The final quarter of 2022 is on track to potentially end on a positive note. Equity prices have generally kept advancing in recent weeks, while interest rates declined from their recent highs – which in turn bolstered riskier parts of the credit market. Notably, unlike during previous bear market rallies, China has at last joined the upswing as well. It is also worth noting that some of the less defensive elements in our allocation, like private equity-related parts of the public markets, also performed very well quarter-to-date.
If the quarter indeed ends up closing with such broad-based gains, it would be the first and only quarter to do so in 2022. This current upswing was triggered by tentative signs that inflation may have indeed partly peaked. Firstly, global commodity prices are generally still trading well below their recent peaks, while international supply chain pressures and the freight costs have also dropped markedly of late.
Secondly, when the latest US inflation data, for October, showed that the annual price increases were smaller than expected, markets rallied. Looking at the bigger picture, the data show that inflation has only partly peaked (mainly in the goods segments) and that core inflation remains rather sticky. In short, the overall inflation problem is not resolved yet. Nevertheless, this moderately positive news was enough to revive hopes of a soft landing of the economy next year, at least in the US.
Thirdly, the Chinese government has communicated a gradual relaxation of its strict Zero Covid policy, along with macro policy measures that make large-scale, cascading bankruptcies in its over-levered property sector unlikely the coming year – by essentially ordering banks to refinance most due loans to the broader sector for another year. Arguably, these decisions could usher in better conditions for a more normal and lasting cyclical recovery going forward. However, that too is only moderately positive news, as the overall debt-deflationary property overhang remains in place and will take time to digest.
Fourthly, relatively good news also emerged in international politics. Most importantly, US President Joe Biden met with his Chinese counterpart Xi Jinping at the sidelines of the G20 summit, and both leaders agreed to tentatively reengage diplomatically to avoid an escalation of their existing tensions.
Finally, the US mid-term Congressional election results did not produce a strong shift in favor of the more divisive Republican candidates, while the G20 and COP27 summits also produced good news at the margin. The common thread of these events is that a more cooperative, compromise-oriented mindset is potentially taking root – against the background of the ongoing war in Ukraine, that would arguably reduce a further increase in international tensions.
The bottom line is that the current relief rally is not based on clearly game-changing news in either the economic or political spheres. And while recent developments were good enough relative to the bearish investors’ sentiment, it remains to be seen how things play out in the coming months.
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Note: The next edition of the LGT Beacon is scheduled for December 2022.