Perhaps there is some light at the end of the tunnel.

This week, the FTSE 100 achieved its best price level since April last year, surpassing the 17 January 2020 pre-Covid level of 7674.6. This leaves it less than 3% below the all-time high of 7877.5 reached on 22 May 2018. In total return terms (with gross dividends reinvested) the index is now at its highest ever, with an absolute return of 15.4% since that peak of May 2018.

It is not quite the same for UK plc as represented by the mid-cap stocks of the FTSE 250. They have shown a positive but small return, a total of 2.7% for the same period. The period of UK mid-cap underperformance is more closely aligned with the commencement of interest rate rises. One thinks of smaller firms being sought by investors for their earnings growth-orientation, but this usually comes with higher financial gearing and revenues are more volatile. It means they can become stressed more quickly when rates rise and demand falls.

Perhaps there is some light at the end of the rate tunnel. While year-on-year inflation data will continue to be uncomfortably elevated, the persistent decline in European energy costs is also happening here in the UK, and that will take some pressure off the Bank of England.

With less valuation pressure from rising interest rates and more revenue positivity would be a great help for stocks in 2023. There may be good news on that front as well, given global consumer demand could recover sooner than previously thought.

European stock markets have had a good start to the year because energy prices have come down quite sharply, partly because of a bout of warmer weather. More importantly, Russia may be looking for a way out of its great mistake. Gas prices have continued to decline, particularly in the longer-dated contracts.

There is now no doubt that China is exiting from its mistaken policy of trying to hide away from the Covid virus. China’s stock markets have bounced in a way reminiscent of the 2020 bounce in western markets, when an end to lockdowns appeared in sight, and there seems to be little to hold them back. Of course, the danger is that pressures on China’s healthcare system could force a reversal of the opening, but the levels of vaccination in the younger population are very high, as good as anywhere in the world. Even though there are likely to be many tragic deaths among the elderly, the fact is that there is now no way back from the path the Chinese leadership have embarked upon.

That should stoke global demand, providing a much-welcomed offset to slowing dynamism in western economies. Amongst those, the US is not slowing dramatically and is not likely to do so anytime soon. Last week’s employment data showed a continuation of steady job gains and no compensating increase in the labour supply. Thus, the unemployment rate fell back from 3.6% to 3.5%. The US Federal Reserve is more focused on labour market tightness than outright price rises for fear of a second-round effect of inflation in the economy. Not surprising then, that many Fed members have been talking this week, with almost all saying they see rates heading above 5% and staying there. The market is having a hard time agreeing with this view, seeing the likelihood that rates will not go above 5% and will start falling before the year is out.

The losers in this situation are those most sensitive to interest rates. Households are not in a bad position generally, although they are clearly curtailing spending which would usually require financing. As a result, car sales are weak, and house prices and construction continue to decline. As a key component of US house building, timber prices falling back to pre-pandemic levels provide strong evidence for this.

The early signs of 2023 are that heavily discounted markets are now seeing some light and are starting to respond. There will inevitable be volatility in markets facing recession but this has already been priced in.

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