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By Haith Nori

October has continued the volatile theme witnessed in September. The situation in Ukraine has continued to deteriorate with Russia having annexed certain areas of Ukraine. The explosion on the Crimean Bridge was crucial for deliveries of arms to Russian troops. Russia has since threatened nuclear warfare, which is seeing countries rally to Ukraine’s aid, especially the US. The Defence sector is seeing strong gains whilst the US, the UK and the EU are all increasing their budget on defence to ensure protection. With the world on the brink of nuclear warfare, companies are attempting to create armaments purely for the purpose of destroying missiles before they land, hence protecting lives. The Bank of England have continued to provide emergency support to gilt markets. The UK government have reversed their initial budget plan of cutting the 45% tax rate and Liz Truss has resigned as Prime Minister, and after a short period of time Rishi Sunak was appointed as the UK’s new Prime Minister. OPEC have had a meeting to cut production by 2 million barrels of oil a day. Germany has authorized 200 million Euros, the German Stabilisation Fund, to dedicate to energy during the current crises which is being unwelcomed by other members of the EU. 15 countries are urging the EU to introduce a price cap on energy. With the hyped activity surrounding Elon Musk and his takeover of Twitter this year, the $44 billion acquisition is now complete with Musk firing top executives in the business.

In the UK, there has been a lot of turmoil since the new government has taken office. Since the new budget was released, we have seen the value of the pound drop to ‘levels not seen since the 1980s’[i]. At the end of September, it hit its lowest point of $1.035 after the budget was announced. Later in October, the UK pound recovered to levels seen before the new finance minister, Kwasi Kwarteng took office. However, confidence in the UK is clearly feeling the pinch as the UK government has reversed its bold plans of axing the 45% tax rate. The Bank of England have stepped in to buy both long dated gilts and Inflation-Linked Gilts, stating this would end on 14^th October, with Governor Andrew Bailey telling ‘pension fund managers to finish rebalancing their positions’[ii]. The aim of the fiscal policy from the new government is to support both households and businesses during the current period of increased energy prices. To add to the chaos, a new finance minister, Jeremy Hunt, was appointed who tore up almost of the original budget plans and Liz Truss announced her resignation on Thursday 20^th October, making her the UK’s shortest serving Prime Minister. Following the resignation came a short period of uncertainty in the race for the new prime minister to be appointed in the hope that some levels of normality can be restored within UK Politics. The uncertainty has made the UK appear unstable which does not bode well for investor confidence. Rishi Sunak was appointed the new Prime Minister to lead the Conservative Party officially on Tuesday 25^th October, where he has decided to keep a number of ministers in their existing posts in order to try to bring the party together and install confidence once more. For instance, Jeremy Hunt has remained as Chancellor of the Exchequer. Some positive news came as the value of Sterling recovered some ground as investors welcomed Sunak’s victory. This may well be the beginning of confidence being restored in the UK. However, all eyes will be focused on the fiscal statement announcement which was scheduled for 31^st October but has been delayed until November 17^th following the appointment of Rishi Sunak’s new government. This, in theory, will be designed to stop markets spiralling out of control once again. Whilst the delay may initially seem frustrating it will allow the government to carefully prepare their announcement.

On Thursday 13^th October, the US released CPI data for the 12 months ending in September of 8.2%, little changed from August’s 8.3% (9.1% in June and 8.5% in July). The US has also experienced many companies releasing quarterly earnings throughout October. For example, it was a brutal earnings week for large Tech names (other than Apple who beat revenue expectations). Alphabet and Microsoft provided disappointing revenue, with Alphabet declining c.7.4% and Microsoft declining c.6.9% following their individual announcements. Meta Platforms declined c.22% on the 27^th October and Amazon also saw declines. Combined, the four big Tech names ‘lost over $350 billion in market cap after offering concerning commentary for the third quarter and the remainder of the year’[iii]. In the UK Shell posted profits of £8 billion for the quarter with the share price increase c.5% on 27^th October. UK CPI data was released on 19^th October dropping to 10.1% for the 12 months ending in September after 9.9% in August and matching the July 40 year high. The ECB met on 27^th October and made the decision to increase interest rates by 0.75% to the highest rate in over a decade. Both the Bank of England and The Federal Reserve will hold their meeting in the first week of November before announcing their decision on interest rates.

In Japan, the Yen has been declining against the dollar for some time. The Bank of Japan has intervened for the second time on 21^st October spending ‘a record 5.4 trillion to 5.5 trillion yen ($36.16 billion to £36.83 billion) in its yen buying intervention’[iv]. The dollar maintained its value but weakened after S&P Purchasing Managers Index data showed a fourth consecutive contraction.

Overall, October has witnessed the volatility continue with further unprecedented affairs, especially in the UK. At the end of the month Global Markets saw a late rally despite mixed corporate earnings season; European equities increased c.9%, US equities increased c.8% and UK large cap equities increased c.3%. Investors seem to be reconsidering the possibility of a soft landing in the US in 2023. We still believe a focus on diversification across asset types, styles and strategies remains of critical importance to portfolios. Bond yields remain to high in value. After the OPEC meeting the price of Brent Crude is trading c.$95 per barrel. Sterling has become extremely volatile against the dollar.

