This month has seen one of the worst weeks in one of the worst years since the 1930s for Wall Street’s S&P 500 Index. In fact, this index has joined a number of others (including the NASDAQ 100) in having descended into bear market territory.
These declines have been fuelled by central bank decisions: in the US, for example, the Federal Reserve Bank has just announced a further interest rate hike of 0.75% in a bid to tackle runaway inflation. It had not raised the rate by such a percentage since 1994. Fed Chairman Jerome Powell has advised Congress that the bank was “strongly committed” to bringing down inflation and was able to do so with its monetary policy tools, so it now seems pretty clear that interest rates will be rising by similar amounts over the coming months. His objective remains a 2% inflation rate and a strong labour market.
Needless to say, aggressive tightening could tip the US economy into recession. Furthermore, there are no guarantees that this course of action will succeed in pouring cold water on inflation. Powell believes, however, that the US economy is currently strong enough to withstand the combined pressures of high inflation and rising interest rates. But even he concedes that there is a chance of recession.
In the UK, the Bank of England has increased its benchmark interest rate from 1.0% to 1.25%, its fifth consecutive rise, and one which now brings the rate to its highest level in 13 years. This most recent hike comes amid warnings that UK inflation could rise well above 11.0% before it starts to fall.
The rise in food and energy prices (combined with future wage inflation which now seems highly probable) will keep inflationary pressures high. Rising interest rates will eventually push inflation down. But at what cost? That remains one of the unknown unknowns.
On Thursday, Robert Habeck, Germany’s Federal Minister for Economic Affairs and Climate Action announced that Germany is to move to stage II of its emergency gas plan. This is tantamount to an admission that Europe’s largest economy is now exposed to a high risk of long-term gas supply shortages. Germany is evidently starting to feel the consequences of its sanctions against Russia and its attempts to phase out Russian gas, and these hardships will only worsen as winter approaches. Indeed, it has joined Italy, Austria and the Netherlands in suggesting that coal-fired plants might be used to compensate for the cut in Russian gas supplies.
Putin’s incursion has pushed petrol and diesel prices up to unprecedented highs, squeezing household spending for millions, but it has also sent food prices spiralling. The Institute of Grocery Distribution (IGD) says that we are facing the most severe cost-of-living crisis since the 1970s, mainly as a result of Russia’s war. It believes that staples such as bread, meat, fruit and vegetables, as well as dairy products, will rise sharply over the summer months – by around 15.0%.
Indeed, the situation in Eastern Europe is the most important factor affecting financial market sentiment this year, pushing up inflation and inciting the leading global central banks to become more aggressive with their monetary tightening policy.
It is this policy that has impacted both equity and bond markets, triggering a 22% fall in the MSCI World Index for the year to date. The UK’s leading index is only down by 6.5%. But this does not tell the whole story. Most global equity markets have felt the full force of inflation and rising interest rates. Bond markets have as well: sovereign bond yields across the developed world have risen quickly in conjunction with the increases in interest rates.
Cryptocurrencies have also been hard-hit in recent months. Bitcoin, which peaked at US$68,789.63 in November 2021, has since fallen by 70%. The carnage we are witnessing in cryptos can partly be chalked up to pressure from macro-economic forces (spiralling inflation and successive Fed fund interest rate hikes). But other factors are at play, including the laying off of employees and solvency meltdowns.
Although some sectors have prospered during the course of this global market correction (anything energy or commodity-related, tobacco…), most other sectors have seen double-digit shrinkage. For many clients and investors, this has understandably been an extremely stressful time. However, we must remember that the pandemic shut down most of the global economy for two years and that we only survived with the help of government and central bank intervention.
We are now moving into the next phase of the transition to a post-pandemic economy – a phase during which the global recovery had been firmly back on track. A shift from quantitative easing to quantitative tightening, therefore, seemed logical. Inflation at a 40-year high thanks to an energy crisis caused by Russia is, however, one of the rogue factors in the overall equation.
Bottlenecks and supply restraints have also created difficulties for many industries, and this will take time to resolve. Inevitably, all of these issues are likely to create a technical recession in many parts of the world, and perhaps a deeper recession in some of the more hard-hit countries.
What is certain, however, is that whatever the outcome, we are entering a new economic cycle… one in which the days of negative interest rates and bond yields are a thing of the past. This new era will be about normalising these rates and yields, and possibly living with higher inflation as the world adjusts to a demand-over-supply conundrum. The world clearly still needs fossil fuel energies and commodities of all descriptions – it will be some years before we have fully weaned ourselves off the petrol pump and embraced electric mobility.
The global meltdowns in asset prices that we saw in September 2008 and March 2020 were painful for clients and investors alike. As financial advisers and wealth managers – often with “skin in the game” –, we shared their fears and anxieties.
Over the past century or so, the financial markets have had to endure numerous crises – from the Great Depression and two world wars to the Dotcom crash and the pandemic, via the Global Financial Crisis and numerous oil crises. Russia’s invasion of Ukraine is a human tragedy on an unimaginable scale. But as far as the markets are concerned, history will simply record it as another correction – albeit a rather severe one.
Every time the markets have entered sharp periods of decline, they have recovered. And the good news is that they have recovered and gone on to deliver excellent returns. Indeed, in most cases, the financial indices have reached new all-time highs. Interestingly, the only developed market that is still below its record high of 1989 is Japan’s Nikkei 225 Index.
Quality growth and quality value aligned with global income and innovation is the magic combination that we believe will deliver clients above-average returns in any normalised circumstances. That is why we believe that the current weakness in financial markets should still be seen as an opportunity that will help you achieve your long-term goals.
