A dichotomy emerges between the United States and the rest of the world
Investment markets edged lower as economic growth and rising inflation weighed heavily on sentiment. Interest rate rises in the United States and United Kingdom were as expected, but the accompanying central bank statements added to market volatility. The US and Japan fell by over 4% in sterling terms, Europe and emerging markets fared better at just 1% lower, and the UK showed marginal gains. Government bonds fell by between 2% and 4%.
Inflation reaches modern-day highs across the developed world
Economic data in general confirmed continued growth, but at a slower pace than immediately post-lockdown, with the service sector taking over from manufacturing. Employment data remained strong in the US and UK, but the European jobs market had stalled since the invasion of Ukraine. Activity in China remained hampered by zero-Covid lockdown measures, which also affected supply chains abroad.
Headline inflation continued to surprise to the upside, recording modern-day highs. The average annual rate of inflation across the developed world, at 8.8%, is the highest since the 1980s. The US report of 8.3%, released in early May, was slightly lower than the previous month but higher than forecast. These data provoked multiple interest rate rises and plenty of tough talking from leading central banks.
The Fed hikes 0.5% while the Bank of England sounds the alarm
The US Federal Reserve raised interest rates by 0.5%, the biggest hike in 22 years, and gave a strong indication that it would consider similar rises in both June and July. Fed Chair Jerome Powell also announced that the process of reducing the bonds on the balance sheet, accumulated through quantitative easing, would begin in June. The US stock market initially reacted well to these announcements, adding over 1,000 points immediately after the statement, but these gains quickly reversed.
The following day, the Bank of England increased its bank rate by 0.25% to 1%. This was in line with expectations, but the accompanying Quarterly Inflation Report shocked markets: the Bank warned that it expected the UK to fall into recession towards the end of 2022 and at roughly the same time for inflation to peak at around 10%. In addition, the Monetary Policy Committee will now consider the process of selling down its government bond portfolio built up through quantitative easing, though this does not look to be imminent.
Tough talk in Washington, apology in London
We see a clear dichotomy between the United States and other economies. The recent rise in US interest rates was preceded, accompanied and followed by tough rhetoric from Fed members, talking of the need for more rate increases. A single rise of 0.75% was widely discussed, though dismissed by the Fed Chair in his recent comments. The view is that the American economy is in rude health and is one of the few economies that can withstand a barrage of rate rises. With mid-term elections approaching, political pressure favours being tough on inflation, even if equity markets suffer. As a side note, Jerome Powell had not yet been confirmed for a second term as Fed Chair, and until then, at least, he was likely to talk tough.
In stark contrast, the Bank of England was almost apologetic in announcing a rate increase, saying that further increases may be necessary depending on what happens in the economy. It then went on to describe how new fiscal measures, energy price-cap rises and the general cost of living would squeeze the economy, leading to negative growth towards the end of the year and into the next. The tricky part is that the correct course of action would be to rein in the rate increases, except that the Bank's forecast is that, subject to an October increase in the energy price cap, inflation could hit 10% around the year end.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
A strong dollar benefits from safe-haven flows and higher rates
All of this is benefiting the US dollar, with higher and rising rates making it attractive as well as offering an economic safe haven. On the flip side, sterling has collapsed on recession fears, the euro is not far behind on worries over the escalation in Ukraine, and the Japanese yen has been hammered because of Japan's policy of capping bond yields at a level not commensurate with global bonds or inflation.
For balance, there is a lot of bearishness already in the market, with Ukraine continuing to impact supply chains, central banks balancing recession worries with rampant inflation, and China two years behind the rest of the world with lockdown measures. The great unknown is how the world will cope with a background of tightening monetary policy instead of low rates and the backstop of central bank buying. However, the returns on cash and bonds remain at extremely low levels and well below the current levels of inflation. We expect market volatility to continue, and we remain of the view that a diversified portfolio, favouring equities over bonds, remains the best way of producing inflation-beating returns over the long term.
The great unknown is how the world will cope with tightening monetary policy instead of low rates and the backstop of central bank buying.
We feel that in the near term bond yields have risen too far, given the genuine fears of a slowdown, and consequently we added a position across our low and medium risk models. There has already been a sharp rebound over recent days, and if this continues we will reduce our corporate bond holdings. We are also reviewing a number of new funds in readiness for when the markets present a good entry level.
We continue to favour equities over bonds, diversify across a wide range of assets, and are adding selectively to bond holdings where yields have overshot relative to the economic outlook.
Equities remain our preferred asset class
Returns on cash and bonds remain at extremely low levels and well below the current levels of inflation. A diversified portfolio favouring equities over bonds remains the best way of producing inflation-beating returns over the long term, even in periods of elevated volatility.
Adding bond exposure on oversold yields
We feel that in the near term bond yields have risen too far, given the genuine fears of a slowdown, and consequently we added a position across our low and medium risk models. If the recent sharp rebound continues, we will reduce our corporate bond holdings.
Alternative assets for inflation protection
Our portfolios diversify risk by investing in a wide range of assets using actively managed funds with sound investment processes. Examples of these alternative holdings include funds invested in gold and silver, infrastructure, agriculture and absolute return strategies.
Building a shortlist for future opportunities
We are currently reviewing a number of new funds in readiness for when the markets present a good entry level. Periods of heightened volatility and depressed sentiment can create attractive long-term opportunities for patient investors.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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