 

[i] https://www.forbes.com/sites/qai/2022/10/07/the-british-pound-has-fallen-to-its-lowest-level-against-the-us-dollar-since-1985heres-why/?sh=4edb4d5c74a7

[ii] https://www.reuters.com/world/uk/bank-englands-bailey-tells-pension-funds-they-have-3-days-rebalance-2022-10-11/

[iii] https://www.cnbc.com/2022/10/28/big-tech-falters-on-q3-2022-results-as-meta-has-worst-week-ever.html

[iv] https://www.cnbc.com/2022/10/24/forex-markets-currencies-japan-yen-bank-of-japan-intervention.html

By Haith Nori

September has seen significant increased levels of volatility return to Global Markets once more. Central Banks in Europe, the UK and the US all scheduled meetings in September following the Jackson Hole meeting. Liquid Natural Gas (LNG) deliveries have taken a turn for the worst with Nord Stream 1 in Germany being closed by Russia, sending energy prices higher in Europe. China have been selling Russian LNG back to Europe at a much larger cost. More and more ships have been able to leave Ukrainian shores delivering agricultural products to African, Asian and European countries. The UK has appointed a new Prime Minister Liz Truss at the beginning of September. Global tensions between countries continues as the US have made a deal of $1.1billion weapons sale to Taiwan, angering China and Russia are buying rockets and weapons from North Korea. Furthermore, China has once again been entering into local lockdowns in the Chengdu and Shenzhen areas due to its zero Covid policy. Queen Elizabeth II, the United Kingdom’s long reigning monarch sadly passed away on September 8^th, seeing the country in mourning, the cancellation of key sport events, and pushing the BOE base rate decision back a week later out of respect.

Inflation has been the hot topic on all Central Bank’s minds, and they have taken drastic action. Markets have reacted negatively surrounding the meetings which were scattered throughout September. On Thursday 8^th September the ECB confirmed a 75 basis point rate hike to 1.25%, which was the largest since its creation in 1999, signalling further rate hikes to come. On Tuesday 13^th September the US released CPI data for the 12 months ending in August of 8.3%, slowing down for the second consecutive month (9.1% in June and 8.5% in July). However, the rate of decline was lower than expected and US markets reacted negatively closing down c.4%, having their worst day since June 2020. In the UK CPI data was released on 14^th September dropping to 9.9% for the 12 months ending in August from 10.1% in July ‘offering some respite to households and the Bank of England after inflation hit a 40-year high the month before’[i]. On 21^st September the FOMC made the decision to increase interest rates in the US by 75 basis points, for the third consecutive time taking the target range to 3%-3.25% being the ’highest the fed funds rate has been since the global financial crisis in 2008’[ii]. The Bank of England has also raised interest rates by 50 basis points on 22^nd September raising the rate to 2.25%. Many anticipated a 0.75% rate hike from the BOE but this came as ‘the bank said it believed the U.K. economy was already in a recession, as it forecast GDP would contract by 0.1% in the third quarter, down from a previous forecast of 0.4%’ [iii]. The Swedish Central Bank (The Riksbank) has also surprised markets with a historically hawkish 100 Basis Points interest rate hike which is its biggest in three decades. The Bank of Japan (BOJ) has maintained ultra-low interest rates to support the country’s fragile economic recovery but intervened in the currency markets on 22^nd September to buy Yen, deploying some of its $1.3 trillion in reserves, for the first time since 1998. The Yen strengthened against the Dollar c.2% after the announcement.

After August’s dramatic increase in bond yields both the UK 10 year Gilt and the US 10 year Treasury yields continue to trade over or nearing 4% which is looking attractive given it is near to overtaking the yield on equity markets. The US 10 year Treasury has reached a level not seen since 2011 breaking the 3.5% mark. The strength of the US Dollar continues to rage on in the foreign exchange markets and it is on track to have its best year since 1984. Sterling has decreased against the Dollar hitting its 37 year low ‘after the new U.K. Government announced a radical economic plan in a bid to boost growth’[iv], including a number of tax cuts. The BOE stepped in to buy £65 billion of UK long dated gilts to help stable the gilt market ‘after the new government’s tax cut plans triggered the biggest sell-off in decades’[v].

Raising interest rates though, whilst being effective to control inflation, may not be able to reduce the ever growing price of LNG and hence energy, especially in Europe. With Russia closing Nord Stream 1 on Monday 5^th September which delivers LNG into Germany, initially stating indefinitely, caused a phenomenal increase in the cost of energy. Gazprom’s Deputy Chief Executive Officer Vitaly Markelov claimed they would not resume shipments until Siemen’s Energy repairs faulty equipment.  Furthermore, Nord Stream 2 has experienced various leaks further depleting the supply of LNG and Poland, Denmark and Germany are not ruling out sabotage. China, having excess LNG, saw an opportunity to sell Russian LNG back to Europe at a higher cost being the Expensive Middle Man. To further muddy the waters, Russia offered China their LNG in both Yuan and the Ruble. With the new appointment of Liz Truss as Britain’s Prime Minister, she has initially stated she will combat the cost of energy in the UK by putting a freeze on energy bills at £2,500 until October 2025. Ships began to set sail from Ukraine from August 1^st, by the end of August more than 50 ships had left Ukraine, and now over 200 have left successfully delivering to African, Asian and European countries carrying c.5.3 million tonnes of agricultural products. At least we can see one area improving in the hope of reducing global hunger and effectively reduce food prices!

Overall, September which has notoriously been one of the worst months for Global Equities, has seen great levels of volatility return. Global equities fell 9.46% in dollar terms during the month closing out the quarter 6.58% lower. We still believe a focus on diversification across asset types, styles and strategies remains of critical importance to portfolios. Central Banks are still taking aggressive action to try and combat inflation with most stating the end is still not in sight. Bond yields continue to increase in value, the price of Brent Crude is trading at c.$90 per barrel, and Sterling continues to decrease against the dollar.

[i] www.reuters.com/world/uk/uk-consumer-price-inflation-falls-unexpectedly-2022-09-14/

[ii] https://edition.cnn.com/2022/09/21/economy/fed-rate-hike-september/index.html

[iii] www.cnbc.com/2022/09/22/bank-of-england-raises-rates-by-50-basis-points-in-seventh-consecutive-hike.html

[iv] https://www.cnbc.com/2022/09/23/british-pound-plunges-to-fresh-37-year-low-of-1point10-.html

[v] https://www.reuters.com/markets/europe/bank-england-buy-long-dated-bonds-suspends-gilt-sales-2022-09-28/

By Haith Nori

August has seen some level of order being restored to markets but could simply be a bear market rally. Central Banks continue to shock the economies by taking aggressive action to control inflation. The first ships have been allowed to leave Ukraine, ending the Russian blockade on the Ukrainian Ports. Nancy Pelosi, speaker of the United States House of Representatives has made a political statement by visiting Taiwan to publicly show support for the island’s independence, however, this may ignite the buried tension between China and the US.

