Market Commentary – 30th May 2022
Over the last month from 29th April to 27th May developed markets have eked out positive returns. However, this masks a high degree of volatility. The S&P 500 fell 4% in a single day, its largest daily fall since the early days of the pandemic and at one point the index flirted with a decline of 20% from its January peak which would have put it into official bear market territory. The strength of the dollar has rendered these moves less dramatic for sterling-based investors and the FTSE All Share has nudged back into the black year-to-date, but it is proving to be a testing time.
Year to date US and UK equity returns (in local currency)
One of the more distressing features of this market turbulence is that there has been no place to hide. Government bonds which usually offer a safe haven when riskier assets are under pressure have also fallen in value with UK gilts1 declining 10.66% and US Treasuries2 8.05% so far this year. With inflation in the US hitting a 41-year peak in March and a 40-year high in the UK in April, on the back of soaring food and energy prices, it is hardly surprising that investors have eschewed the negative real returns available on bonds, pushing up yields and depressing prices in both bonds and equities as investors have fretted about stagflation.
However, with the annual rate of inflation in the US slowing to 8.3% in April from 8.5% in March, a modest shift but the first reversal since October 2021 and results from US retail bellwethers Target and Walmart suggesting they have been unable to pass on increasing costs to their customers, the 4% fall in the S&P 500 seemed not to be predicated on concerns about inflation but about the recession that may be caused by Central Bank action to bring inflation under control. This is backed up by very weak consumer confidence surveys and whilst retail sales volumes in the UK rose by 1.4% in April, the longer-term trend remains downward.
It seems, then, that the outlook for bonds may not be as negative as it has been especially if the Federal Reserve is forced to curtail its plans to hike interest rates as much as has previously been deemed likely.
As one fund manager recently wrote - have bonds gone from being the problem to being the solution?
If there is to be a rally in bonds driven by fears of a recession, then it seems reasonable to suggest that this will be to the detriment of equities. Tactical investors might consider reducing their exposure to equities in favour of bonds but there remains the possibility that central bankers will be able to engineer a soft landing or that any recession will be shallow and short-lived. Furthermore, inflation has not proved to be as transitory as many, including ourselves, thought likely and the amount of government debt accumulated in response to the pandemic suggest that central banks might well allow inflation to run higher than the 2% target on a more sustained basis, once they have got it under control, assuming they can. Under this scenario owning the shares of companies able to grow their earnings remains an important part of maintaining purchasing power. However, keeping the rate stable is far from easy and investors will need to get used to greater volatility both in the rate of inflation and how risk assets react.
As always, we would like to remind clients that the best way to achieve their investment objectives over the longer term is to remain invested in portfolios that are diversified across different asset classes, geographies and investment styles and which are commensurate with their capacity for loss and appetite for risk.
(1FTSE Actuaries UK Conventional Gilts All Stocks index, 2ICE Bank of America US Treasury, Source: FE Analytics, Bid to Bid, Total Return, local currency, 31/12/2021-27/05/2022)
30th May 2022
RiverPeak Wealth Limited