Equity Market Review
Equity markets finished a rollercoaster year with a strong rally. The MSCI World Index (net div. in US dollars) returned +9.8% in the fourth quarter on optimism that the US Federal Reserve (Fed)may be winning the battle with inflation and can now enter a new phase of more modest rate rises. For the full year, the index fell by -18.1%, the biggest annual decline since 2008. There was certainly “no place to hide in 2022” with bond markets also falling sharply, recording the biggest decline since the 1960s, with the yield on US 10-year government bonds rising from 1.5% at the start of the year to finish at 3.9%. Global stocks and bonds lost over $30 trillion in total value over the year, according to Bloomberg estimates. Mega-cap technology stocks were particularly hard hit by rising interest rates, with the tech-focused Nasdaq index falling 33%. The reset came after strong returns in previous years driven by low inflation and falling interest rates and provided a dramatic end to the era of “cheap money.” Everything changed in 2022 with a transformation to a new era of higher inflation, rising rates, and heightened geopolitical tensions, which completely changed market leadership.
All sectors rose during the fourth quarter, except for Consumer Discretionary, with a strong rally in cyclical sectors, such as Energy, Industrials, Materials and Financials. Looking at the full year, Energy was by far the stand-out feature with a strong positive return when many sectors fell by double digits. Also interesting to note, a disconnect has opened against the oil price which started the year at $72 and year-on-year was +19%, driven mostly by supply side issues since Russia’s invasion of Ukraine.
From a style perspective, there was a notable outperformance of value versus growth for the quarter and the year. For the full year, the picture was more extreme with value beating growth by the widest margin for many years. It was clearly a year in which investors preferred to back near-term certainty in volatile markets and reappraise what they were willing to pay for long-duration growth assets.
Fixed Income Market Review
Global bonds staged a long overdue recovery in Q4 as data indicated a potential plateauing of global inflation despite regional variations. While central bankers were keen not to be interpreted too dovishly, investors chose to look beyond the hawkish rhetoric. Meanwhile, the large number of interest rate increases in Q4 only met already hawkish expectations. Credit markets also benefited from the subsequent easing of financial conditions and hopes of a soft landing or at least a milder recession in the United States (US). Mild winter weather in Europe also served to ease energy price concerns. The combination of these factors resulted in the first positive quarter of the year, with the Bloomberg Global Aggregate Index (Hedged to USD) returning 0.99%. The gains were led by credit, with government bonds still under pressure especially in Europe and Japan. The gains in Q4 were moderate compared to the heavy losses earlier in the year. The index fell 11.22% for the year, easily the worst year since its inception in the early nineties. It also marked the first time that global bonds have dropped for two consecutive calendar years.
The Fed delivered two rate hikes during Q4, pushing the upper bound of the Fed Funds rate to 4.5%. Despite these hikes, and generally strong US labor data, the market remained reluctant to push the Fed's terminal rate much higher than previous expectations. The key focus of the market remained the monthly CPI prints which despite exhibiting stubbornly high core measurers, failed to beat elevated market expectations, providing some market relief and weakness in the US dollar (USD). The US yield curve continued to flatten with the 2s/10s curve inversion falling further into negative territory (-55 bps) highlighting ongoing recessionary concerns. Real yields were little changed over the quarter. 10-year real yields ended the quarter at 1.58%, close to a post-GFC crisis high, reflecting ongoing tight monetary conditions.
Non-US Treasuries underperformed the US over the quarter, as the European Central Bank (ECB) adopted a markedly hawkish tone. The Bank of Japan (BoJ) also surprised markets by widening the trading range of 10-year Japanese government bonds (JGBs) from +/- 25bps to +/- 50bps (from a zero yield). The move prompted investors to speculate that the central bank might soon prepare the markets for an end to its ultra-loose monetary policy.
The ECB's hawkish tone put pressure on European bonds. The ECB also upgraded its inflation forecasts for 2023 to 6.3% (5.5% had been the forecast as recently as September) and outlined their plans for Quantitative Tightening (QT) measures to begin in March at a pace of €15 bn per month.
United Kingdom (UK) bonds massively outperformed in Q4, reversing the declines of Q3, as the new Chancellor stabilized the gilt market with numerous revisions from the previous disastrous "Mini Budget" under the Truss regime. Meanwhile, the Bank of England (BoE) continued to raise rates to 3.5% as it aimed to calm rampant inflation and ongoing tight labor markets. The BoE was however keen to push back on aggressive market pricing which was previously expecting terminal rates to reach above 5%. It also continued to be cautious on the economy, forecasting a "prolonged" recession ahead.
While rates performance was mixed in Q4, credit posted good gains with global investment grade spreads tightening 32 bps to 147 bps over the quarter. European investment grade bonds significantly outperformed their US peers despite a hawkish ECB. European credit was helped by declining European energy prices resulting from milder winter temperatures and the outperformance of the banking sector. Sterling credit also recovered as the incoming government stabilized the local bond market and reversed many of the previous unfunded tax cuts from the previous mini budget. High yield outperformed with US spreads 83 bps tighter, with lower-quality bonds marginally outperforming. The best performance was, however, reserved for EM hard currency bonds which tightened 93 bps to 374bps.
The Sun Life MFS Global Total Return Fund F outperformed its blended benchmark (60% MSCI World, 40% Bloomberg Barclays Global Agg Hedge C$) in Q4 2022. The Fund Series F returned 8.16% while the Fund’s blended benchmark posted 5.33% during the fourth quarter.
Within the equity sleeve, an underweight position in Consumer Discretionary and an overweight position in Financials contributed to relative performance. Stock selection within the Consumer Discretionary and the Financials sectors also contributed positively to the Fund’s performance. Currency effect with in Information Technology added to performance. Stock selection within Industrials detracted from relative performance.