Inflation once again remains a key factor in Global Economies. The cost of energy is rising and a bleak forecast for January 2023 has been painted that energy bills will reach a new record high having serious implications for the cost of living. Food prices also remain at a higher cost causing a shift in consumer spending to more affordable options. Ships carrying much needed grain have finally left the Ukrainian shores with the first carrying 26,000 tonnes of corn to Lebanon. Since the sea blockade was lifted on August 1^st more than 50 ships have set sail from Ukraine delivering to not only the poorest regions, the immediate plan, but branching out to the rest of the world. This marks a major breakthrough since the Russian invasion as this now will help address global hunger and restore some normality. At the beginning of August, the UK joined the US and EU in a ‘shock’ increase in interest rates, the largest in 27 years, up 50 basis points to 1.75%, the sixth time since December 2021. In the US, markets were shocked by the Non-Farm Payroll figures on 5^th August, adding 528,000 jobs, versus the 250,000 expected providing positive efforts to reduce unemployment. On 10^th August the US released the CPI data for July of 8.5% vs 9.1% in June. Equities rallied and Treasury yields decreased with signs of ‘decelerating U.S. inflation prompted bets that the Federal Reserve would “pivot” raising rates at a slower pace than previously expected’[i]. In the UK CPI data was released on 17^th August which saw Consumer Price Inflation jump to ‘10.1% in July, its highest since February 1982, up from an annual rate of 9.4% in June, intensifying the squeeze on households’[ii]. The Bank of England will continue to increase interest rates if they need to, keeping a tight control on inflation. Analysts at Citi Bank have suggested that the CPI figure in the UK could reach as high as ‘18.6% in January, more than nine times the Bank of England’s target’[iii]!

On 26th August at the Jackson Hole meeting in Wyoming, Federal Reserve Chair Jerome Powell gave a very ‘hawkish’ speech sending US markets into a downward spiral, reiterating the central bank’s commitment to halting inflation and price stability. The next Federal Reserve meeting will be on September 21^st where they will review the decision to increase interest rates once more. After the last interest rate hike of 75 basis points in July, Powell mentioned ‘another unusually large increase could be appropriate at our next meeting’[iv]. There will be several economic data inflows to review before that meeting which will guide the next decision. European and Asian markets also fell after the meeting. The outlook from the meeting that many investors were hoping for that there would be one large rate hike in an attempt to bring inflation back to normal, sadly was not witnessed suggesting further surprising rate hikes to come. Also at the Jackson Hole meeting, Isabel Schnabel, an ECB executive board member, called for ‘strong determination to bring inflation back to target quickly’[v], adding that the persistence of inflation must not be underestimated and that sacrifices would be needed to tame surging inflation. Clearly, not only the US will be continuing to tighten monetary policy after the Jackson Hole meeting.

In the UK Fixed Interest Markets two year Gilt yields increased by more this month than any other month since May 1994. On August 24th two year Gilt yields hit 2.959%, their highest level since November 2008, up from 1.72% at the start of the month.

Countries around the world are attempting to assist with the energy crisis in Europe. The US, in particular, has shifted more Liquified Natural Gas (LNG) to Europe in the month of June than it did for the whole of 2021 and is planning more in the second half of the year. Currently, Europe has filled their reserve tanks 70% for the winter but to fully refill will come at a cost of c.50-55 billion Euros with the end consumer taking the brunt of the cost. With Russia still limiting the distribution of LNG to Europe, it is essential for them to find alternative options. Olaf Scholz, Chancellor of Germany signed a green hydrogen deal with Canada on Tuesday 23^rd August. This is a promising step towards both an alternative and sustainable source of energy, but the first deliveries will not be until 2025, meaning the current situation still needs to be urgently addressed.

Overall, August has seen a correlation in asset markets. We still believe a focus on diversification across asset types, styles and strategies remains of critical importance to portfolios. However, global markets have eased after rallying back in July. Central Banks are still taking aggressive action to try and combat inflation with most stating the end is still not in sight. The two year UK Gilt yield has hit its highest level since November 2008 while Brent Crude has fallen below $100 a barrel. At the Jackson Hole meeting Powell gave a very hawkish view suggesting further interest rate hikes are coming in order to halt rising inflation with the potential of other central banks following suit. Sterling has been depreciating in the run up to the announcement of the new Prime Minister in the UK scheduled to be announced on September 5th.

 

[i] https://www.reuters.com/markets/europe/global-markets-midday-wrapup-1-2022-08-10/

[ii] www.reuters.com/world/uk/uk-cpi-inflation-rate-rises-101-july-2022-08-17/

[iii] https://www.reuters.com/world/uk/uk-inflation-hit-18-early-2023-citi-forecasts-2022-08-22/

[iv] www.bloomberg.com/news/articles/2022-08-26/read-fed-chair-jerome-powell-s-speech-at-jackson-hole-symposium

[v] www.ft.com/content/5afd5140-605f-447d-a30c-cc7355ceea59

By Adam Jones

Following a June in which global equity markets declined by 8%, July offered investors some welcome respite as markets rose by >7% over the month. Government bond yields trended lower, however measures of bond volatility (which indicate the extent to which prices fluctuate) remain highly elevated as market participants attempt to front-run the policy adjustments of developed market central banks. The US central bank raised interest rates by 0.75% in July and the ECB raised by 0.50%, bringing their Deposit rate back up to 0% following 8 years of negative interest rates. The Bank of England is also expected to make its next move higher on August 4^th, with futures markets currently anticipating an increase of 0.5% in the base rate[i].

