H1 2022 Investment Summary
A difficult and dismal June capped off the worst six month start to a year for 50 years. Most major equity markets fell between 6-9% for the month. Sterling based investors received a minor boost from the weakness in the pound so their loses would have been a few percent less, but not enough to cheer them up. Only China saw a positive month as some easing of Covid-19 related restrictions lifted activity and there were some hints of a loosening of government pressure on Chinese technology companies.
The H1 2022 numbers don’t make pretty reading: Nasdaq -29.7%, S&P 500 -20.3%, Euro Stoxx 50 - 18.7%, Nikkei 225 -8.9%, CSI 300 -7.9% and the FTSE 100 -4.5%.
Bonds didn’t offer any help as most bond markets saw losses of 10%, for the first six months of the year! The typical 60/40 portfolio lost nearly 20% in just six months.
I think it is worth reviewing how we got here and perhaps it will help us understand what will have to happen to get us out of this mess.
We began the year with what we thought was high inflation and central banks telling us not to worry as it was likely transitory, primarily due to post Covid-19 economic re-opening of economies and lingering supply chain issues. By spring however, capital markets and the central banks realised inflation was more persistent and more deeply entrenched in the world economy. The Russian invasion of Ukraine added to the problem by producing a spike in energy and food prices, leaving the world facing the possibility of energy and food shortages.
In reaction to the elevated levels of inflation, central banks begrudgingly swung into action. The US Federal Reserve (Fed) hiked 25 basis points (bps) in March, a further 50 bps in May and 75 bps in June. Their language after each hike sounded more determined and just last month Chairman Powell even suggested a recession was possible, unlikely, but possible as a result of higher rates. At the time of writing, markets are pricing in a 33% chance of a recession in the U.S. over the next 12 months.
The Bank of England (BoE) hiked at a slower but steadier pace, with four 25 bps hikes so far this year. This has not been viewed as enough by markets as UK inflation now stands at over 9% with the BoE’s own economists forecasting this could hit 11% before the end of the year - pound sterling has suffered as a result. The BoE may have to accelerate its actions.
In Europe, the European Central Bank (ECB) is still running negative interest rates even as inflation runs at over 8%. This has certainly contributed to the weakness in the euro’s exchange rate. They have, however, promised to hike this month and again in September. Perhaps as important, these three central banks have ended their asset purchase programmes. They will no longer be buying several hundred billion dollar and euro and pounds worth of bonds every month.
These changes to the investment environment have had profound effects on capital markets. For over a decade, central banks have always been there keeping liquidity abundant (too abundant for the past two years) and supporting markets with a steady stream of asset purchases. No more. High flying growth stocks, without profits, have been exposed and seen their valuations rightly corrected. In fact, many of the financial market distortions these central bank policies have caused are being reversed. Interest rates are slowly returning to more normal levels and equity valuations are also returning towards fairer levels. Some of the more speculative investments such as crypto are seeing a harsh reckoning.
How does this all end? When will the central banks conclude they have defeated inflation? Unfortunately, they won’t know it until they see it. So, for now, more rate hikes are in order. To some extent the markets have already adjusted to this new regime of higher interest rates, although possibly not enough. How will earnings be impacted? Not all businesses have been able to pass on price increases so there will surely be some profit margin contractions. This shouldn’t be a surprise, but it may be. The upcoming earnings release season could be bumpy for equity markets.
Is a recession likely? There is already evidence of some slowing in activity, particularly in manufacturing, where inventories have become too high. Companies expected goods purchases to continue at their heightened pandemic pace. That was a mistake. Consumers are switching to buying more services. High energy and food prices are also forcing households and businesses to better manage their spending. So yes, a slowdown in activity is, and will be experienced, but not necessarily a recession. It will depend on how stubborn inflation is and how resolute the central banks are. Fortunately, labour markets remain tight and many households built savings during the pandemic. This should help limit the damage higher interest rates and slower growth have on the world economy.
It would be very unlucky for the second half of the year to be even worse than the first or frankly even as bad. More likely we continue to experience the very volatile back and forth we have seen in the second half of June until the inflation outlook and central bank behaviour becomes clearer.
We continue to prefer firms with good earnings or good earnings prospects, reasonable valuations and strong businesses. Firm risk management and diversification are of course, also required.
About the Author
Jeff brings decades of investment markets experience to his role of Chief Investment Strategist at Oakbridge Wealth. He was one of the founding partners of Rubicon Fund Management LLP and was latterly Head of Investor Relations. Prior to his return to Rubicon he was founder and CIO of Onewall Advisors UK LLP. Before setting up Onewall, Jeff was a Partner and Portfolio Manager at Strategic Fixed Income UK LLP where he was involved in managing strategies in the macro hedge fund and a variety of managed accounts. Earlier in his career he worked for the foreign exchange unit of Salomon Smith Barney (in Singapore) and managed a variety of global fixed income portfolios at Prudential Global Advisors (a unit of The Prudential Insurance Company of America), and as an analyst in the economic research department of the Irving Trust Company in New York City. Jeff holds a BA with High Honours in Economics from Rutgers University and an MBA from New York University’s Stern School of Business Administration.
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