The start of 2022 proved an eventful one, with markets adjusting to the evolving interest rate outlook. The backdrop favoured “value” as investors shied away and sold highly rated “growth” shares. This, as well as the buoyant oil price, meant that the FTSE 100 was a notable outperformer and one of the few stock markets globally to rise over the month, hitting a fresh pandemic high.
War Games
Nasdaq posts worst January since 2008 and narrowly avoided its worst ever start to a year.
“Growth” hits the buffers and investors have reality check.
US CPI inflation hits 7% in December and the Fed prepares to withdraw monetary stimulus.
Bond markets react with substantial moves in nominal yields.
US real yields continue to trend higher, from -0.91% to -0.62%, putting further pressure on “growth” stocks.
UK equities continue to outperform driven by Energy, Basic Materials and Financials.
IMF lowers global economic growth outlook for 2022. UK growth also cut but still the fastest growing of the G7 nations.
Eurozone inflation hits 5% in December, but the ECB remains dovish.
UK political turmoil with “party gate”.
The Bank of England hikes rates to 0.5%, the threshold to begin unwinding QE.
In contrast to other major central banks, China announces further reduction in lending rates.
Russia masses 100,000 troops along border with Ukraine.
Oil hits a 7-year high on Russia/Ukraine crisis - Russia is second largest oil producer in the world.
The Ukrainian situation continued to simmer, with ongoing deployments and hardening rhetoric. Whilst Putin’s motives are questionable, the reality is that NATO has massively expanded into Eastern Europe since the end of the Cold War. The leverage that he holds from Russian energy supplies and the risks around a Russian invasion, suggest that a military outcome is low, but clearly the situation is tense and a miscalculation by either side could cause an escalation.
The changing interest rate backdrop unsurprisingly saw significant change in financial markets. Government bonds yields saw notable rises and highly valued/speculative areas of stock markets, such as technology, were under pressure. Notably, the US technology focused “Nasdaq” index was off some 10% in January alone. The index posted its worst January since 2008 and narrowly avoided its worst ever start to a year.
With inflation concerns evermore in the spotlight and a still red-hot US labour market, language from the Federal Reserve pointed to a faster rate of tightening. Some economists are forecasting up to seven interest rate rises for 2022. Ongoing energy price pressure is certainly unhelpful to the inflationary backdrop, but the main issue has been the continued strength of the jobs market, which is resulting in a record number of unfilled vacancies and as such upward wage pressure as employers compete for workers.
The Bank of England Governor Bailey recently attempted to highlight this issue when asking for wage growth restraint, as price rises feed into wage increases, turning into a vicious cycle driving one another ever higher. Even the European Central Bank has become more mindful of inflation risks, signalling the likelihood of a change in approach in the coming months.
The oil price has continued to be buoyed by both this and the fact that OPEC has not been able to meet its higher supply targets. With covid data rapidly improving and economies reopening, the oil price has also been driven by recovering demand. However, given the substantial rise in price, over 15% in January alone, it is not unreasonable to expect demand to be affected, and in time, for supply to also respond.
For households, this is a difficult time with utilities and food prices rising. In the UK, inflation has hit a 30-year high and is expected to increase to around 7% in the coming months, as the impact of higher utility bills feed through. Overall, consumers and businesses came out of the pandemic with healthy finances, after a period of extraordinary support from Governments and central banks. However, whilst neither they nor companies will be immune to rising prices and higher interest rates, financial markets have reacted swiftly to the changes and have at least, in part, priced them in.
Given the current uncertainties and concerns around the path of inflation and as a consequence interest rate policy, the coming months are likely to see further periods of volatility. At a headline level, corporate profitability has a number of headwinds to navigate, particularly wage growth, as such, the importance of pricing power and equity valuation are paramount. Whilst mindful of the backdrop, we continue to favour equities.
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