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WeekWatch -‘Equities experienced a sharp sell off in the second half of last week as investors reacted to interest rate rises’ May 22

WeekWatch -‘Equities experienced a sharp sell off in the second half of last week as investors reacted to interest rate rises’ May 22

Equities experienced a sharp sell off in the second half of last week, as investors reacted to interest rate rises in the UK and US.

In the UK, the Bank of England’s (BoE) Monetary Policy Committee increased interest rates by 0.25%. The base rate now stands at 1.00%, the highest in 13 years. A third of the committee voted to increase the rate even further, to 1.25%, suggesting further rates are likely in the future, as the economy battles rising inflation.

At the same time, the committee released further updates to its economic forecasts. It now expects UK inflation to break 10% later this year, because of dramatic energy price increases to household bills. It also reduced its 2022 economic growth forecast and cited the increased possibility of a recession.

George Brown, economist at Schroders, commented: “Concerns amongst the committee about inflation becoming embedded are justified. But we also believe that near-term economic momentum is more fragile than it has concluded. Further hikes will hinge on how the data evolves over the coming months. In particular, whether the deterioration in consumer confidence sees spending scaled back.”

The gloomy economic outlook was reflected in the market, with the FTSE 100 falling 2.1% over the course of the week.

The US is moving in a similar direction. Last week the Federal Reserve (the Fed) voted to increase its base rate by 50 basis points (0.5%) to a range of 0.75%-1.00%. This was the largest increase since 2000. It was also the first time the Fed had raised rates at back-to-back meetings since 2006. It warned similar hikes were likely for the next couple of meetings.

Lewis Aubrey-Johnson, Head of Fixed Income Products at Invesco, said: “Assume further 50bps hikes at the next two Fed meetings, then 25bps for the remaining three Fed meetings of the year.

“That gets you to 2.5% of tightening – the most in a year since 1994. However, if we add another 25bps for the reduction of the Fed’s balance sheet, then it will represent the most aggressive Fed tightening in a calendar year since 1978. With the US economy running hot and inflationary pressures abounding, investors understand that it will be a tall order to cool things down without creating a recession. “

With hawkish central banks and a weakening economic outlook as a backdrop, US markets were shaky last week. Having initially gained in the immediate aftermath of the Fed meeting, equities quickly retreated on Thursday and Friday. On Thursday, the NASDAQ Composite fell 5%, its largest daily fall since June 2020, while the S&P 500 fell 3.5% the same day. Both fell further on Friday, ending the week lower than they began. This was the fifth straight week of declines for these indices – the worst streak in approximately 10 years.

The coming week may add further challenges, with inflation figures due in the US. These are expected to show a further rise to the headline rate.

The situation wasn’t much better outside of the UK and US, as the MSCI Europe ex UK index slumped by 4.6%, with similar fears around inflation, the ongoing war in Ukraine and strict lockdowns in China weighing on sentiment.

With markets currently struggling, it might seem like a moment to panic. However, savvy stock pickers know that this actually provide an opportunity. George Droulias, investment team member at Edgepoint, says: “Typically, it’s during periods of high uncertainty that we see an opportunity to buy growth and not pay for it. The most attractive opportunities often appear in businesses with fundamentals that are tangential to the overarching market concerns.”

This is one of the reasons we believe active management can play an important role in earning long term returns. While 2021 saw the market rise overall, it is in these more difficult times where research and diligent decision-making can really help fund managers find opportunities to help create long term good outcomes. However, tempting it may be, exiting after markets have fallen means missing out on these opportunities.

 

 

 

 

 

 

 

 

Edgepoint, Invesco and Schroders are fund managers for St. James’s Place.

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