- Global stock markets fell over the past three months as investors became worried about high inflation and the possibility of a recession
- Inflation continued to be elevated, reaching multi-decade highs in the UK, Europe and the US
- Fixed-interest securities were also negatively impacted as the Bank of England and the US Federal Reserve continued to raise interest rates, while the European Central Bank pivoted to a tougher stance on inflation
Throughout the past three months, the mood among investors became increasingly downbeat as the combination of high inflation and rising interest rates raised fears of a coming recession. While the ongoing Covid-19 pandemic continued to disrupt global supply chains, much of the focus in recent months has instead been on whether or not inflation will subside as time passes, and how this will affect economies, consumers and businesses. Central banks have sought to rein in this inflation by raising interest rates; however, this has so far been unsuccessful, leading some to warn that it will be challenging to avoid an economic downturn.
Global stock markets on average delivered negative returns to investors during this time, with China being the only region with a positive return. The US, with its high concentration of growth-orientated technology companies, was the worst performer among major markets over the past three months, primarily because rising interest rates serve as a headwind to companies that borrow money to fuel their growth. The UK stock market was also negative over the period as recession fears increased, despite being one of the best performers in the first three months of the year.
Fixed interest securities, both government debt and corporate bonds, were also negatively impacted by both real and assumed rises in interest rates. Typically these asset class moves in different ways to stock markets, but in the past three months the general trend in most asset classes has been downwards.
Much of the economic news during the past three months focused on the cost-of-living crisis that rising consumer prices are creating around the world. The UK, much like Europe, North America and other regions of the world, experienced soaring fuel and energy costs, higher prices for food and staples. Some of this was caused by the ongoing COVID-19 pandemic, but the war in Ukraine caused grain and fuel prices to soar.
In the UK, inflation reached a 40-year high of 9.1% in June, while consumer confidence dipped to a record low. This made for a challenging environment for consumer-facing companies in the UK, with the British Retail Consortium reporting that retail sales fell by 1% between 29 May and 2 July. Understandably, companies in consumer discretionary sectors, such as retailers and housebuilders, were among the worst performers in the stock market over the period.
The Bank of England continued to raise interest rates over the period, announcing two 25-basis-point increases in May and June to bring its base rate to 1.25% from 0.75%.
The story was much the same in the rest of the world. In Europe, where inflation has often been non-existent in recent years, consumer prices in the eurozone increased at the fastest rate on record, at 8.6% in June. Unsurprisingly, overall economic sentiment and consumer confidence were downbeat, and there were concerns about high energy prices and the prospect of dwindling gas supplies as a result of the war in Ukraine. Despite previously stating that it would hold off on interest rate hikes until the final three months of the year, the European Central Bank changed course in June and signalled that it would soon raise rates.
Similarly, consumer price inflation in the US remained above 8% and this took its toll on consumer confidence. The Conference Board Consumer Confidence Index, which gauges the mood among consumers, fell for two consecutive months in May and June, with rising gas and food prices being key concerns. The US Federal Reserve made aggressive moves to cool down high prices by raising interest rates by 50 basis points in May and 75 basis points in June. Fears of a recession grew over the quarter after updated figures showed the economy shrank by 1.6% in the first quarter and consumer spending in May was weaker than expected.
In Asia, all eyes were on China. Throughout the spring there was a prolonged Covid-19 lockdown in Shanghai that was believed to be a significant cause of falling factory output in the country. There were initial suggestions that China was about to ease its zero-tolerance approach to Covid-19, which includes those strict lockdowns, but President Xi Jinping set the record straight in late June by stating that he would rather temporarily sacrifice economic growth than harm people’s health.
It was a volatile time for financial markets as both equities (shares) and bonds fell at the same time. The US and Europe were among the worst performers among major markets, followed by the UK, emerging markets, Japan and Asia Pacific excluding Japan. China bucked this trend as its stock market bounced back from a prolonged negative period after investors began to view it more favourably after lockdowns were lifted and the government’s tech crackdown appeared to have passed.
Global bond markets also fell during the past three months. The combination of high inflation, rising interest rates, fears of recession and the ongoing war in Ukraine contributed to one of the worst quarters in decades for bond investors. Both corporate bonds and government bonds in the UK, US and Europe were negative during this time.
Historically speaking, equities and bonds tend to move in opposite directions because bonds are viewed as safer havens when equities are falling. During recent months, however, the two have been falling in unison for different, but related, reasons.
Equity markets have been falling because investors are concerned about high inflation, slower economic growth and the risk of a downturn in the months ahead, which would threaten corporate profits. There is also a broader concern that the inflation we are seeing today could lead to what is known as stagflation, a period of economic stagnation punctuated by slow growth, high levels of unemployment and rising consumer prices.
Bond markets, meanwhile, have been falling because their prices are affected by both inflation and rising interest rates. Bonds pay interest to investors and inflation and rising interest rates erode the value of future cash flows from these payments. With inflation running high and central banks hiking interest rates, bond prices are falling.
There is no hiding the fact that the past few months, along with the year so far, have been difficult for investors. What we are observing is the culmination of several different factors on stock markets: the ongoing pandemic, rising prices as supply chains struggle to meet consumer demand, soaring energy and grain prices because of the war in Ukraine, and negative investor sentiment due to worries that a recession is coming.
We now expect higher inflation to linger longer than was previously expected, which will likely cause further turbulence in stock markets in the months ahead. Central banks around the world will continue to raise interest rates in their attempts to pull back rising consumer prices, possibly threatening an onset of a recession in the process. In many ways, central banks are caught between a rock and a hard place, and are increasingly willing to risk a recession because allowing inflation to run too hot is not an attractive option.
While we believe that the months ahead will see similar risks and threats for equities than what we just experienced, we do not necessarily expect to see the same degree of negative performance in stock markets. However, for fixed interest securities the markets have priced in their expectation of future rate increases. If rates rise slower than anticipated this could be positive for bond markets, conversely if they rise faster it would be negative.
A note about current market conditions
We know that this has been a difficult time for anyone with an investment portfolio, as it seems as though everything is falling at the same time. Taken as a whole, it is true that global stock markets have fallen significantly this year. But much of this negative movement has been focused on specific markets or types of companies – for example, high-growth technology companies in the US, consumer-facing companies in the UK and Europe. Conversely, large banks and the commodities sector have performed better because their revenue streams are less affected by the current economic conditions.
Periods of extreme volatility and falling stock markets can certainly be unsettling. It is during these times that we reiterate the importance of maintaining your current financial plan and holding firm on your investment objectives. As you may know, we have been here before: when markets fell at the beginning of the pandemic in 2020, during the crash that triggered the great financial crisis in 2008, when the technology bubble burst in the early 2000s.
Through all of these events, stock markets eventually recovered and then resumed their upward movement. It may be tempting to sell investments when markets are falling, but the problem is that this works against you when they bottom out and begin to recover. It is impossible to predict when this will happen, and you may miss out on the opportunity for investment growth in the process.
We plan for events just like this as part of our investment process. Each of our portfolios is based around a series of market assumptions that takes into account the state of the economy, the performance of different stock markets and asset classes around the world, and a global view of what is likely to take place in the months ahead. It is not always possible to completely shelter our portfolios from falling markets, but we truly believe that markets will recover from this event just as they have in the past, and that is why the best decision is to remain invested.
However, as the economic picture evolves, we encourage clients to contact us with any concerns over the risk level of their portfolio. Our team will be happy to discuss this with you and review your risk appetite relative to the current climate.