Global stocks have been hit hard in recent months falling 16% in 2022 as measured by the FTSE All-World Index. The technology laden US NASDAQ Index is down by over 24% since its peak last November. Even indices, such as the UK FTSE100 which is has significant weightings in oil and gas has declined since the start of the year.
The fall in global stocks is a consequence of worries in respect of rising inflation, falling economic growth, increasing interest rates, as well as heightened geo-political tensions. This bearish outlook has been increased by a sense that the US Federal Reserve is no longer willing to support financial markets, but rather is willing to see equity markets decline as it attempts to get a grip of inflation.
Inflation initially surged coming out of the Covid pandemic with demand for goods and services far outstripping supply. This scarcity of goods resulted in price inflation which was fuelled by years of loose monetary policy – interest rates close to zero around the world and enormous amounts of stimulus from quantitative easing (QE), whereby governments printed money by issuing bonds, so as to increase the amount of money in circulation.
Indeed, the Bank of England warned last week of inflation hitting 10% this year, its highest level since 1982, with oil, utility bills and food rocketing in price. High inflation is prevalent too in the US, 8.5% currently and 7.5% in the Euro zone.
Central Banks Tighten Monetary Policy
Consequently, the US Fed increased interest rates by 0.5% last week to 1% and flagged further significant upward moves in rates are to be expected in the coming months. The Bank of England, Australian and Indian central banks are amongst many others around the world which have also embarked on tightening. Current projections are for interest rates to reach around 3% by the end of 2022, a sea change from the zero rates seen last year, nevertheless low by longer term historical comparisons.
In addition to significant increases in interest rates, the US Fed has announced quantitative tightening (QT) by reducing its balance sheet by $47.5bn per month from June, increasing to $95bn in September. It will do this by allowing bonds to mature, effectively reversing the QE conducted during the pandemic, reducing the amount of money in circulation. This is a further deflationary measure.
Economic Growth Slowing
Global growth is slowing, the IMF recently reducing growth forecasts from 4.4% to 3.6% for 2023. Last week, China announced that export growth is at its lowest level for two years and German and French manufacturing data has recently disappointed. The Bank of England has signalled the risk of the UK economy shrinking in 2023, with many commentators in agreement that growth in the UK next year may be close to a recession (technically, where there are two consecutive quarters of negative economic growth). Even if a recession is narrowly avoided in the UK and elsewhere, stagflation is much more likely – a period of stubbornly high inflation and low economic growth leading to a fall in living standards.
War in Ukraine
The war in the Ukraine has exacerbated the inflation concerns. A consequence of the war has been to increase the cost of oil and gas, with Europe importing around 40% of its energy from Russia before the conflict. In addition, the Ukraine is a key exporter of agricultural produce, such as cereal crops and sunflower oil. Accordingly, the cost of food has rocketed around Europe. Longer term, the war has focused the weaknesses of global supply chains and led companies and governments to reappraise security issues. The result is a movement towards re-shoring manufacturing and services in western Europe further adding to the costs of products and services.
China’s Zero Covid Policy
At the start of the year, it was expected that China would abandon its zero Covid policy. In fact, the Chinese government has doubled its efforts to enforce just such a policy with strict enforcement in Shanghai and elsewhere in the country. This has not only hit Chinese domestic growth hard, but also continues to impact global supply chains and add to global inflationary pressures.
Despite the broad negative economic outlook and geo-political tensions in the world, analysts have been upgrading many leading companies’ earnings forecasts. These earnings upgrades as well as the decline in share prices has reduced the prospective Price Earnings ratio for the US S&P 500 from around 22 to 17. Whilst investors are influenced by current sentiment, analyst forecasts are based on projections of corporate performance. Certainly, the number of positive Q1 company results has been encouraging.
It is also reassuring to observe that US consumers are continuing to buy, employment markets are robust and employees are getting pay rises by changing jobs. Also, many consumers have built up significant savings during the coronavirus period.
From a corporate perspective, lots of companies are well financed, unlike past recessions. Companies in many cases hold plenty of cash on their balance sheets or have raised capital by re-financing debts or issuing new shares or bonds. This should allow companies to weather a difficult year in 2022.
Problems with supply chains should ease as the world re-adjusts after Covid, especially if the Chinese economy re-opens fully later in the year. Moreover, slowing global growth should ease demand and inflationary pressures should therefore reduce.
Markets Rebound Potential
In terms of market performance, the top eight stocks in the S&P 500 make up nearly 25% index. They are all ‘growth’ technology related companies, so have contributed significantly to the market decline. Leaving aside oil and gas, which has significantly outperformed but is vulnerable to the end of the war in Ukraine as well as the faster move to green energy, other sectors offer interesting opportunities and value. These include infrastructure, utilities, pharmaceuticals, food production and financials. The US is likely to offer both a safe haven with a strong dollar and growth with an excellent range of quality technologically advanced companies.
Overall, markets in the short-term are facing a painful re-adjustment to the new climate of inflationary pressures and geo-political worries. However, once inflation peaks potentially later this year, investors are likely to re-focus on economic growth. Companies which can demonstrate a strong growth profile, most likely in the digital economy should be well placed to see a rebound in valuations and potentially push market indices back to make new highs.
Please note, our Market Overview & Outlook is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch, telephone 01392 875500, info@SeabrookClark.co.uk