Quarter 3, 2022 Market Commentary

• Published on October 10th, 2022

Quarter 3, 2022 Market Commentary

Past performance is not indicative of future results. The information mentioned is for illustrative purposes and should not be considered a recommendation to buy or sell.

After a rally in July, both shares and bonds turned lower, registering negative returns for Q3. Hopes for interest rate cuts were dashed as central banks reaffirmed their commitment to fighting inflation. The Federal Reserve, European Central Bank, and Bank of England all raised interest rates during the quarter. Emerging markets underperformed their developed counterparts, and commodities generally declined.

US

US equities fell in Q3. The communication services sector, including telecoms and media stocks, was among the weakest, along with real estate. The consumer discretionary and energy sectors were the most resilient.

In July, the market focused on the possibility of interest rate cuts from the US Federal Reserve (Fed) in 2023 due to concerns about slowing growth. However, at the August Jackson Hole summit, the Fed reaffirmed its commitment to fighting inflation, which sent stocks lower in the second half of the quarter. The Fed raised the federal funds rate by 75 basis points (bps) to 3.25% in September, marking the third consecutive 75 bps increase.

The Fed’s preferred measure of inflation, the core personal consumption expenditure (PCE) index, ticked up year-on-year from 4.7% to 4.9% in August. GDP data confirmed that the US economy is in a technical recession, with GDP falling by -0.6% year-on-year in Q2 after a -1.6% contraction in Q1. However, the August non-farm payrolls report showed resilience, with 315,000 new jobs added.

Eurozone

Eurozone shares experienced sharp falls in Q3 amid an ongoing energy crisis, rising inflation, and fears about economic growth. Every sector posted negative returns, with communication services, real estate, and healthcare seeing the steepest declines. Some pharmaceutical stocks were hit by worries over potential liabilities related to US litigation around the heartburn drug Zantac. The real estate sector was pressured by rising bond yields.

The European Central Bank raised interest rates in July and September, taking the deposit rate to 0.75% and the refinancing rate to 1.25%. Annual inflation for the eurozone was estimated at 10.0% in September, up from 9.1% in August.

Energy costs continued to be the largest contributor to inflation. The Nord Stream 1 pipeline, supplying gas to Europe from Russia, was closed for maintenance in July, reopened temporarily, then shut down again in early September. This increased pressure on power generators and intensified worries over potential energy shortages this winter, sending the euro to a 20-year low versus the US dollar.

GDP figures showed the eurozone economy grew by 0.7% quarter-on-quarter in Q2. However, forward-looking indicators signaled a weakening economy, with the flash composite purchasing managers’ index (PMI) for September at 48.2, representing a third consecutive month below 50.

UK

UK equities fell in Q3. A key event was the election of Liz Truss as the new Conservative Party leader and prime minister. The new government announced a fiscal package in September, poorly received by markets, sending sterling to an all-time low versus the US dollar.

Sterling weakness was already a feature of the quarter, especially after the US Fed warned it would continue raising interest rates. Initially, expectations in July were that the peak in US rates might be near, but this shifted focus back to near-term cash flows, favoring the UK’s large-cap constituents.

Large multinational consumer staples and energy companies outperformed, as these areas are seen as better placed to cope with a ‘stagflationary’ economic environment. The strong dollar also positively influenced these market segments, given their significant overseas revenues.

In contrast, rising energy bills weighed heavily on consumer discretionary spending, impacting retailers, travel and leisure, home construction, and other domestically focused companies. Sterling weakness at the period's end exacerbated these trends.

Japan

After rising in July and August, the Japanese stock market followed global equities lower in September, ending Q3 down 0.8%. The yen weakened continuously against the US dollar, breaking the 140 level for the first time since 1998.

Early in the quarter, market events were overshadowed by the assassination of former prime minister Shinzo Abe on 8 July. Abe was shot while delivering a campaign speech in Nara, two days ahead of nationwide Upper House elections.

The first estimate of GDP showed a quarter-on-quarter annualized growth rate of 2.2%, slightly below expectations. However, resilience in consumption and capital expenditure was noted positively.

The Bank of Japan left policy unchanged, widening the interest rate differential with the US after successive Fed rate hikes, contributing to the yen's weakness. On 22 September, the Ministry of Finance intervened in currency markets when the yen depreciated rapidly, reaching 146 against the US dollar. This was the first direct intervention in support of the yen since 1998. By the end of September, the yen closed at 144.6 to the dollar.

