What a start we had to the stock market year 2023 and positive returns broadly across several asset classes. It has been risk on and risk taking has paid off during January and the higher you are on the risk scale, the better the return. It has been positive and welcome for investors after a black night in 2022.
The upswing has been characterized by a rebound rally and as Global Security was one of the minority of funds that were up last year, the sub-sector defense shares, for example, has not followed up in the same way in the upswing. That it was a rebound rally was further demonstrated by energy, which was the only major positive sector for 2022, being down sharply for the month. The fund which was up 10.02 % for 2022 was down 0.98% during January. The fund has holdings that rose sharply during the month and the cyber security companies were some of the strongest yielding companies during the month, but because the fund has a relatively low weight in these companies, the NAV contribution has been limited.
Sentiment has also been marked by reduced inflation concerns, a more dovish FED with confidence behind it. The FED seems to have regained confidence, which is positive for the equity markets and reduces the risks of runaway inflation. The labor market has been strong, but at the same time we see that large austerity packages are rolling out with extensive redundancies, especially from Big Tech with a large impact on the market. We know that the effects of interest rate increases are lagged by 6–9 months, which means that we still do not know how the actions of the central banks ultimately affect the economy. The risk of recession is still tangible, even if a mild recession can be considered discounted.
The companies' profits affect the market and during January and early February we received reports for Q422. We have a spread in how the reports come in against estimates and in forward guidance, but the companies' profits have generally not surprised negatively. The concern on the downside is that the high growth is not sustained in the cyber security companies and for the defense companies it mainly concerns problems with supply chains and the US debt ceiling and if it temporarily affects budget allocations. The upside potential lies in the fact that the valuations have come down a lot in the cyber security companies and the growth can be sustained and that it results in profitability in the larger companies, there is significant upside.
In the defense companies, we will see the effects of a global increase in demand and that during the year it will begin to show up in order books and that we will get transparency in how large the defense appropriations will be and how they are judged to be allocated. We look positively at the development of defense companies in 2023 and believe that the continued fund will contribute to good diversification in a macro climate of risk on and risk off.
In the shadow of the stock market rally, the security policy risk between above all the US and China is growing. A balloon may seem harmless and insignificant, but it appears that there was a very clear purpose for that particular type of craft. As a result, Blinken's visit to Beijing has now been canceled and what would have been a follow-up to a softer tone and improved relationship between the countries has developed into a crisis of confidence that raises big questions about how China intends to act going forward. China also clearly communicates that Taiwan is part of China and that it can be forced to act by force to incorporate the country, again talking about one country, two systems. We saw how it developed in Hong Kong and that scenario is not something that attracts either Taiwan or the West. The Biden administration has clearly stated its support and defense of Taiwan. An escalation of the conflict between these two superpowers could have a significant impact on world markets.
The West's relationship with Russia is, of course, still tense against the background of the ongoing war and now with interference from North Korea and Iran together with the above-mentioned situation with China, the risk of industrial espionage and cyber attacks is greater than ever and we are already seeing a sharp growth in attacks carried out. The geopolitical risks also spill over into infrastructure in space and the competitive situation between the countries.
In light of a very positive start to the year, investors should continue to be diversified against different types of risk in the markets. The megatrends of defence, cyber security and space are very much still relevant.
