Sentiment swings from doom and gloom to unbridled optimism and back again
Markets remained volatile throughout August, with sentiment swinging between extremes. The month began with strong gains as US inflation decelerated in July by more than expected, reflecting lower energy prices and a stronger dollar. The CPI rose 8.5% on an annual basis, down from the 9.1% increase recorded in June, raising hopes that the Fed could ease off the pace of rate hikes enough to avoid an economic hard landing. At the same time, profit expectations rebounded from pessimistic July forecasts following a better-than-expected second quarter results season. However, the second half of the month saw a sharp reversal as central banks stepped up their anti-inflation rhetoric.
A rally that ran too far, too fast
The US rallied to recover more than half of its losses since the start of 2022, a milestone that is often seen as a signal that a new bull market is underway. Technology shares led the charge, with the Nasdaq recovering 20% from its June low. Walmart highlighted the improving tone in a trading update showing recent trends ahead of expectations following an earlier profit warning.
The second half of the month saw a sharp reversal of gains as central banks signalled that markets had been premature in pricing in rate cuts for 2023. The US Fed moved quickly to dispel any notion of an early "pivot" on interest rate policy, making it clear that it would like to see inflation under control for some time before changing course, even if that would "bring some pain to households and businesses". Global equities closed the month broadly flat in sterling terms, as weakness in the pound mitigated losses overseas, with gains in Asia and emerging markets offsetting falls in Europe and the UK. Trends in the major bond markets followed a similar pattern.
Consumer prices back in double figures for the first time in 30 years
British consumer price inflation returned to double figures for the first time in 30 years, rising 10.1% year-on-year in July, up from 9.4% in June. The Bank of England raised rates by a further 0.5% and issued an extremely downbeat statement, expecting consumer prices to rise to a peak of 13% in the fourth quarter and remain at elevated levels throughout 2023 before falling back to the 2% target in two years' time. The economy was expected to enter recession by the end of 2022, with the downturn potentially lasting throughout the following year.
Signs of a consumer slowdown, but employment holds firm
There were growing signs of a deceleration in global growth as higher interest rates started to bite. Rising energy prices, increased mortgage costs, excess retail inventories and a slowing housing market all pointed to a consumer slowdown ahead. Despite these headwinds, the US economy proved surprisingly resilient and opinion remained divided on the likelihood of a recession. Slower growth had yet to feed through to employment numbers, where the latest figures showed total payrolls at a record high, with companies adding twice as many workers as forecast. Labour market statistics are generally a lagging indicator, but the current data was impressively strong.
Authorities in China were already in easing mode. The central bank unexpectedly cut key interest rates for the second time in 2022, in an attempt to revive credit demand and support its flagging economy following repeated Covid lockdowns. This was accompanied by a $146 billion fiscal stimulus package focussing on infrastructure spending. Elsewhere, equities in Asia and emerging markets remained relatively resilient. Many of these economies have a long history of fighting inflation and were much quicker to raise rates early on, putting them arguably much closer to the end of their current tightening cycle.
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
Risks finely balanced between high inflation and weaker growth
Policymakers were in a difficult position. On the one hand, inflation was unacceptably high and with major economies operating at or near full employment following the post-Covid recovery, the risk of it becoming entrenched was rising. On the other hand, there were emerging signs that inflationary pressures were receding, economies were slowing and recessionary warning signals were flashing red. A global recession was not yet a foregone conclusion, but the odds were increasing.
Under normal circumstances, rising inflation does not coincide with recessionary conditions for very long. History suggests that once inflation has peaked, equities can rally, but that a sustainable recovery is more likely to coincide with a peak in interest rates. Most economists would agree that this was likely to occur soon, but the shape and extent of any subsequent decline remained unclear. It may therefore have been premature to say that equities were out of the woods until the Fed itself called for a victory.
Against this background, markets were likely to remain volatile over the coming months until there were concrete signs that inflation was abating and the extent of any slowdown in growth and earnings became clear. Arguably, a mild recession had already been discounted by lower prices and the underperformance of more cyclical sectors. Many shares had fallen significantly and, while growth stocks remained historically expensive, other areas of the market offered strong value. Once the outlook cleared, a good opportunity to reinvest cash should emerge.
A sustainable recovery is more likely to coincide with a peak in interest rates than a peak in inflation.
The backdrop to the rise in commodity prices had been a major period of under-investment over the past decade, particularly in oil and gas, where new investment focussed on renewable energy. An increase in post-pandemic demand was met with capacity constraints, suggesting that prices may remain elevated for a considerable period as supply adjusts slowly. This structural dynamic continued to support the case for holding real assets and commodity-linked positions within portfolios.
Diversification for different outcomes is essential in the current environment, with risks finely balanced between high inflation and weaker growth. We have structured portfolios to reflect either outcome, or both.
Reducing cyclical exposure into strength
The recent sharp recovery took markets back into overbought territory. We used this strength to cut cyclical exposure in anticipation of slowing growth through the sale of Artemis UK Select in favour of cash.
Defensive equity through income funds
Overall equity exposure is focussed on relatively defensive areas such as income funds that own companies with strong cash flow and resilient balance sheets. There is much to be said for the steady accumulation of dividends during periods of uncertainty.
Inflation protection across asset classes
We have sought where possible to mitigate the impact of inflation. In practice, this means owning index-linked bonds (TIPS) and other inflation-linked areas such as infrastructure and renewables, along with real assets such as gold bullion and precious metal and commodity stocks.
Commodity prices supported by structural under-investment
The backdrop to the rise in commodity prices has been a major period of under-investment over the past decade, particularly in oil and gas, where new investment has focussed on renewable energy. An increase in post-pandemic demand has been met with capacity constraints, suggesting that prices may remain elevated for a considerable period.
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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