These moves are being made primarily in attempts to address the ongoing issue of inflation. US data once again surprised on the upside in July, with the headline inflation rate pushing to new highs of 9.1%. Similarly eye-watering figures arose both here in the UK (9.4%) and in Europe (8.9%). Part of the difficulty central banks currently face is that a large proportion of this inflation is being driven by factors that are outside of their control, such as commodity prices, ongoing supply chain issues and tight labour markets. In our view this greatly increases the probability that mistakes will be made as consumer demand falls further into what appears to be an already slowing global economy.

Major indicators of sentiment and economic activity in Europe fell to levels last seen during the pandemic and in our belief is that the Euro Area remains particularly vulnerable in terms of its dependence on imported energy. A further reduction in gas from Russia in July drove the European Union to agree to cutting gas consumption by 15%[ii], however natural gas prices in Europe remain far higher than those in other parts of the world. In the US economic activity also showed signs of deceleration as early estimates of services & manufacturing activity fell to its lowest level in two years[iii].

In China we received news that the country’s economy had contracted in Q2, due in large part to continued lockdowns in the wake of renewed pandemic fears. The government is making efforts to shore up the property market and support economic growth, however a Zero-Covid policy remains its top priority which will continue to affect the region.

July also saw the beginning of the Q2 US earnings season, which provided some useful insight into the performance of many of the world’s largest companies. Results here have been fairly mixed, however as at the end of July some 77% of the largest US companies had reported earnings that came in ahead of analyst expectations[iv]. Often seen as something of an economic bellwether, Walmart Inc declared that it expected full year profits to fall by more than 10% as customers continued to cut back on discretionary purchases amidst higher food & energy costs[v]. In stark contrast to this, however, excellent results were delivered by global payment companies such as Visa and Mastercard whose management teams suggested they are still seeing no signs of a slowdown in consumer spending.

In currency markets the US Dollar showed tentative signs of having peaked in mid-July, however the Dollar tends to perform well in an environment of slowing global growth which, at least to us, feels increasingly likely to be the case moving forward. During July we saw the Euro (very) briefly trade through parity versus its US counterpart, however the currency went on to recover marginally and close the month nearer 1.02. The British pound displayed similar dynamics, strengthening in the latter half of the month to close at 1.22 vs the Dollar. Following a period of very significant weakness the Japanese Yen posted its largest weekly gain in over 4 months, a move which could be self-reinforcing given the large number of speculative traders who are betting against the currency[vi].

In some respects July saw the return of more ‘normal’ market relationships (bond yields lower, equities higher), however we continue to believe that the distribution of potential outcomes remains wide for both markets and economies moving forward and that a focus on diversification across asset types, styles and strategies remains of critical importance.

[i] Refinitiv, CME Group SONIA Futures

[ii] EU Seeks 15% Cut in Gas Use on Russian Supply Squeeze (yahoo.com)

[iii] U.S. July flash PMI data show ‘worrying deterioration’ in economy | Morningstar

[iv] I/B/E/S Data from Refinitiv

[v] Walmart Inc.

[vi] Yen rises to two-month high as investors slash short bets | Financial Times (ft.com)

By Haith Nori 

June has been another chaotic month for most asset classes. Central Banks are taking aggressive action to control inflation. The Ukraine Crisis has entered its fifth month presenting further global issues. Russia has taken control of Ukraine’s major ports or has hemmed in by its naval blockade (Ukraine is a critical global producer of wheat) which could lead to a serious impact on global hunger. In China, after the good news of lifting Covid restrictions, and markets factoring in the positive news, further lockdowns were introduced under its zero Covid policy as cases accelerated once again.

Inflation remains a hot topic for global central banks which, in June, have begun to take more aggressive action in raising interest rates. After the US May Inflation data – the single most important data point for the global economy (released on 10^th June) – delivered a headline number of 8.6%, markets immediately factored in an expected 50 basis point rise in interest rates by the US Federal Reserve. In the end markets were surprised with a more aggressive increase of 75 basis points at the Federal Open Market Committee (FOMC) meeting on June 15^th, with Chair Powell stating;

“The Committee is strongly committed to returning inflation to its 2 percent objective” [i]

This suggests the path of interest rate hikes in the US might have further to run, along with the expectation that inflation must be bought under control. However, this may come with a nasty side effect – The slowing of the US economy along with the potential for a higher unemployment rate.

After an initial recovery, which was sadly short lived, US equity markets declined significantly the following day, falling more than 3%. The Swiss National Bank also went on to surprise markets with a 50bps increase in interest rates (the first in 15 years) from -0.75% to -0.25%. Here in the UK, on 16^th June the Bank of England (BoE) also took action to raise interest rates for the fifth time since December 2021 by another 25 basis points up to 1.25%, the highest level seen in 13 years. The FTSE 100 also fell following this news.

On the 9^th of June Christine Lagarde, President of the European Central Bank (ECB), after months of suggesting an increase in interest rates, finally announced a plan to tackle the ever-growing issue of European Inflation. Currently it is engaged in Corporate-Bond buying which Lagarde has now stated will end on July 1^st – a €3 Trillion bond-buying programme. Also, the ECB will begin to combat inflation by raising interest rates by a suggested 25 basis points later that month, ‘the first interest rate hike since 2011 followed by a potentially larger move in September’[ii]  which may be as high as 50 basis points. With inflation in Europe currently at c.8.1% (and still rising), the ECB needs to take drastic action in order to achieve their 2% target.

Over in Japan the Bank of Japan (BoJ) on 17^th June decided to maintain ultra-low interest rates and ‘vowed to defend its cap on bond yields with unlimited buying, bucking a global wave of monetary tightening in a show of resolve to focus on supporting a tepid economic recovery’[iii].

The Japanese Yen has historically been considered a ‘safe haven’ within the investment community. However, over the past few years the price has depreciated very significantly against major currency crosses given a monetary policy stance which stands in stark contrast to that of other developed market peers. Since its highest point in January 2021 the Yen has depreciated by 31.4% against the US Dollar, reaching its lowest level since 1970.

