Which investors will win?

– 2023 is slightly different than any other year. That is because last year turned out to be quite a shock for many, particularly for the equity investors. And every time you’d think it was over, you’d see another train car getting derailed. Consequently, many investors got burned in 2022. Every time the markets got a bit optimistic and started buying, the next thing they knew was the markets just plummeting again.

– Investors are keen to get a sense of how they should be positioning their portfolios… and right now it all seems to depend on the path of inflation. Yet inflation seems elusive. US Central Bank (FED) has not been great at forecasting inflation. In fact, they have been really bad at it. But the good news is that they now seem to be aware of it too. Indeed, in the minutes of their December meeting which was published on January 4^th it showed that Fed decided that they would make decisions “meeting by meeting”.

– Barely three weeks into the year the equity markets already experienced the type of fluctuations that they sometimes have in one whole year. Indeed, as of January 20^th the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM were both up on the year 5.5% and 10.1% respectively. On the bonds front, the US yield curve remained inverted due to continued rate hikes by the FED and some chance of economic slowdown or recession reflected in the long end of the curve. 

– Crypto markets turned out to be one of the biggest beneficiaries of this positive market sentiment. As of January 20^th both Bitcoin and Ethereum were up 36% year to date. Part of this spike in crypto was thanks to the markets finally shrugging off the fallout from the FTX blowout as its ex-CEO Sam Bankman-Fried was extradited to the US and also some $5 billion money was recovered giving FTX investors some hope that their losses may not be as big as originally envisioned.

– Despite having a phenomenal 2022 with a 194% return in Turkish Lira (109% in US dollar basis), Turkish stocks started the year slightly in the red with -0.35% (-0.7% in US dollar basis) return as of January 20^th. In the meanwhile the Turkish Lira started the year with slight drop of -0.3% against the greenback.

– Commodities enjoyed somewhat of a relief rally on the back of China reopening after scratching its covid zero policy. This prompted the expectation that increased activity in China could put a lid on a potential global recession or stagflation. Indeed, as of January 20^th first month futures contract for US crude oil WTI was up by 1.3% hitting $81.3 as markets hoped for an uptick in Chinese demand as well as a potentially much softer winter than expected in Europe.

– After a directionless year, gold finally started to show some sign of life with 5.6% return year to date, shooting over $1920 only 6% below its all-time high. But gold prices owe their rise to very different reasons than that of oil. Part of it has been driven by the strong central bank demand for the precious metal since the increasing interest rates put a dent in US Treasury returns. Gold price was also supported by the demise of crypto prices, gold’s biggest contender.

– January is shaping up to resemble another bear market rally on the back of a market with wishful thinking that inflation is no longer a problem. Whether the markets are getting their hopes up high or they indeed got it right this time remains to be seen. We will get a glimpse of that on February 1^st when the FED meets for the first time in 2023. One thing is for sure though – as we have said before those investors who have diversified their portfolios will be the ultimate winners in the marathon of investing.

With 2022 in the rear view mirror, markets have already started speculating as to what kind of a year 2023 will be for the global economy.

This is not surprising; markets love theorizing at the beginning of each year as to what will be in store for them… what is surprising is the fact that market outlooks disagree with each other, and that is not just on a single point. It is across the board spanning from the number and size of central bank hikes to level of inflation to volatility in equity markets to crypto and commodity prices. This is not typical. Markets may get it right or wrong. But they tend to get it right or wrong together.

2023 IS SLIGHTLY DIFFERENT THAN ANY OTHER YEAR

Then 2023 is slightly different than any other year. That is because last year turned out to be quite a shock for many, particularly for the equity investors. It was somewhat reminiscent of a slow train crash, that seemed to be happening in slow motion. And every time you’d think it was over, you’d see another car getting derailed. Consequently, many investors got burned in 2022.

The chart below that illustrates the weekly returns of the US equity index SP500 is a good depiction as to how last year has turned out to be a roller coaster for its investors. Every time the markets got a bit optimistic and started buying, the next thing they knew was the markets just plummeting again.

PREDICTING INFLATION IS DIFFICULT

For this very reason, investors are keen to get a sense of how they should be positioning their portfolios… and right now it all seems to depend on the path of inflation. Yet inflation seems elusive. As we discussed in our previous issue in the article “What does the crystal ball say for 2023?” the developed market central banks, particularly the US Central Bank (FED) has not been great at forecasting inflation. In fact, they have been really bad at it. But the good news is that they now seem to be aware of it too. Indeed, in the minutes of their December meeting which was published on January 4^th it showed that Fed decided that they would make decisions “meeting by meeting”. They of course reiterated their resolution to stump out inflation as well. To interpret it, this means there will likely be more market volatility than before as the markets will try to “guess” which data FED is going to focus on and how they will interpret them, which is more of an art than science at this point.

You can already see glimpses of this behavior if you look at the market action in main asset classes in the first couple weeks of January.

