[This video was recorded in late December 2022]

Impacts of higher inflation and interest rates yet to fully feed into the economy

Coming into 2022 there were a number of things we were worried about. One of them was rising interest rates and inflation. Rates have gone up this year and inflation has been very high. In terms of the things that we worried about was the de-rating of equity markets as rates went up. And also worries about the destabilisation of financial markets when interest rates went up maybe more rapidly than people thought. I think both those events have largely happened this year. In terms of interest rates going up, we feel we’re largely through that process. This is positive, the equity market is revalued to a large extent.

I think the part that hasn’t been affected yet in markets is the impact of higher rates on the real-world economy. We still remain wary of businesses that rely on debt to generate a large part of their returns, so being leveraged. That might include property areas, certainly areas that are more speculative, non-cash generative companies. We’re also not quite sure of the impact it might have on the consumer. So whilst wages are going up, which is good for the consumer, we haven’t seen the full reposting of rates for households and for corporates.

So on the positive side, valuations are lower, on the cautious side, just watch out for companies that perhaps have a bit too much leverage. Because we don’t expect rates going back down to the levels they have been over the last few years, and we do feel that change from central banks will take a while for markets to digest.

Inflationary pressures may abate but won’t disappear

Whilst we did anticipate interest rates going up this year, we certainly didn’t anticipate the conflict in Eastern Europe and the impact that it would have on energy markets. We’ve had the view for a number of years that the demand-supply balance within the energy market, in oil & gas, was tighter than perhaps the market anticipated, and that’s proved to be correct. It’s had a big impact on inflation, we’d hope to see inflation abating a bit, but we don’t see a return to the very low energy prices that we’ve experienced over the last decade, because of lack of investment. So, whilst we see inflation falling, we do see higher costs and higher energy prices being a factor that markets need to consider.

Potential for a China turnaround?

The last significant factor this year that we didn’t anticipate was that China would remain as impacted by COVID as it has done. We’ve seen many economies around the world, many countries around the world open in 2021, early 2022 after vaccination programmes. Certainly the route that China has taken has been very different. This has delayed its reopening but we do see that the potential for opening is there. And actually some of the recent news on China on its COVID zero policy has changed significantly.

So I think the wildcard for next year will be a more open China, and that will be positive for global growth, and certainly positive for Asian equities, which currently trade at very depressed valuations.

Positive outlook for global dividend growth

In terms of 2022, one of the very positive things has been the strength of dividend growth. We’ve seen a number of companies who rebased their dividends in 2020 with COVID have increased them again, companies generally in the large, listed area have got strong balance sheets. And we have consistently upgraded our dividend expectations this year.

The outlook for 2023 also looks good. Dividend cover remains high on a comparative historical basis. Areas like the energy market, the resources market, are still seeing high prices which leads through to strong cash flow. And in the financial services sector, whilst there are concerns around credit potentially from higher interest rates, many companies also benefit from higher interest rates. So some of these larger sectors are actually doing quite well. We often see in periods where you get rising rates that dividends are a large part of the total returns for equities over the following years. And certainly we would see that could be something that could happen from here.

Cautiously optimistic for 2023

So to conclude, there are still challenges for 2023, we remain cautiously optimistic that some of the things that weighed on markets this year, and weighed on economies this year such as China and energy might abate slightly. Valuations on a historical basis remain attractive and we haven’t seen a full unwind of the kind of value-growth dynamics that we’ve seen over the last few years. So, valuation of value portfolios still remains very low in a historical context. On top of that dividend growth looks good, and the broadness of that dividend growth suggests that it could continue into 2023.

Balance sheet: a financial statement that summarises a company’s assets, liabilities and shareholders’ equity at a point in time.

Equity market de-rating: occurs when investor sentiment becomes negative, for example when there are weaker prospects for corporate earnings growth.

Growth vs value investing/portfolios: value investors look for companies that they believe are undervalued by the market, and therefore expect their share price to increase, while growth investors search for companies with earnings that are expected to grow faster, and therefore anticipate the share prices will increase in value.

Leverage: a company with higher leverage typically has higher debt levels, which increases risk.