Global equity markets showed signs of a rally later in the month as the G7 Summit took place in Germany over the 26^th-28^th June. Markets are factoring the hope that some resolution may come of the G7 Summit with Global leaders, for instance trying to find alternative overground routes for grain exports. The S&P 500 had its largest one-day percentage gain in more than two years on Friday 24^th June.

China’s escape from lockdown was short lived at the start of the month as, due to their zero-tolerance policy, new lockdowns were once again imposed. China remains unpredictable as June data does not ‘show the powerhouse bounce-back most expected, perhaps reflecting the view that corporates do not see their Covid Zero nightmare as over’[iv]. We can not rule out the end of Covid Lockdowns which will continue to exert an impact on global markets. Perhaps counterintuitively, Chinese equities are in a bull market, with the Shanghai Shenzhen CSI 300 Index having risen from its low point 26^th April of 3784.12 to 4486.08 at the end of June– up 18.6%!

To conclude, the S&P 500 started the month at 4101.23 and fell by 7.7% to end the month at 3785.38. The FTSE 100 also gave back some of its more recent relative gains, having entered June at 7532.95 while going on to close at 7169.28, a reduction of 4.8%. In Germany, the DAX opened the month at 14,340.47 and finished at 12,783.77, a fall of 10.86%. The French CAC40 Index fell from 6418.89 to 5922.86, a reduction of 7.7%. The Italian MIB fell from 24,283.56 to 21,293.86, a decline of 12.3%. Japan’s Nikkei 225 fell from 27,457.89 at the beginning of June to also end lower at 26393.04, a decline of 3.9% during the month. Brent Crude, having rose to highs of $123.58 during June, started the month at $116.29 ending at $114.81.

Overall, it has been an extremely volatile month for many asset classes, especially equities. The best performers remain companies with sufficient pricing power to avoid suffering from inflation. Healthcare, Consumer Staples and utilities were the best performing sectors through June. Both the effects of Covid restrictions and the Ukraine Invasion are still very much having an impact on global markets. Central Banks are acting much more aggressively in trying to combat the overall cost of living and inflation.

Finally, US stocks have capped off their worst first half year performance since 1970.

 

[i] Bloomberg Points of Return – Be Warned – So Now we have Clarity. The World has Changed

[ii] https://www.reuters.com/markets/europe/ecb-chart-course-out-stimulus-setting-stage-rate-hikes-2022-06-08/

[iii] https://www.reuters.com/markets/currencies/boj-maintain-ultra-low-rates-sound-warning-over-weak-yen-2022-06-16/

[iv] Bloomberg Points of Return – Be Warned – Gaming the Post-Peak Rates World Is No Easy Task

By Haith Nori 

May has been an extremely volatile month. There seems to be no short-term resolution to the Ukraine crisis and therefore it can still have unpredictable effects on global markets. For example, India has made a move to halt wheat exports to ensure it will have continued access to supply (Ukraine is a critical global producer of wheat and hence global demand for Indian wheat has increased). China has also been in Covid-related lockdown for several weeks which has served to further exacerbate both supply constraints and a softening global growth outlook.

Inflation remains a key focus for global central banks, with the US Federal Reserve having finally taken action to increase Interest Rates in the US after months of hesitation. “The Federal Reserve administered its biggest rate hike in 22 years as it raised the fed funds rate by 50 basis points” [i] to 0.75% from 0.25% on May 4th. This initially triggered a rally in the S&P 500 of 3% which was very short lived, however, as over the following week the market fell a further 8.6% to 3930 on 12^th May. US Federal Reserve Chair Jerome Powell has suggested further rate hikes at the next Fed meetings later this year, stating he is prepared to take continued action until inflation shows convincing signs of retreat.

Markets need time to adjust and factor in rate hikes. In the UK, on 5^th May the Bank of England (BoE) also took action to raise interest rates once again this year from 0.75% to 1% as the annual inflation rate in the UK hit 7%, the highest level in 30 years. The FTSE 100 fell c.3.8% in response as concerns for domestic growth increased. In Europe the ECB have yet to take action but key policymakers stated “Momentum is building for the European Central Bank to raise interest rates in July to fight soaring inflation, after dovish policymakers indicated they are ready to accept an end to almost eight years of negative borrowing costs” [ii]. Global Markets began the month on a downward spiral but from May 13^th started to rally back, regaining some of their lost value.

The US Dollar has continued to surge throughout May reaching a fresh 20 year high on May 12^th “as concerns persisted that central bank actions to drive down high inflation would crimp global economic growth, boosting the currency’s safe-haven appeal” [iii]. The Euro also remains weak which will likely drive higher imported inflation moving forward. This is yet another key factor that the ECB must take into consideration for raising interest rates this year and an issue they are keenly aware of.

Commodity prices remain very elevated, having recently touched their all-time highs in March which will offer no comfort for those anticipating lower inflation ahead. The WisdomTree Enhanced Commodities fund still hovers near the highs of March at 1570.80p as at the end of May.

On 16^th May, Walmart Inc., considered to be the world’s largest retailer, fell 11.4% after reporting a 25% drop in quarterly earnings, cutting its full-year profit forecast and falling far short of expectations. Higher staff costs (hiring more employees to cover staff sick from Covid) and more expensive fuel ($160 million more than usual) took their toll on profits. Shoppers facing decades-high inflation made the conscious decision to move to lower margin basics. Clothing and home furnishing fared particularly poorly in what are usually profitable categories. “The results are unusual, though, because Walmart has been famously cost-conscious” [iv]. Walmart’s stock price reached record highs on 21^st April 2022 of $159.87 (the price has since reduced by c.19.5%!).

