, including the Governor of the Bank of England, have warned that it may remain higher than this for a long period of time.
Economic indicators are clearly pointing to a slowdown across the G7. We will probably see recessions later this year. Interest rates are likely to continue to rise in the first half of the year, but they will most likely peak by the third quarter. Bond markets currently expect them to fall in the fourth quarter - but that is very much dependent on the growth and inflation outlook at the time.
Equities were pretty expensive at the start of 2022. We've since corrected quite sharply. Lower starting valuations tend to be associated with higher long-term returns – so prospects are probably better than they were a year ago. However, the journey will most probably be bumpy. Why would it be bumpy? Well, business surveys still indicate slowing activity and equity markets tend to struggle while these indices are in decline. Earnings expectations could also be a headwind. Profit forecasts for 2023 and 2024 have started coming down and could have further to fall. We anticipate margins will be under pressure in the current inflationary environment. These two factors lead us to think there may be opportunities to buy and increase equity positions at lower levels.
Bond markets corrected very sharply last year. A year ago, a 15-year gilt (UK government bond) would have yielded about 1% to maturity. It now yields above about 4%. The value of that bond has fallen by around 23%. However, following these sharp moves across government bond markets, starting valuations have become more attractive.
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The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.