The fallout from the Ukraine crisis and a hike in interest rates were the key factors in market direction in 2022. In the year ahead, active managers will be hoping for less macro and more micro.
- Four key themes are likely to influence stock market returns in the months ahead: the Dollar, inflation, China and geopolitics
- A reversal in the Dollar’s recent strength would have repercussions across global financial markets
- China’s reopening could be a double-edged sword: boosting economic growth, but adding to inflationary pressures
At the start of 2022, investors were looking forward to a year of recovery after the volatility and uncertainty of the pandemic. Instead, it was dominated by a grim combination of the fallout from the Ukraine crisis, the abrupt shift in monetary policy and mounting geopolitical tensions. Making predictions for the year ahead is always a hazardous occupation. Nevertheless, there seem to be four key themes likely to influence stock market returns in the months ahead.
A Dollar reversal – with interest rates high and moving higher, a reversal in the US Dollar is by no means assured. However, on almost every measure and against almost every currency, the Dollar looks over-valued. The impact of a weakening of the Dollar could be significant: it may finally put an end to the popularity of highly-valued US stock markets, to the benefit of other markets. Notably, emerging markets and Japan have struggled to make progress against a strong Dollar.
It may also influence UK markets. The strong Dollar has flattered UK companies with Dollar revenues, boosting the performance of the FTSE 100. A weakening Dollar may realign the large cap versus small cap divide in the UK.
Inflation rolling over – inflationary pressures already appear to be diminishing. Recent inflation readings across the UK, US and Eurozone have all come in below expectations. This gives central banks some breathing space to halt rate rises. The Federal Reserve is still talking tough on curbing price rises, saying interest rates will need to rise higher than the market is currently expecting. While no-one is expecting an abrupt cut in interest rates once inflation is under control, stock markets are likely to anticipate better times ahead. This could bring much-needed confidence back to investors.
China reopening – for the time being, the focus is on China’s battle with a Covid surge. However, it shows the country is committed to reopening and to preserving its economy. This could have repercussions for the global economy in the year ahead. It may raise inflationary pressures for example, particularly for key commodities. Alternatively, it may reinvigorate global growth and help Western economies side-step stagflation.
Geopolitical realignment – 2022 is likely to go down in history as a pivotal year for the world’s political power balance. It is clear that a number of commodity-producing companies now look to China as their key market rather than the US. This has implications for the long-term relative strength of the US and the Dollar. The ultimate fall-out of the war in Ukraine and US/China tensions remains difficult to judge, but it may have set a significant realignment in process.
The alternative is that macroeconomic factors will diminish in importance over the next year, allowing the characteristics of individual companies to come to the fore once again. For active managers, it would be a welcome boost for 2023.
