market #intelliGENce May'22

A detailed analysis of what's been moving markets over the last month

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In a nutshell

• Central banks keep increasing rates in response to persistent inflation

• Global growth revised down due to economic and political risks

• Bonds and equities suffer, property providing some positive returns

What’s moving markets…

April was another challenging month for markets, as inflationary pressures, interest rate rises and the Ukraine war continued to weigh on fixed income and equity markets. Combined with slowing growth and renewed lockdowns in China, it leads to a difficult environment for investors.

In the UK, the rising cost of living and monetary policy tightening by the Bank of England continue to dampen growth forecasts. Following three rate hikes to 0.75%, the Monetary Policy Committee increased the base rate to 1% at its meeting on 4 May. This is the highest level since 2009, and puts more pressure on consumers already dealing with a 54% rise in the energy price cap. These moves are intended to moderate demand and reduce inflation – figures released in April show CPI hit 7% in March. However, central banks need to be mindful that raising the base rate too far or too fast could choke growth. Data is already showing the impact of rising costs, for example UK retail sales fell by 1.4% in March.

The impact of inflation is similarly being felt in Europe, which is more vulnerable to the Ukraine war due to its higher dependence on Russian energy, particularly natural gas. As a result, the European Central Bank has become more hawkish, with a 25bps rate hike now expected in July.

In the US, the Fed raised interest rates to a target range of between 0.75-1%, the largest increase since 2000. They also announced they’ll begin their quantitative tightening (QT) programme in June, i.e. the sale of large bond holdings from its balance sheet. Both moves will further tighten financial conditions.

In Emerging Markets, increased COVID cases led to renewed lockdowns in China, Shanghai being in lockdown for the past month and Beijing also having some restrictions in place. With Chinese economic data already slowing, this suggests further impact to global growth. Other emerging countries have fared better, typically the commodity net exporters rather than importers, but it’s been mixed overall. The appreciation in the dollar, which has risen c.8% YTD both due to rising yields in the US and increased risk-off sentiment, will also impact those with dollar denominated foreign debt.

Overall, this has resulted in downward revisions in global GDP forecasts, with the World Bank projecting growth of 3.2% this year, down from 4.1%.

Asset class implications…

These factors have been detrimental to fixed income and equity markets in April. The outlook for rising interest rates has put downward pressure on equity valuations, especially growth stocks including those in the technology sector. The FAANG stocks* struggled, with Facebook and Netflix falling 37% and 67% respectively YTD. The market is now favouring ‘value’ companies with higher current earnings and those benefitting from rising rates and/or inflation, such as utilities, rather than those with higher future earnings growth. The UK, with its high weighting to value stocks, particularly energy companies such as BP and Shell, has been one of the few markets to post a positive return YTD (+0.80%). In contrast the growth and tech-heavy US market, particularly the Nasdaq, experienced one of its worst starts to the year on record. The FTSE USA is down -7.07% YTD.

Property is the only other asset class to post positive returns so far this year, gaining 3.79% YTD. This highlights the diversification benefits of the asset class within an overall portfolio. The regular rental income, with some inflation linkage, remains attractive to investors.

Fixed income markets have suffered in the current environment, with bond yields rising in response to central bank policy and inflation expectations, leading to capital losses. The FTSE Actuaries UK Conventional Gilts All Stocks index is down -2.83% over the last month alone and -9.80% YTD.

The big question is whether central banks, particularly the Fed, can engineer a soft landing, i.e. increase rates without inducing a recession. The recent yield curve inversion suggests they may find it difficult, however this will depend on economic data in coming months, particularly inflation. In the meantime, keeping a diversified portfolio across different equity, fixed interest and alternatives asset classes is arguably more important than ever.

Asset classes in numbers

Source: FE Analytics, GBP total return (%) to last month end

* FAANG is the acronym for some of the largest tech companies in the world. FAANG essentially includes Facebook, Amazon, Apple, Netflix, and (G) Alphabet (new name for Google)