Financial markets have been fairly resilient over the first four months of the year, successfully withstanding interest rate hikes, stubbornly high inflation and even a regional banking crisis in the US.
Those interest rate hikes have been particularly steep in the US, creating volatility in the government bond market and – for several regional US banks – a mismatch between their lending and asset book.
The regional banks that have found themselves in difficulty in recent months have had extremely high deposits taken out of them. Their share prices have then plunged and subsequently recovered, taking shareholders on something of a rollercoaster ride. This was despite assurances from financial regulators and even bankers (including JPMorgan CEO Jamie Dimon) that the worst of the crisis was over and that the banking system remained robust.
The markets have recently been buoyed by news that US inflation is still on a downward trajectory and that employment figures remain strong. But uncertainty over the regional banking crisis and a further quarter-point rise in interest rates have combined to create a nervous backdrop for some risk assets.
The corporate earnings season, however, is off to a good start: many large US tech companies have announced better-than-expected numbers, supporting their recent share price rebounds and propelling the NASDAQ 100 Index higher. This index is now firmly rooted in bull market territory – perhaps lifted by the fact that it will be difficult for the Federal Reserve Bank to raise rates further without major consequences.
Indeed, the markets across the board are now behaving as though the end of this spate of interest rate hikes is imminent, and believe that central banks will now need to pivot and cut rates sometime soon. This is positively impacting several interest rate-sensitive sectors (such as tech and growth stocks). Furthermore, US economic data remains robust, allaying recession fears.
Falling energy prices and a relatively mild European winter have helped counteract OPEC's surprise cut in oil production (a reduction of some one million barrels per day). It is thought that the Saudis’ actions were influenced by the US announcing that it was not going to purchase any crude oil to restock its strategic reserves. This has added to geopolitical tensions between Washington and Riyadh.
Over the past week, however, the financial markets have had to cope with three challenges: another Federal Reserve Bank interest rate hike, ongoing turmoil in the banking sector and an important jobs report for April.
In just one year, the Fed has raised interest rates by over 5%. Market watchers are now wondering when there will be a pause in its tightening cycle. The delayed effects of its aggressive policy are already impacting the real economy.
One consequence is the uncertainty shrouding the regional banking sector. The consensus now is that a mild recession is likely in the US. But its consequences will be mitigated by a relatively resilient labour market.
Overall, the markets have climbed higher over this year. But the equity leadership has remained relatively narrow, with quality growth and defensive sectors leading the way. Conversely, those parts of the market that are more sensitive to economic growth appear to be lagging. Cyclical sectors (energy and financials) and small-cap stocks are good examples: these have drifted lower over recent weeks.
It’s important to bear in mind that the markets and economic cycles are distinct. Markets tend to be forward-thinking, so as the economy heads towards a bottom, they will start to look beyond the problems of today and focus on recovery. Following the extended bear market of the past 16 months, we believe that opportunities will form in both equity and bond markets as the economy slowly recovers. Historically, the investment returns that can be harvested after a prolonged downturn have been significant. So it is important to take advantage of uncertain times and volatility by purchasing quality assets on any significant pullbacks.
There is every indication that the US stock market has entered a new bull market phase. The S&P 500 Index has spent more than 25 weeks above its 200-week moving average, and since 1950, there has not been a single instance of this index hitting a new low once it has recovered above the 200-week moving average and spent at least 15 weeks in this vicinity. So we continue to believe that 12 October 2022 was the low for this current cycle. The stock market is on the rise amid a barrage of negative economic headlines – another sign that the bears are trapped and the bulls are now on the rise. This year is likely to be bullish for the stock markets, hopefully heralding the beginning of a global economic recovery.