Twitter has also had rather the rollercoaster ride since hitting its peak for 2022 at $51.70 on the back of the news that Elon Musk had made a deal to buy Twitter inc. for $44 billion cash (25^th April). In May the stock dropped 27.7% after Musk “tweeted that he was pausing his bid as he awaited further information to confirm whether the social media company’s quarterly estimates of its fake accounts were accurate” [v].

Finally, some good news at the end of a testing month! Shanghai and Beijing, among other areas of China have announced easing Covid Restrictions allowing 22 million citizens to be able to travel once more. This is having a positive effect on Markets not only in China but also Japan was up by c.2% on the back of the news. Asian Markets will welcome this positive news and once the economy starts to re-open this will have a knock-on effect and could potentially prove positive for Europe. In the context of China’s reopening the price of Brent Crude Oil has increased to its highest level since the Ukraine Invasion ($122.84) which will add further pressure to headline inflation data.

To conclude the S&P 500 started the month at 4115.38 and dropped by 6.2% but had a late surge ending the month slightly higher at 4132.15. The S&P experienced its biggest drop in price (-4.04%) in the past 2 years on 18^th May. The FTSE 100 has also seen a reduction during the month of 2.3% beginning the month at 7561.33 but had a late month surge ending slightly higher (7607.66). The German GDAX began April at 13,939.07 and finished 14,388.35 up 3.22%, after experience a 4% drop, while the French CAC40 began May at 6425.61 ended slightly higher at 6,468.8 after experiencing a 5.3% drop. The Italian MIB began May at 23,857.23 to end at 24,505.08, however saw a reduction of 4.3% during the month. To combine with the disappointing European Equity performance, the Euro has fallen to its all-time low against the dollar which will drive inflation higher in Europe. Japan’s Nikkei 225 began May at 26818.53 and ending slightly higher at 27,279.80, seeing a price drop of 4% during the month. Brent Crude has risen to $122.84 having started the month at $107.58.

Overall, it has been an extremely volatile month for asset classes across the board, particularly within equity markets. The best performers continue to be real assets and companies with sufficient pricing power to avoid suffering from inflation. The effects of Covid restrictions are still very much having an impact on global markets and will likely last longer than many anticipate.

 

[i] Bloomberg Points of Return – Be Warned – Powell Won’t Welcome Being Seen as Dovish

[ii] https://www.ft.com/content/273d2613-93b8-4224-8f81-7281337ab618

[iii] https://www.reuters.com/markets/europe/dollar-hovers-near-2-decade-high-cpi-keeps-aggressive-us-rate-hikes-likely-2022-05-12/

[iv] Walmart Flashes Inflation Warning Sign for Target and Consumer Economy – Bloomberg

[v] Why is Elon Musk really putting his Twitter deal ‘on hold’? | Financial Times (ft.com)

By Tim Sharp

It has been a testing month for global bond markets, despite inflationary pressures from Central Banks and the Ukraine Crisis market pessimism has been running on stretched levels. When bond yields go up there is an inverse relationship on the price which will go down. An inverted yield curve, when short-dated bonds yield more than long-dated bonds, could be a sign that a recession is coming under normal circumstances. Central Banks look to combat inflation by raising interest rates. Some would argue that Central Bank intervention since the global financial crisis has blunted the signalling skills of the bond markets, but we believe history suggests that the US Treasury yield curve remains the most accurate predictor of recessions. During March, the US Treasury yield curve has flattened considerably with the yield differential between two-year and ten-year benchmarks have reduced to 0.02%, while the five-year to ten-year part of the curve has inverted 0.11% as at month end. The speculation continues and time will tell if central banks can engineer a soft landing.

In the Eurozone, growing investor uncertainty over future ECB (European Central Bank) rates have boosted fixed income volatility, which is assisting the rise in bond yields. Eurozone benchmark bond yields have been soaring recently, with 10-year Bund yields rising by about 75bps so far in March, which is cheapening Bunds. This rising trend in eurozone bond yields reflects the growing investor uncertainty over the future trajectory in ECB policy rates[i]. Price pressures intensified substantially within the Eurozone in March, headline inflation hit 7.6% in Germany and 9.8% in Spain, both statistics were well above expectations, and both at 40-year highs. Pressure on policymakers to act will rise as the market prices in almost three quarter-point hikes from the ECB by the end of the year. The story of inflation within the eurozone is mainly being led by the increase in energy prices and supply disruptions[ii].

In the US, the 10-year U.S. Treasury yield hit a fresh two-year high Friday 25^th March as investors anticipated a more aggressive Federal Reserve tightening cycle. The 10-year rate hit 2.50%, its highest level since May 2019, having started the week near 2.15%. The yield on the 30-year Treasury bond jumped 8.1 basis points to 2.59%. “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” Powell said in a speech to the National Association for Business Economics. The increase in Interest Rates comes as Powell has said “inflation is much too high” [iii]. As we have previously seen from January this year, there could be as much as seven interest rate hikes this year by the Fed.

Europe has started to feel the effects of the Russia-Ukraine crisis for which unfortunately no end is currently in sight[iv]. Investors have grown increasingly convinced that the fallout from Russia will have a lasting effect on the region’s economy. We see that output has suffered in countries with a greater supply exposure to Russia, with Germany seeing the largest declines. We have already seen rising energy prices and firms passing on higher costs to consumers. This has also been reflected in stock markets with the Italian MIB Index down 1.02%; the Dutch AEX down 0.48%; The German GDAX down 0.14% and, while the French CAC40 was up 0.30% over the course of the month.

We see that the stocks that have performed the best in March have been quality stocks with good cash flows and low debt profiles. Tech stocks that are predominantly software based have very little debt and are typically asset light. A few examples would include Alphabet, up 3.0% on the month, and Microsoft up 3.2% from the start of March.

Global stock markets have had a late month surge on the possibility of a possible ceasefire in Ukraine and a Russian announcement that its military was cutting back operations around Kyiv and Chernihiv in the North of Ukraine that looks like signs of progress[v]. The MSCI World Index has increased 9.1% since March 8^th, 2022.

