Half Year Review

The first half of this year has seen market volatility rise as central bank money printing ends and is replaced by quantitative tightening against a background of high valuations in both equities and bond markets around the world. The highly unpredicted and appalling Russian invasion of Ukraine has added to volatility as well as exacerbating concerns about food and fuel price inflation.

We remain focused on the US picture as the USA remains the world’s largest economy (for now), the US Dollar is the world’s reserve currency, it has the world’s deepest bond markets and US equities drive global equities markets sentiment.  

The other big allied issue is the rise in US (and UK) interest rates as central banks play ‘catch up’ due to their massive past underestimation of inflation. We have also seen this happen and there is more en route.  The most recent US inflation print of 9.1% (US Bureau of Labor Statistics) a few days ago reinforced concerns about the peak and the persistence of US inflation. Concerns are growing over ‘stagflation’, ie high inflation and low (or even negative) economic growth. Another 0.75% interest rate rise this month by the US Federal Reserve looks nailed on with more hikes to follow. Statistical base effects of low US inflation in Q3 2021 and the continued strength of the US (and UK) labour markets suggest that inflation may remain higher for longer.  

Unsurprisingly we are witnessing an equity bear market. Bear markets do happen from time to time and we feel this is a classic bear market driven by rising interest rates and rising risk of all types hitting high valuations. However, there is no need to panic. This does not look like 2008.

Bond markets, especially government debt, have been hit hard after a multi-decade period of rising prices and falling yields. Year-to-date prices have dropped and yields have risen off these historically low and even negative bases. The US 10 Year Treasury yield, arguably the world’s most important financial metric, has risen to 2.93%. US (and UK) mortgage rates are therefore rising sharply. The US 10 year Treasury yield has been even higher at above 3.2% but has recently dropped back, as have major commodity prices like wheat, copper and oil, due to concerns over a global recession.  

So, what’s the outlook from here? The most important thing to note is that equity markets are discounting mechanisms and look up to six months’ ahead.  Persistently higher-than-expected (if gradually declining) US inflation, the growing risk of recession in Europe driven by Russia’s energy-based reaction to EU/UK sanctions, Chinese growth concerns driven by their insane Covid policy and the impact of the massive appreciation in the US Dollar on US multinationals’ earnings suggest that we are likely to see more downside over the next few months in global equity indices.

However, on a more positive note it is reasonable to suggest that we are well past halfway on the downside. From peak to today, the S&P 500 is down in US$ terms by about a fifth. It is also worth noting that the US Federal Reserve has form in changing its tune very rapidly – it could at some point signal a less ‘hawkish’ stance on interest rates if recession fears start to outweigh inflation fears. This would immediately boost equity markets. In addition, we have already seen a significant valuation compression in large parts of the equity markets and price-earnings and other valuation ratios have fallen considerably. At some point, the war in Ukraine will cease, whilst there are signs that China is becoming more sensible in its ‘zero-Covid’ policy.

Whilst trying to guesstimate when and at what level we will see the market floor is a mug’s game, what is undeniable is that the best way to generate capital growth is to invest long-term, to ride out bouts of volatility such as we are seeing today and to rely on multi-year performing high quality active fund managers.

It is important therefore to maintain the long-term approach to your investment strategy.  

The value of an investment can go down as well as up.

You may get back less than you invested.

Past performance is not a reliable guide to future performance.

The opinions expressed are those of Irongate, this material is not a recommendation, or intended to be relied upon as a forecast.‍

Data sources used in this newsletter: FE Analytics, St. James’s Place and Asset Risk Consultancy.