MARKETS ARE EXCITED THAT THE FED MAY BE ENDING ITS RATE HIKE

Let’s take US equities for example. Right after the US inflation and unemployment data were released on January 6^th, the SP500 had a nice little rally that saw a 3% increase in the index that lasted till January 13^th. The reason for the spike was the inflation data that showed that core CPI had dropped from 6% in December to 5.7% in January and the headline number had dropped from 7.1% to 6.5% over the same period. Given this was the second drop in inflation in a row, it very much excited the markets that the FED may finally be ending its rate hike.

As for the unemployment rate, the gauge of economic activity, it was great news on that front too showing labour market was still very healthy despite higher rates. Indeed, the data showed a drop to a historic low of 3.5% from 3.6% signaling the rate hikes may not be as recessionary as many feared.

This optimistic mood got dispelled on the back of the housing data released on January 19^th that signalled a potential slowdown in economic activity. And immediately the market sentiment soured, SP500 reversed course and dropped 2.5% by the end of the day. But with the existing home sales data that was released the next morning markets figured the previous day’s data wasn’t as important. After all this new data seemed better. Besides slowing inflation and low unemployment were more significant for the FED so markets course corrected and went up by 2% over the next day. After all was said and done, SP500 was up 3.5% as at end of January 20^th.

EQUITY MARKETS EXPERIENCED FLUCTUATIONS THAT HAPPEN OVER A FULL YEAR

 Barely three weeks into the year the equity markets already experienced the type of fluctuations that they sometimes have in one whole year. Indeed, as of January 20^th the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM were both up on the year 5.5% and 10.1% respectively.

On the bond yields front, the US yield curve remained inverted (that is the short term yields are higher than the long term yields) due to continued rate hikes by the FED and some chance of economic slowdown or recession reflected in the long end of the curve.

However, the risk-on sentiment impacted the long tenured bonds positively (meaning the long term yields dropped) with the markets betting on inflation coming down. This was reflected in the Bloomberg Global Corporate Bond Index which as of January 20^th saw a 3.2% return year to date as investors gradually started to increase their exposure on that front. Corporate bonds get negatively impacted when the markets are in a risk off mode. This is because investors flee from corporate and other riskier bonds to more secure government bonds. The reverse happens when markets feel comfortable taking more risk which tends to get reflected as better returns in corporate bonds vs. government bonds during such environments, which has been the mood in January so far.

Case in point, over the same time frame the Bloomberg Global Aggregate Bond Index was up by 2.4% undershooting the corporate bond index returns. The Bloomberg Global High Yield Bond Index, which is considered riskier than the corporate bonds, was up by 3.6% in line with the positive risk sentiment.

CRYPTO MARKETS WAS ONE OF THE BIGGEST BENEFICIARIES

Crypto markets turned out to be one of the biggest beneficiaries of this positive market sentiment. As of January 20^th both Bitcoin and Ethereum were up 36% year to date. Part of this spike in crypto was thanks to the markets finally shrugging off the fallout from the FTX blowout as its ex-CEO Sam Bankman-Fried was extradited to the US and also some $5 billion money was recovered giving FTX investors some hope that their losses may not be as big as originally envisioned.

TURKISH STOCKS STARTED THE YEAR SLIGHTLY IN THE RED

Despite having a phenomenal 2022 with a 194% return in Turkish Lira (109% in US dollar basis), Turkish stocks started the year slightly in the red with -0.35% (-0.7% in US dollar basis) return as of January 20^th. In the meanwhile the Turkish Lira started the year with slight drop of -0.3% against the greenback.

COMMODITIES ENJOYED SOMEWHAT OF A RELIEF RALLY 

Commodities enjoyed somewhat of a relief rally on the back of China reopening after scratching its covid zero policy. This prompted the expectation that increased activity in China could put a lid on a potential global recession or stagflation. Indeed, as of January 20^th first month futures contract for US crude oil WTI was up by 1.3% hitting $81.3 as markets hoped for an uptick in Chinese demand as well as a potentially much softer winter than expected in Europe.

After a directionless year, gold finally started to show some sign of life with 5.6% return year to date, shooting over $1920 only 6% below its all-time high. But gold prices owe their rise to very different reasons than that of oil. Part of it has been driven by the strong central bank demand for the precious metal since the increasing interest rates put a dent in US Treasury returns. Gold price was also supported by the demise of crypto prices, which is gold’s biggest contender, and the lackluster returns from pretty much all other risk assets.

JANUARY IS SHAPING UP TO RESEMBLE ANOTHER BEAR MARKET RALLY

It is still early days to judge what the rest of the year will look like. However, January is shaping up to resemble another bear market rally on the back of a market with wishful thinking that inflation is no longer a problem. Whether the markets are getting their hopes up high or they indeed got it right this time remains to be seen. We will get a glimpse of that on February 1^st when the FED meets for the first time in 2023.

One thing is for sure though – as we have said before those investors who have diversified their portfolios will be the ultimate winners in the marathon of investing.

ELA KARAHASANOGLU, MBA, CFA, CAIA

International Finance Expert

karahasanoglu@turcomoney.com

ela.karahasanoglu@ekrportfolioadvisory.com

https://www.linkedin.com/in/elakarahasanoglu/