The brutal sell-off in markets this year finally stabilised during May, although the rally was by no means uniform, and investor sentiment remained nervous in the face of intense uncertainties about inflation, growth, and the unfolding impact of the war in Ukraine. No single catalyst triggered the rally, rather a combination of factors: signs of a consumer squeeze and economic slowdown ahead, leading to a sense that inflation is nearing a peak and the Fed’s hawkish policy shift could be enough to bring it under control; improved valuations leading to some dip-buying and a short squeeze in some of the big tech stocks which have been hammered this year; a weaker dollar; and China’s support for its ailing economy and loosening of covid restrictions in major cities.
The war in Ukraine, and widespread evidence of Russia’s depravity as its advance falters, continues to cast a dark shadow over the world. With Russia’s invasion now into its third month, and both sides increasingly intransigent with no signs of a negotiated end in sight, the probability of a long, attritional war is rising. The longer the war drags on, the greater the risk of longer lasting economic damage, transmitted primarily through global energy and agricultural commodity prices. Yet in April it was deepening worries about economic imbalances, which had been developing long before the invasion, that drove financial markets – ultra-loose monetary and fiscal stimulus adding fuel to the fire of post-pandemic release of pent-up demand, triggering excess demand in supply-constrained markets, in turn leading to high and persistent inflation.
The benign conditions enjoyed by financial markets in the 18 months since the depths of the pandemic were well and truly shattered in the first quarter of 2022, driven by two powerful shocks, both largely unexpected and each with huge consequences globally: Russia’s invasion of Ukraine and the Fed’s very sharp hawkish shift in policy. The immediate consequences of the war produced surges in energy prices and further disruptions to key commodity markets and supply chains, adding to the damage inflicted by the pandemic. But away from commodities, there were few markets that could withstand the heightened risk of a significant slowdown in global growth and much higher interest rates than anticipated only a few months earlier.
“There are decades where nothing happens; and there are weeks where decades happen.” Lenin
The quote is attributed to Lenin shortly before the Russian revolution. The week which started on February 24th, when Russia invaded Ukraine, is one of those weeks. Russia’s aggression and the unfolding humanitarian disaster have shaken the West to its core. The self-indulgent complacency spanning three decades since the fall of the Berlin Wall and the break-up of the Soviet Union has hit the brick wall of an existential threat to the liberal order of the democratic free World.
Markets suffered a severe jolt in the early weeks of the new year. Bond yields rose sharply, and Wall Street suffered its steepest drop since the pandemic crash of March 2020. The S&P 500 fell by close to 10% from its all-time high recorded on 3rd January before a late rally reduced the loss for the month to 5.2%. Most other equity markets were dragged down with similarly large declines, but there were notable exceptions; some emerging markets benefitted from strength in commodity markets, notably oil, up +17% in January, while the UK market delivered a positive return, up +1.6% in GBP terms. UK equities have underperformed substantially in recent years, held back by an especially steep drop in economic activity during the pandemic, and by a high weighting in energy, commodity and financial stocks, representing 40% of the index, and seen by many investors as long term laggards. January saw a sharp reversal in these trends, with the UK emerging from the pandemic earlier and more robustly than other major economies, oil and mining shares enjoying a strong tail wind from commodity price rises, and financials responding to the prospect of higher interest rates, leading to improved margins and earnings.
Two years ago, news began to emerge of a cluster of a pneumonia type sickness in China, soon to be identified as a novel coronavirus.
The buoyant markets of October continued through most of November, taking several equity indices to new all-time highs, until news of the new Covid variant, Omicron, at the end of the month reverberated globally and sent equity markets into their sharpest one-day falls of 2021, pushing all major markets into negative territory for the month.
The abrupt fall in markets in September was equally abruptly reversed in October, with Wall Street enjoying its best month of the year, the S&P 500 returning 7.0% and closing the month at an all-time high. Other markets generally made progress, but could not keep pace with the US; the only major market to fall was Japan, down 1.4% in local currency terms (-3.8% in USD terms), reversing some of its strong outperformance of September in the face of uncertainty ahead of the general election on 31 October. Emerging markets continued their run of underperformance, returning 1.0% in USD terms in October compared with 5.7% from developed markets, leaving their year-to-date returns at -0.3% and 19.4% respectively. However, stripping out the top performer of the major markets, the US, from the MSCI World index, and China, the weakest of the large markets, from the MSCI Emerging Markets index, paints a rather different picture, with returns much closer together. China stabilised in October but has fallen by 14.0% so far this year as its problems, some self-inflicted, mounted.
In the face of strengthening and broadening headwinds, the unbroken run of seven months of gains in equities came to an abrupt halt in September.
In a relatively quiet month for markets, equities made further progress while government bond markets slipped back.