Fund Return 2022-2023

Investment Commentary

Provided by Mercer - CERS Investment Adviser

Market Developments

Equities and other growth assets maintained the positive momentum from October. The main driver of improved investor confidence in November was a better than expected US inflation reading, which strengthened hopes that monetary tightening may slow down later this year and into 2023.

The overall economic outlook remained soft. Purchasing manager indices remain in contraction territory, and layoffs are increasing. Some regions, such as the UK and Europe, appear to be in a recession already. However, investors took this as a sign that monetary policy tightening is now taking effect, which should allow the Federal Reserve to slow down the pace of monetary tightening, with better than expected inflation figures in the US strengthening this conviction.

This continued to fuel the rally in equities that began in October. A weaker dollar boosted returns for international equities further, which outperformed the US on a local currency basis as well. Emerging market equities were driven by their own dynamics, as rumors of an easing in COVID restrictions as well as the announcement of meaningful support to the ailing property sector led to a massive rally in Chinese equities. Uncertainty returned later in the month when an increase in COVID restrictions led to unrest.

Fixed income returns were positive. Lower real yields supported bond returns across the board and falling credit spreads gave additional boosts to investment grade, high yield credit and emerging market debt. Lower real yields also allowed gold to make a comeback.

Commodities had a strong month in spite of falling oil prices. Russia rejoined the deal allowing the safe passage of grain from Ukraine, which among other factors led to a decline in wheat prices.

There were a number of political events over the month, some impacting markets more than others. Changing perceptions on the future path of China’s COVID restrictions led to some volatility.  Meanwhile, US midterm elections did not have a major market impact as a split government was widely expected. Talks between President Biden and President Xi were seen as an encouraging step towards preventing a further deterioration in the relationship between the world’s two largest economies.

The US dollar weakened substantially in November as risk on sentiment reduced demand for safe haven assets. At the same time, an expected slowdown in the pace of monetary tightening made US dollar less attractive relative to other currencies.

Outlook

The global economy is bending, but not breaking. A further slowdown in 2023 should be anticipated, but we do not expect this to culminate in a deep global recession. There is plenty of regional divergence, however, with some countries potentially seeing worse economic performance than others.

Inflation is peaking, but not disappearing. We expect annual inflation rates to fall in 2023 but remain firmly above the 2% targeted by developed central banks.

Central banks can be expected to pause their tightening campaigns in early to mid-2023 to assess the impact of recent policy changes. Our base case sees rates staying at high levels in most countries before eventually being cut. That said, further inflation surprises may prompt additional and aggressive action that would weigh on equity and fixed income returns.

Numerous geopolitical worries are likely to remain, with the conflict in Eastern Europe, China’s position on Taiwan and ongoing tension with Iran continuing to impact economies and markets. There remains a large question mark over China due to its continuing economic slowdown (driven by the government’s zero-Covid policy), regulatory crackdowns, a collapsed property sector and President Xi's tighter grip of political power following the recent National Party Congress.

Investors have had very few places to hide as they adjust to a world of higher inflation and tighter monetary policy. Corporate bonds now look attractively priced and defaults and downgrades appear to be contained. Sovereign bonds offer better value than before, as do equities, where reasonable valuations must be balanced against optimistic earnings expectations and higher discount rates. The US dollar is significantly overvalued and should weaken longer term, although the near-term outlook remains unclear. Those investors with a longer investment time horizon could look to other currencies such as the euro and the yen, due to their cheap valuations.