Despite many in finance being on holiday over the last few weeks there was a fair bit going on in markets, so we’ll start with a brief summary:

•  During the last few weeks, the prospect of rising interest rate expectations continued to grip markets, as the soft landing/rapid disinflation thesis was tested. Tight labour markets in the US have firmed the case for tighter monetary policy and in that sense, it was perhaps not surprising to see a continuation of the dominant trends of 2022 where interest-rate-sensitive tech stocks took the brunt of the selling while value and ex-US stocks were more resilient.

•   That left markets down for the month and more or less level for the quarter, with value managers mainly staying in positive territory while growth strategies suffered another violent leg down.

•   Looking at the year as a whole the differences are even more stark, with the Nasdaq and most of its blue-chip high-flyers having lost a third of their value, while the old economy money stocks of the UK’s FTSE 100 actually rose in value. Australia, once more the ‘lucky’ beneficiary of global trends (Ukraine’s misfortune in this case) was only slightly down. Europe and Japan suffered more modest falls, while the mighty S&P 500 and China centric emerging market indices were level pegged at almost -20%. The big story though was rising interest rates and the resultant double digit falls in value of the highest-grade fixed interest government bonds.      

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With the year ending as it had begun, perhaps the most interesting thing about the last few weeks was that even though US tech stocks were the biggest losers it was other bond markets outside the US that provided the impetus. Early in the quarter it was the UK bond market that came under pressure (for reasons that seemed very specific at the time). Then, just before Christmas, it was the turn of the Japanese Government Bonds (JGB) as the central bank attempted to get ahead of the imminent realisation by market participants that even the modest inflation that the Japanese are experiencing might be enough to threaten the longstanding regime of (downwards) Yield Curve Control (YCC). More recently, European yields(and even German Bunds) have spiked and the discount of Australian long term bond rates to their US counterparts has started to narrow.

These look like subtle moves of 0.3-0.6% but the amount of debt issued in recent years makes them influential, and nowhere has this been more evident than in equity markets, or more specifically in the divergence between the performance of growth and value strategies (or very similarly, US stocks vs the rest of the world). Just when those that had pinned their hopes on technological disruption thought that the worst was over, the selling pressure started again in the last few months, meaning that by the end of the year some fairly mainstream growth investors had seen their portfolio values halve over the year, while more staid value managers remained in positive territory. The price action of the last quarter also means that much-feted COVID lockdown beneficiaries have now done a full round trip, with many below their pre-COVID levels.  Meanwhile erstwhile bricks and mortars laggards now look pretty respectable over 3 years.

For the average multi-asset investor, the outcomes of the last three years are nuanced. Active management(particularly where asset allocation has been active) has made a dramatic comeback for two reasons. Firstly, most of these investors follow a fundamental process which has led them to progressively de-weight US equities, and in particular tech stocks, in a way that is antithetical to a passively managed portfolio. Secondly, and probably more influentially, it was a relatively easy call to not invest in negative yielding government bonds, even if the dramatic normalisation seen in 2022 wasn’t anticipated by all. Again, index funds by design invested more in these bonds just as the forward-looking returns looked, increasingly, to offer the prospect of ‘return-free risk’. That meant that actively managed conservative portfolios outperformed their passive counterparts by an even greater margin. Unfortunately, it also meant that many conservative investors (and particularly those invested in passive funds) endured a similar fate to equity biased aggressive investors in 2022, something which would have been surprising to many and which the disinflationary period of the last 40 years left many advisers and their clients ill-prepared for.

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