Japan’s inflation continued to edge up, with the headline rate reaching 3.0% and the core rate, excluding fresh food and energy, at 1.6%. Profit momentum slowed from the previous quarter, but overall results were ahead of expectations, and profit margins remained resilient despite increasing cost pressures.

Asia ex Japan

Asia ex Japan equities were weaker in Q3 due to rising inflation, higher interest rates, and fears of a global slowdown. The war in Ukraine and ongoing China-Taiwan tensions also weighed on sentiment.

China was the weakest index market in Q3, despite data showing unexpectedly expanded factory activity in August. Concerns over rising interest rates and the alarming spread of Covid-19 weakened sentiment, prompting fears of further lockdowns.

Taiwan and South Korea also saw weaker share prices. In Hong Kong, share prices fell sharply as investors sold riskier assets for the safety of government bonds amid the threat of more interest rate hikes and economic recession.

India ended the quarter positively, though sentiment weakened towards the end due to concerns over US Fed rate hikes. Share prices in Thailand, Singapore, and Malaysia were weaker, while Indonesia posted positive returns.

Emerging Markets

Emerging market (EM) equities posted negative returns in Q3 against a backdrop of slowing global growth, heightened inflationary pressure, and rising interest rates.

Poland was the weakest index market, with Hungary and the Czech Republic also declining significantly due to the Russian war in Ukraine escalating the European energy crisis and accelerating inflation. China underperformed due to a slump in the property market and Covid-related lockdowns affecting domestic demand.

Growth-sensitive North Asian markets, like South Korea and Taiwan, suffered as the global trade outlook deteriorated. Colombia performed poorly due to falling commodity prices, while the Philippines and South Africa lagged, with South Africa’s power situation weighing on sentiment.

Turkey was the best-performing market, despite inflation over 80%, as the central bank cut interest rates twice, and the economy grew strongly. India and Indonesia also posted positive returns ahead of the broader index. Brazil performed well as narrowing opinion polls ahead of October’s presidential election and improving economic data comforted investors.

Global Bonds

Q3 saw heightened market volatility as central banks and investors grappled with persistent inflation amid slowing growth.

The Federal Reserve raised rates by 75 bps in September, bringing the rate to between 3.0% and 3.25%. This was the fifth rate hike of the year, following increases to 1.75% in June and 2.5% in July. The US 10-year yield rose from 2.97% to 3.83%, and the 2-year yield from 2.93% to 4.23%.

The UK’s budgetary announcement accelerated a sell-off as investors questioned the government’s fiscal framework credibility. The Bank of England intervened by temporarily buying long-dated gilts, with sterling hitting an all-time low of $1.03 before recovering some losses. The UK 10-year yield increased from 2.24% to 4.15%, and the 2-year yield rose from 1.88% to 3.92%.

The ECB raised rates by 75 bps in September, following a 50 bps rise in July, with eurozone CPI at a record high of 10% year-on-year. Germany’s 10-year yield increased from 1.34% to 2.11%.

Government bond yields were generally higher, and credit spreads widened, weighing heavily on market returns. Credit spreads widened amid fears that tighter monetary policy might undermine economic growth prospects.

Across global credit, returns were poor, with sterling investment grade and high yield being the worst performers. European investment grade and high yield, as well as emerging markets credit, fared better relatively, but returns remained negative.

Emerging market currencies weakened as investors fled to the US dollar on recession fears. Central and eastern European currencies were mixed against the euro.

Convertible bonds protected well against equity market headwinds, with the Refinitiv Global Focus Index shedding just -1.7% for the three months. After a better primary market month in August, September was lackluster for new issues, with only US$14 billion of new convertibles coming to market for Q3.

Commodities

The S&P GSCI Index recorded a negative performance in Q3, driven lower by weaker prices for energy, industrial metals, and precious metals. Energy was the worst-performing component, with sharply lower prices for crude oil, Brent crude, and unleaded gasoline offsetting higher prices for natural gas.

In industrial metals, aluminum, copper, and nickel prices fell. Zinc prices saw more muted declines, while lead achieved a small price gain. In precious metals, gold and silver prices declined. In agriculture, higher prices for wheat and corn helped offset declines in cotton, sugar, coffee, and cocoa prices.