In Japan the Yen is generally considered to be a safe haven in times when geopolitical and financial tensions are raised, and as an example strengthened against the dollar during the years of the Global Financial Crisis[vi]. However, that is not the case this time as the Yen has weakened against a strengthening dollar by around 6.5% due to its position as a significant energy importer. The Nikkei 225 has been equally disappointing having fallen 5.58% over the course of the year.

Commodity prices have also rallied this past month amongst the growing uncertainty with the Russia-Ukraine Crisis and the resulting disruptions to supply. Russia and Ukraine are two of the world’s largest suppliers of wheat/grain (around 30%) and Russia has temporarily put a ban on grain exports to ex-Soviet Countries (March 14^th) [vii]. US retail gas prices ‘at the pump’ have reached all-time highs due to concerns about supply which has been reflected in OPEC reports and US ban on Russian Oil imports[viii], with oil prices reaching $130 a barrel, almost double their price in early December! Prices of Energy have been increasing and energy related stocks have seen surging share prices. Good news for existing commodity investors with the WisdomTree Enhanced Commodity ETF 10.8% stronger in dollar terms in March.

To summarise, March has seen significant rises in volatility and market turbulence driven by the knock-on effects of the Russia-Ukraine crisis. The S&P closed at 4530, and the UK FTSE 100 closing at 7515 both up 8.6% and 8.0% respectively from Month lows on March 8^th. There has been a late rally in market prices on hopes of Russia reaching an agreement with Ukraine, however the war is not yet resolved, and it is too early to say that markets will not revisit lower prices. The Wisdomtree Enhanced Commodity ETF has been a strong performer in March hitting all-time highs (1596 up 15.8% from the start of March in sterling terms) while the S&P 500 hit its lowest in March albeit ending the month 6.3% higher than at the start. The iShares Physical Gold was up 8.6% on March 8^th although ending the month only 1.4% higher. There will undoubtedly be a knock-on effect due to the restrictions on Russian exports which markets probably still need to factor into pricing. We are in a highly inflationary environment that still needs to be addressed by central banks while attempting to avoid a global recession. The Bank of England has increased UK interest rates in March to 0.75%, the Federal Reserve is still aggressively approaching US Interest Rates, and the ECB is still contemplating its position. Finally, the Japanese Yen once considered a safe haven in times of uncertainty has not lived up to its reputation.

 

[i] Absolute Strategy Research – EUR bond yields’ shifting drivers – March 30, 2022

[ii] Absolute Strategy Research – Eurozone inflation surge continues – March 31, 2022

[iii] https://www.cnbc.com/2022/03/25/us-bonds-treasury-yields-flat-friday.html

[iv] Absolute Strategy Research – Europe starts to feel Russia-Ukraine effects – March 25, 2022

[v] Bloomberg Points of Return – Be Warned – A Piece of Paper – John Authers – March 30, 2022

[vi] Bloomberg Points of Return – Be Warned – What a Time for Japan to Matter to Markets Again – John Authers – March 28, 2022

[vii] https://www.reuters.com/business/russia-may-suspend-grain-exports-until-june-30-interfax-2022-03-14/

[viii] https://www.reuters.com/business/biden-bans-russia-oil-imports-us-warns-gasoline-prices-will-rise-further-2022-03-08/

By Tim Sharp

In a world that is suffering from high inflation due to supply disruptions, the tragic Russia – Ukraine conflict represents another supply shock for the global economy, the impact of which will depend largely on the length of the war and the effectiveness of the sanctions imposed upon Russia. The European Union does not have a good track record for decisive action but the implementation of the policies against Russia have probably surprised many, particularly the historic changes in foreign policy by Germany in support of Ukraine. Higher commodity prices are likely to have a global impact with oil, industrial metals, and agricultural commodities all impacted by the conflict, but the effects of European gas prices will ensure that Europe is hardest hit putting pressure on prices that will squeeze household incomes, and likely depress European growth. Europe is also likely to question its energy policies going forward with the long-term implications to growth and strategy that will cause. Higher commodity prices can correct lower through changes in supply, and although the US announced that it would use its strategic oil reserves to bolster supply shortages, this coupled with the uncertainty regarding the ongoing conflict, and the effectiveness of sanctions, has so far failed to pause the rising price of crude oil. The alternative potential headwind to higher commodity prices is lower demand caused from tightening central bank policy response, and an unwillingness from the consumer to spend in uncertain times when household incomes are under pressure. Absolute Strategy Research (ASR) point out commodity price inflation tends to fade with world trade growth[i].

Judging by Jerome Powell’s speech to the House of Representatives Financial Services Committee, the US feels far enough removed from the Russia – Ukraine crisis for it not to affect Federal Reserve policy. Governor Powell intimated that policy was likely to tighten 25bp at the March meeting drawing a line under the speculation that the rise might be 50bp or even deferred due to the conflict in Europe[ii]. The speech also confirmed to us that the Fed’s attention has turned firmly to inflation at the expense of growth in the short term. We believe wage inflation is a big consideration for the Fed because the policies used by the US during the pandemic did not furlough workers but offered direct financial compensation. This has led to a much higher flexibility within the employment market, a higher churn rate, and in turn, a boost to workers’ bargaining power as they re-enter or move around the jobs market. Therefore, the fed appears to fear that sustained wage growth through pressure in the labour market may keep inflation elevated. We believe that wage growth and earnings will be key to Fed policy going through this year as balancing upward wage pressure against corporate earnings will provide an indication as to how the economy is progressing. We have been mindful of the possibility of a central bank mis-step due to the delay in quantitative tightening reducing the tightening landing strip and believe that the Russia-Ukraine conflict has heightened the possibility of this occurring. While earnings are growing albeit at a slower pace, it is unlikely that the economy will roll over into recession, but a war that is likely to drive inflation higher and eventually cause global growth to contract will create a more difficult environment for central banks to set appropriate policy.

