Strong data lifts markets before inflation worries trigger a swift sell-off
January began with euphoria as economic data around the world surpassed expectations, sending many stock markets into historically extreme overbought positions. That optimism was punctured late in the month when unexpectedly strong US wage growth highlighted possible inflation risks, triggering a marked downturn that accelerated into early February.
Global equities surge, but sterling strength tempers returns
In local currency terms, Asian and emerging market indices rose by over 6%, with the US close behind at plus 5%. A strong month for sterling, however, reduced these gains considerably: emerging markets returned 3.5% in sterling terms, while Asia, Europe and the US were broadly flat. Shares in the UK fell by around 2%. Government bonds fell by a similar amount, although corporate bonds showed little change on the month.
Upbeat comments from the US Federal Reserve and members of the European Central Bank unnerved bond investors. Speculation that the US might squeeze in an additional interest rate rise, and that the ECB would end its bond purchases sooner than planned, saw yields on 10-year government bonds rising by nearly 0.5%, with bond prices falling accordingly.
Initially, this move had a limited effect on share prices. But a succession of stronger than expected US data, culminating in an unexpectedly large rise in US wages, highlighted possible inflation risks and led to a marked downturn in markets. The main US S&P 500 index had celebrated a record 15th straight monthly rise and the longest period without a 5% correction. The after-party, leading into February, heralded a swift collapse in prices, surpassing 5% and briefly touching 10%.
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
Was this the correction, or a foretaste of what is to come?
At the time of writing, markets are rallying hard, keen to prove that the shock fall in the United States was an idiosyncratic event and that, on the whole, there is nothing to worry about. This sell-off was not a reflection of a deteriorating economic situation. If anything, the catalyst was the recognition that stronger than expected growth could lead to higher inflation and accelerate central bank monetary tightening. The turbo-charge was produced by some complicated exchange-traded funds, ironically designed to reduce risk, going very wrong.
We had warned about an "undignified rush for the door" on negative news. This week we saw one isolated example of that, when demand to close positions in a couple of exchange-traded funds far exceeded the liquidity available, forcing extreme price moves.
What we, and other investors, will not know for some time is whether that was the correction, done and dusted, or whether it was a foretaste of what is to come. Although a specific event triggered the 4% fall in American shares, we now return to a world where strong growth will keep the pressure on central banks to curtail their bond purchases and edge interest rates higher. Closer to home, the polarity of parties on both Leave/Remain and UK/EU fronts makes any Brexit outcome look implausible, causing a prolonged period of uncertainty in both business and investment markets.
On the other hand, whilst holding cash is the safest form of capital preservation, returns remain low and fall some way below current levels of inflation. Investors will continue to seek returns above inflation by investing in other assets, but this year could see a return to more normalised markets that fall as well as rise.
The sell-off was not a reflection of a deteriorating economy; the catalyst was the recognition that stronger growth could accelerate central bank tightening.
We are continuing to run diversified portfolios, with lower exposure to bonds, and with the capacity to take advantage of opportunities when they become available. For now, we are maintaining our existing positions while we wait for the markets to settle down.
Diversified portfolios with reduced bond exposure
We are continuing to run diversified portfolios with lower exposure to bonds, maintaining the capacity to take advantage of opportunities as they become available.
Selective fund performance
Our holding in the Woodford Equity Income fund detracted from performance; Neil Woodford has an excellent long-term track record but has suffered from several poor calls over the past year. We have a meeting scheduled with him to discuss the fund in more depth.
Specialist holdings performing well
Our biotechnology and Russian funds continued to perform well, although the gold fund gave back some of the previous month's gains.
Maintaining positions for now
For the time being, we are maintaining our existing positions while we wait for the markets to settle down, ready to act when opportunities become available.
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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