December Market Update – equity wealth still on the shelf

For financial professionals only

In a nutshell:

• Equities continue rising to cap another strong year of double-digit returns
• Bank of England first to move with an interest rate rise, pushing bonds lower
• Inflation continues to exceed expectations

What’s moving markets…

December was a month of changed plans for many, with Omicron infections spreading quickly around the globe. However, the month ended with business pretty much as usual for equity investors, with global developed markets up another few hundred basis points to cap a second year of double-digit growth. Much like our friend the Elf on the Shelf there was plenty of movement over the month, with markets responding to central bank updates and public health guidance.

Initial concern around the Omicron variant appeared to subside far quicker for equity markets than the rest of us. The first week of December provided positive returns, responding to early consensus that the variant appears to be a “milder” strain than Delta.

The following weeks were initially cautious with little movement in anticipation of central bank meetings, notably the Fed’s FOMC meeting on 15th December. Inflation across a number of metrics (particular energy, goods and labour), continues to be higher than we’ve been used to, intensifying the pressure on the Fed to respond. In the US, CPI climbed 6.8% in 12 months (to November, before seasonal adjustment), the largest increase in nearly 40 years. In the UK, CPI rose by 5.1% (over 12 months to November), the highest increase since 2011.

Once again, Jerome Powell succeeded in providing market participants with that reassurance, and a notable uplift in equity markets followed the meeting. The Fed signalled a speedier end to their bond purchase program, doubling the pace of tapering. In addition, the “dot plot” of individual members’ rate expectations indicated that just six of 18 FOMC members saw fewer than three rate increases next year, and no members predicted rates staying near zero. Market participants appeared to be encouraged by this quicker route to rate rises, with expectation that dealing with inflation sooner rather than later will result in a smoother journey. However, the first week of January has been less settled following the release of the FOMC meeting minutes.

Conversely, the Bank of England enhanced its unfortunate reputation for unreliable communication with an unexpected rate rise to 0.25%, after retreating from the move a month earlier despite issuing stronger signals. It was explained as responding to greater persistence in cost and price pressures from inflation and a labour market that continues to tighten. The Monetary Policy Committee indicated that further “modest” rises would be needed in the months ahead to control inflation.

Asset class implications…

The rise in yields in response to central bank actions and communications had implications over the month across assets.

Naturally bonds fell due to expectations of tightening, with roughly a 260bps decline across UK Gilts and the Global broad market. Index-Linked Gilts suffered a sharper fall, being hit not only by the rise in yields but also the expectation that central bank action will temper inflation. Over the year, returns from Index-Linked bonds remain positive in contrast to other fixed interest.

UK equities delivered stronger returns than other regions, a consequence of lower exposure to higher duration stocks that come under pressure as yields rise. Despite this pressure, US equities held up and delivered positive returns again, wrapping up the year with over 27% gained.

Emerging Markets and Asian equities fell slightly over the month, amid continued concerns of a slowdown in the Chinese economy, despite signs of a more accommodative policy stance from the People’s Bank of China.

Asset classes in numbers