Following the invasion of Ukraine, equity markets reacted in line with our expectations by selling off on uncertainty before rebounding once the facts of the situation start to be released. There is still much that is unknown regarding the geo-political risk surrounding Russia’s overall intentions, the likely protraction of the conflict, and the fallout from the aftermath. There seems to have been very little evidence of the “buy on dip” mentality that had underpinned equity markets throughout the pandemic. ASR point out that fundamentals suggest that US equities are trading in line with their 10-year average trailing earnings of 21 times, while Europe are trading on a 20% discount to their trailing earnings of the last decade of 14 timesi, so we would argue that there is little need to rush back into risk assets but remain in defensive equity strategies.

The rotation into quality stocks with strong earnings protection and predictable dividend policies suggests that investors are also focusing on high inflation rather than slowing growth. We believe it is unlikely that the global economy rolls over into recession while earnings are growing, therefore, reporting seasons in the second and third quarters will be key to understanding the impact of the current pressures on earnings. This also spreads to the ability of companies to maintain dividend policies in the light of potentially tighter margins, and we feel that the maintaining of dividends will be another touch point for signs that companies are under pressure. The threat of recession and stagflation has seen bond yields fall once more and yield curves flatten putting pressure once more on the banking sector, particularly in Europe where exposure to Russia is inevitable. The iShares Euro Stoxx Bank ETF is now 24.77% weaker year-to-date having fallen 11.61% in February.

This environment seems to favour the mix of companies within the main FTSE UK indices which are dominated by energy, pharmaceutical and domestic banking stocks and possibly explains the outperformance of the FTSE 100 Index when the main indices have been in drawdown. Over the month of February, the S&P500 fell 5.01%; The German DAX was down 6.53%; and the Nikkei 225 in Japan fell 1.76%, while the FTSE 100 fell just 0.08%. Oil prices remain elevated, particularly as US allies discuss adding oil to the growing list of sanctions against Russia, and inventories remain very low, which will continue to support the earnings, and dividends paid by the energy sector. After years of underperformance since Brexit the UK equity markets seems to be rewarding investors with the right breakdown of exposures in the current climate.

We would also draw attention to John Authers Points of Return newsletter dated March 7, 2022[iii] which points out that commodity exporting companies such as Canada, Australia, Brazil, and Norway have also outperformed global indices so far in 2022 and the situation is likely to continue over the rest of this year in the current climate of supply disruptions. More generally we had been researching Emerging Market Local Currency Debt prior to the invasion as a fixed income diversifier but feel that such a move now would add unwanted volatility to portfolios.

China’s policy moves to encourage a more consumer-led economy seem to have been deferred in the latest five-year plan as it looks to boost productivity through manufacturing. This coincides with a need to be more self-sufficient to secure supply chains that have proven frail during the pandemic. Many large consumer countries have suffered from just-in-time delivery problems, and global supply chains that have proven unreliable when challenged by a global event such as Covid-19. An emphasis on onshoring is likely to replace globalisation, in our opinion, to secure manufacturing supply chains, and due to changing views surrounding climate change. This could have implications for growth in emerging markets and the general cost of goods in the future suggesting negative global GDP growth effects.

 

[i] Absolute Strategy Research – Investment Committee Briefing – March 1, 2022

[ii] Powell backs quarter-point rate rise in March despite Ukraine war effects | Financial Times (ft.com)

[iii] John Authers’ Points of Return (bloomberg.com)

By Tim Sharp

We are deeply saddened by the historic decision taken today by Russia to pursue a military invasion of the Ukraine and the humanitarian impact of these events. However, we also wanted to focus on the potential financial impact on investors as market volatility increases. Global investors have initially reacted sharply with broad Russian equity indices falling by c.35%, the price of Crude Oil exceeding $100 per barrel for the first time since 2014, and benchmark Dutch gas futures rose as much as 62%, the most since 2005[i].

After an initial sell-off in developed equity markets of up to 4% the US markets recovered during afternoon sessions to end the day up 1.49% (S&P500) and 0.63% (NASDAQ). European markets have followed suit this morning opening in positive territory buoyed by the perceived lighter than expected impact of western sanctions announced so far on energy markets although this remains ongoing.

Our approach to these types of geopolitical event is to remain invested as the resulting economic effects tend to manifest most acutely at the regional level and less so at the global level (see table below). while we have no direct exposure to Russian equities, and while markets have, at least initially, moved in unison, history would suggest that now would be perhaps the wrong time to take any evasive actions.

Indeed, we believe attempting to do so could materially affect longer term investment returns in a negative way.

Regional Market Returns Following Russian Invasion of Crimea;

Russia remains a relatively small part of the global economy (c.1.5% according to World Bank estimates) and while we do expect to see significant disruption to areas such as energy and food prices, we also feel confident that these are outcomes for which we are already positioned. The threat of greater escalation and the wider impact of financial sanctions suggest volatility will likely remain elevated over the coming days and weeks.

So far this year the rotation from growth and momentum driven stocks towards cheaper value and yield bearing sectors has continued with the S&P 500 Value and Growth Indices down 5.41% and 14.16% respectively. Barclays point out today that falling markets on higher earnings have created a de-rating in European equities that may provide opportunities once the outcome of the Ukraine crisis is more fully understood[ii].

We have always taken a diversified approach toward portfolio construction however, and recently have been focusing on fixed income and alternative investment exposures. This exercise was undertaken to maximise the extent to which these allocations could help diversify risk through periods of equity market stress.

As a result, we favour exposure to carefully chosen assets such as agricultural commodities, precious metals, GBP & JPY denominated government bonds, and a small number of actively managed and genuinely uncorrelated investment strategies. We are encouraged to see these assets having generally increased in value, providing a welcome offset to some of the weakness seen more broadly across the equity markets.

 

[i] Europe Natural Gas Prices Jumps 41% After Russia Attacks Ukraine Targets – Bloomberg

[ii] Barclays – Equity Market review – Wartime – February 25, 2022