The return on LD Discretionary, which is the largest investment fund within The Cost-of-Living Allowance Fund, stood at –8.1% on 22 December 2022. Over a 36-month period, the portfolio has generated a positive return of 2.6 per cent. The return on the employees' holiday allowance fund is also negative. At the start of December 2022, the return stood at –5.7%. The last three months of the year have been characterised by inflation, rising interest rates and concerns about a slowdown in global growth.
Central bank statements come as a surprise
In October and November, global equities rose by 8.6% as measured by the MSCI World Index in Danish kroner. In December, however, equities have fallen back again, and year-to-date the return on global equities stands at -12.7% measured in Danish kroner. Danish equities, as measured by the OMXC25 index, have fallen by 14.2% year-to-date.
Stock markets rose in late autumn as investors saw signs that inflation had peaked. Both US and European inflation figures were lower than in previous months, to which the stock markets reacted positively. It appeared that the central banks’ tightening of monetary policy was having the desired effect, and that it would not be long before they began to cut interest rates again.
In December, both the US Federal Reserve and the European Central Bank (ECB) adopted a more hawkish tone, making it clear that key interest rates would be raised further to tighten monetary policy until they saw inflation had been brought down further. The announcements from the central banks took the stock markets by surprise, leading to falls in the days that followed. The Bank of Japan, which has also maintained low interest rates for some time, has likewise recently announced changes to its key interest rates.
The interest rate and bond markets have experienced significant volatility over the last three months of the year. In October, the yield on a 10-year US government bond reached 4.25 per cent, its highest level since 2010. The yield on a 10-year German government bond has risen from -0.25% at the start of the year to 2.25% in December.
Continued focus on inflation and growth
Interest rate rises, combined with high inflation, have a significant impact on consumers’ purchasing power. When consumers’ purchasing power deteriorates as a result of tighter credit conditions, this affects companies’ profitability. This is also reflected in the leading indicators of economic growth, which have fallen significantly throughout 2022. Corporate earnings have also fallen. And corporate earnings are expected to fall further in 2023. This will have a negative impact on the equity markets. However, higher interest rates will help to boost returns on bonds. Bonds have therefore become more attractive in portfolios containing both equities and bonds.
The focus going forward remains on inflation. Although there are clear signs that inflation has peaked and is falling, central banks are wary of easing monetary policy too soon. The US labour market therefore remains strong, and wage growth is higher than usual. This is putting upward pressure on inflation.
The next 6–12 months are therefore fraught with considerable uncertainty. The markets expect central banks to continue raising key interest rates, but the question is: at what pace? The pace depends to a large extent on the trend in inflation, and central banks have made it clear that inflation must be brought down, even if this comes at the expense of economic growth.
