Before we talk about the first quarter of 2022, it’s worth noting that last year was a positive one for global stock markets, with the standout performer being the US where indices skyrocketed by up to almost 30%.
Perhaps surprisingly, given this backdrop, equity and bond markets got off to a mixed start in 2022. Highly-valued US stocks – such as technology companies, which had performed well when many people were at home during lockdowns – started to fall off their pedestal. The UK stock market, on the other hand, which has more energy, healthcare and financial businesses, outperformed.
The general market sentiment quickly deteriorated, however, following the news that Russia’s military troops had gathered on its border with Ukraine. With a potential invasion on the horizon, some investors reacted by selling their European assets. Market concerns then came to fruition on 24 February, when President Vladimir Putin gave the order for Russian forces to invade Ukraine. A sharp decline in equity markets followed and investors shifted their attention to government bonds, often seen as a ‘safe haven’ in volatile times.
However, government bonds did not offer their usual level of protection in the first quarter of 2022. The conflict in Ukraine was the main reason for this, as it pushed commodity prices higher – exacerbating already rising inflation rates. There is also a belief that central banks – including the US Federal Reserve, the Bank of England (BoE) and the European Central Bank – will continue raising interest rates to help combat inflation throughout the rest of the year. It is important to note that as interest rates go up, bond prices move in the opposite direction, due to the ‘inverse’ relationship between them.
Europe has historically had a closer trading relationship with Russia than countries such as the UK and US, and most of the Eurozone’s oil and natural gas imports come from Russia. Germany’s decision to halt the Nord Stream 2 gas pipeline project can therefore be seen as a very strong message – it was willing to risk meeting its own national energy demands to add to the international financial pressure being put on Russia. Many nations have imposed sanctions, including on wealthy individuals connected to the Kremlin. The list is growing every week, and because sanctions are likely to remain in place while Russia’s aggressive military activities continue, energy prices are likely to remain high for the short-term future too.
Soaring energy prices are just one part of the inflation story. Food prices are another. Both Russia and Ukraine are significant exporters of wheat and corn, which are key ingredients in staple foods, so prices for those crops will remain high for some time to come. This also has wider implications, such as the cost of feeding livestock. Food production costs have soared for businesses too, in part due to rising energy bills, meaning they have to charge more for their end products on supermarket shelves. The costs associated with logistics have also risen, particularly when accommodating air cargo diversions to bypass Russian and Ukrainian airspace.
When combined, ‘inflationary pressures’ have created a perfect storm for consumers, whose pay packets will struggle to keep up with rising prices. The circa 2% inflation rate target shared by many central banks certainly seems like a distant dream at this stage. US inflation reached 8.5% in March – a 40-year high.
Closer to home, UK inflation continues to climb significantly above the BoE’s 2% target. In March this year, it reached 7%, and the Office for Budget Responsibility expects inflation to peak close to 9% this year before falling in 2023.
Due to the global inflation landscape, government bonds are set to struggle for the short term, as the yields available are likely to be offset by rising inflation. We believe that commercial property and stocks, selected on a case-by-case basis after rigorous research, still offer the best potential for long-term returns.
In an environment of rising inflation and interest rates, many economies – including the UK – will face several hurdles to growth. As such, within the next two years recession is a rising possibility in several developed economies.
Warning signs of such an eventuality can already be seen in the UK and US government bond markets, as longer-dated yields, which are represented by the 10-year bond yield, are converging with short-dated two-year bond yields. Historically, when the US 10-year treasury yield is less than the two-year yield, a recession has often followed.
At the time of writing, the conflict in Ukraine continues. Russia’s objectives remain unclear, and the outcome is impossible to predict. The humanitarian crisis in Ukraine is a tragedy and one that outweighs the economic impacts, but investment markets view the world through a dispassionate lens. To them, geopolitical events are an ever-present backdrop for them to look beyond. The Covid-19 pandemic, Brexit, the Global Financial Crisis and the Iraq War are just some events from the last 20 years that have caused noticeable market volatility, but over time they have not held markets back.
With the ongoing war and the cost-of-living crisis, Covid-19 has fallen off some people’s radars, but it has not gone away. Case numbers remain high, at approximately 1.5 million new cases worldwide every day. New Covid-19 variants could also emerge and there is a chance that their impact on human life is greater than previous variants. The path the pandemic will take is unknown, and we can all remain hopeful that the worst days are long behind us. China, however, has been forced to act quickly after experiencing a peak in cases that far surpasses its February 2020 figures. As a global manufacturing powerhouse, the situation in China will have a ripple effect on supply chains – Shanghai, which was recently placed under lockdown, is home to the world’s largest port, but since the middle of March its output has fallen sharply.
Though market volatility and the threat of recession can be unnerving for clients, it can also create new investment opportunities. When it comes to investing your money, our Investments team use their expertise to assess market conditions, opportunities and risks, paying close attention to developments while remaining committed to a long-term investment strategy. They invest accordingly, managing our customers’ money with the aim of achieving strong long-term returns for everyone who trusts us to invest wisely on their behalf.