What to make of recent volatility?
Despite early optimism that 2022 would see a sustained period of post-pandemic economic growth, financial markets have instead taken a different turn. Faced with heightened volatility, soaring inflation, and war in Eastern Europe, investors have unexpectedly encountered uncomfortable short-term conditions.
At the time of writing (10 May 2022), markets had experienced a difficult 24 hours, with the S&P 500 dropping 3.2% and closing below 4,000 - a level last seen more than a year ago. Global equities are now down some 15% from their January 2022 highs, and have wiped out all of the gains registered in 2021.
Unfortunately, fixed income markets have been of little help with the Bloomberg Global Aggregate Index down some 12.5% so far this year (at the time of writing).
As Julien Lafargue, Chief Markets Strategist at Barclays Private Bank explains, it’s a challenging period for investors: “Conditions arguably suggest that the acronym TINA - “There Is No Alternative” - is alive and well after all. In today’s climate, it may in fact refer to cash versus everything else, rather than stocks versus bonds.”
Yet, cynicism aside, we believe there are reasons why investors needn’t succumb to the overwhelming short-term gloom that surrounds us.
Are you ready to influence tomorrow?
The global appetite for sustainable investing is growing at a phenomenal pace, and it’s a megatrend that we believe is set to continue. Investors are sensing the opportunity and even the obligation, to align their portfolios with their values, in the belief that purpose and profit can co-exist.
The COVID-19 pandemic, the climate emergency and rising social inequalities are just some of the drivers behind the recent shift towards sustainable investing, together with greater awareness around the importance of non-financial factors for investment returns.
The wall of worry
First, let’s take a step back and reflect on the four main reasons why markets are struggling to find their footing:
- Persistent inflationary pressures (and the associated central bank tightening campaign):The post-lockdown inflation that was initially labelled as ‘transitory’ has not only lasted longer than many expected, but has also risen higher than previously anticipated.
- Increasing recession probability (central bank-induced): Challenging conditions all over the world have led some to speculate that a recession may be back on the cards -something that was inconceivable at the start of 2022 when sentiment was good.
- China’s “zero-COVID” policies (and lack of economic and monetary support): The unshakeable faith in lockdowns in the world’s second largest economy, means global supply chains are faltering. It sees China committed to a healthcare strategy that Western economies abandoned long ago in the face of Omicron.
- The Russia-Ukraine war: This brutal conflict has created a geopolitical divide between East and West, simultaneously damaging supply chains and impacting global commodity prices.
Reasons for hope
While there doesn’t seem to be a quick solution to any of the issues addressed above (adding to investors’ pessimism), we see some light at the end of the tunnel. The short-term outlook may be uncomfortable, but we maintain that the case for long-term investing remains strong.
At Barclays Private Bank, we have long argued that inflation was likely to peak sometime in April or May. While there is no tangible sign of that happening just yet, there are clear indications that inflation could be stabilising. Indeed, a multitude of data points (CPIs, PCEs, BLS wages, Manheim used car index, etc.) are pointing to a plateauing of price pressures.
Similarly, while the latest New York Fed survey on 9 May showed that 3-year inflation expectations rose (from +3.7% to +3.9%), the 1-year measure has dropped (from +6.6% to +6.3%), and both series are 30bp off their highs.
These positive developments could lead, as we expect, to some gradual moderation in the US Federal Reserve’s language. In fact, Atlanta Fed President Raphael Bostic expressed optimism yesterday (9 May 2022) that the inflation backdrop is beginning to turn the corner and head in a more encouraging direction.
Things may take a few months to improve on this front (CPI will be very closely watched on Wednesday 11 May 2022), but our view stands and, with it, the possibility of a more supportive backdrop for markets. Interestingly, the market-based expectation for the Fed Funds rate in December hit a recent high of 2.88%, but has since dropped nearly 25bp with the market effectively pricing out a hike this year.
With markets pricing in an increasingly aggressive Fed, a recession has become a clear concern for investors in recent weeks. While we do expect global economic growth to slow meaningfully (and possibly to enter a technical recession), we don’t think this should be associated with a full-blown crisis. Unfortunately, the term ‘recession’ often brings back bad memories for many people, whether from the 2008/09 global financial crisis, the challenges of the 1980s, or events further back in time.
Crucially, we think it’s worth noting that a recession does not need to lead to a repeat of 2008. This is not to say that recessions are good for markets, but with stocks having plunged by close to 20% on aggregate (and much more in some parts of the market), one could argue that a recession has already been priced in, at least partially.
The second most influential economy in the world is in a difficult position, striving to eradicate Omicron while simultaneously keeping the economy in good working order.
That said, events in this part of the world could probably be resolved relatively quickly. Indeed, it would take a (even minimal) relaxation of current restrictions for markets to feel much better about China. There is no sign of that being on the cards, for now, but if we’ve learned anything from the pandemic, it is that there is life after lockdowns.
Assuming more deadly variants don’t emerge, there is no doubt in our view that the situation in China will have improved in three to six months’ time.
War in Ukraine
The raging battle in Eastern Europe remains a wild card and a massive overhang. Encouragingly though, the “Victory Day” celebration in Russia was a relatively muted affair compared to prior years, and versus expectations. An escalation remains a strong possibility but the same could have been said about Taiwan (or any geopolitical flash point) at any point in the last few years, and that uncertainty didn’t prevent markets from reaching all-time highs.
In addition to the human tragedy unfolding, the impact on input costs (energy and grains) will likely be felt for years to come. However, with inflation being a year-on-year measure, it may not matter as much in twelve months’ time (at least in the developed world).
Are we there yet?
While we can never predict the future, we can say with some confidence that the next few weeks are likely to remain volatile. Investors may be tempted to hide somewhere safe, but options are few and far between, and properly timing such a short-term tactical move is next-to-impossible in the current context.
For anyone with an investment horizon longer than a couple of months, we believe that the smarter option is to stay put and true to long-term objectives.
Encouragingly, judging by the sharp sell-off in cryptocurrencies – the epitome of speculation, by how negative sentiment has become among investors - and by yesterday’s price action (indiscriminate selling in equities and a return of the negative correlation between stocks and bonds), the current selling pressure may be close to its denouement. You can read more about our views on digital assets in a dedicated chapter within May’s Market Perspectives report.
We may not have reached the point of capitulation just yet, preventing us from turning unconditionally bullish, but opportunities are emerging. More so than ever, now is the time to be both well diversified (including outside of stocks and bonds), and selective.
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