WeekWatch – ‘Some uncertainty and volatility returned to markets last week’ February 23
Some uncertainty and volatility returned to markets last week, but investors’ worries were put into stark perspective by the tragic earthquake disaster in Turkey and Syria.
Markets retreated early in the week as investors reflected on the surprisingly strong US jobs data released the previous Friday and what it meant for the future direction of the US economy and interest rates.
After cogitating for a couple of days, markets recovered the lost ground as investors appeared to agree with Federal Reserve Chairman Jerome Powell’s suggestion that another couple of smaller rate hikes before July would be needed to bring inflation fully under control.
“We believe the data last week does not accurately reflect the US economy. It isn’t booming, although it clearly isn’t on the verge of recession either,” noted Columbia Threadneedle Investments.
US Treasury Secretary Janet Yellen expressed confidence that recession could be avoided, and that inflation would decline significantly. “You don’t have a recession when you have 500,000 (new) jobs and the lowest unemployment rate in more than 50 years,” she said.
The MSCI World Index is up 8% so far this year, propelled by the ‘not too hot, not too cold’ Goldilocks view that the global economy will slow sufficiently to quell inflation, but not so much that earnings will collapse.
Bond markets disagree. US, German, and other government bond yields are deeply inverted, which means that short-term borrowing costs are much higher than long-term ones. This has previously proved a reliable indicator that recession is coming.
There are signs too that earnings could be hitting a soft patch ahead. Around 70% of S&P 500 companies have reported fourth-quarter earnings, and results have been mixed at best. It’s expected to be the first negative earnings quarter since 2020, and forecasts are suggesting negative earnings growth in the first two quarters of this year as well. This may in part be down to companies lowering expectations, but softening earnings would indicate a broader economic cooling. Lower earnings may also make it harder to justify elevated US equity valuations.
As relations between the US and China plumbed new lows over the Chinese moon balloon controversy, official figures showed that trade between the two countries hit a record high last year. US imports from China increased to $536.8bn last year as American shoppers spent more on Chinese-made goods, including toys and mobile phones. In the same period, US exports to China increased to $153.8bn.
Despite having been in a trade war since 2018, the figures show the extent to which the two countries are reliant on each other, and highlights the challenges of trying to decouple their economies at a price that consumers and companies are prepared to pay.
At the end of the week came news that the UK economy narrowly avoided falling into a technical recession in 2022, registering zero growth in activity in the fourth quarter. However, the economy contracted by 0.5% in December alone – largely down to disruption caused by industrial action – suggesting the recession may only just have begun. Chancellor Jeremy Hunt adroitly observed that “We are not out of the woods yet.”
Although households will benefit from lower wholesale gas prices by late spring, Azad Zangana of Schroders pointed out that, at around the same time, lower fixed-rate mortgages will be coming to an end, pushing mortgage costs higher. “The squeeze on household income is likely to hit activity further and cause a more meaningful decline in the economy through 2023,” he suggested.
The National Institute for Economic and Social Research believes the UK will dodge recession in 2023, but cut its forecast for GDP growth this year to 0.2% from 0.7%, warning that people will face the after-effects of a severe fall in living standards.
The FTSE 100 Index hit new highs midweek, although this was largely attributable to the surge in BP’s share price after it reported record annual profits. The index is very heavily weighted towards oil companies and banks.
But by the end of the week, major benchmarks in the US, Europe and UK had given back part of the previous week’s gains, as investors were unsettled by rising interest rates and the chorus from central bank officials that policy would need to remain tight for some time to quell inflation.
Reflecting on markets so far this year, Tom Beal, our Executive Director of Investments, urged investors to remain cautious. “After the disappointments of 2022, the strong start to this year is welcome. But the view through the windscreen matters more than what’s in the rear-view mirror. Sticky inflation, earnings disappointments, recurring recession worries and, of course, the ongoing crisis in Ukraine, could all create volatility. As we’ve seen this week, there are likely to be bumps in the road and investors need to keep calm. Markets have a strong tendency to follow bad years with good ones, but it’s important to stay invested.”
Columbia Threadneedle and Schroders are fund managers for St. James’s Place.
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