WeekWatch -‘Somewhat counter intuitively, markets bounced back last week, with the US market recording some of their strong performance figures of the year’ June ’22

Somewhat counter intuitively, markets bounced back last week, with the US market recording some of their strong performance figures of the year, despite recession fears growing.

So far, this year has proven brutal for equity markets, as rising inflation and interest rates have seen the likes of the S&P 500 and NASDAQ shed much their gains from the past two years. This has been especially true of technology ‘growth’ shares, and even the likes of Apple have seen large declines in their share price value.

The threat of inflation continued last week, as the UK’s Office for National Statistics revealed inflation accelerated to 9.1% in May, up from 9% the month earlier. The Bank of England expects inflation to break 11% in October, when the fuel price cap is expected to increase dramatically.

Yet despite the UK’s cost of living crisis worsening, the FTSE 100 climbed 2.7% over the week, while the FTSE 250 also climbed 1.1%.

In the Eurozone, there was a similar tale of seemingly negative economic data being following by a rise in equity markets. Last week, a set of Purchasing Manager Index (PMI) figures – which are often used as a measure of business confidence – fell, with manufacturing sector especially hard hit. Yet the MSCI Europe ex. UK index climbed 2.4%.

In the US, the S&P 500 climbed an impressive 6.4% over the week, while the tech-heavy NASDAQ jumped 7.5% – it’s largest weekly gain since March.

This came despite US consumer confidence, as measured by the University of Michigan’s sentiment indicator, slumping to its lowest ever level, largely due to surging inflation which has placed a considerable squeeze on disposable income.

Given recent headlines around the risk of recession, increasing interest and inflation, and an ongoing war in Ukraine, stock markets recovering on these bits of news might seem counter intuitive.

The reason the market is behaving this way is because investors are hoping the risk of recession will see reduced demand, leading to lower inflation. As higher interest rates push down economic growth, there is also a hope that central banks will also be a little more conservative in their interest rate hikes than they might have otherwise been.

Kristina Hooper, Chief Global Market Strategist, Invesco said: “Markets are still digesting the dramatic shift that began only a few months ago. Once the Fed has finished its “frontloading” of rate hikes, I suspect the environment will become less hostile for asset prices, especially higher quality credit but also equities. If Western central banks can slow tightening later this year (they likely feel some pressure to keep up with the Fed) it would potentially help the asset price environment. A long-awaited moderating in inflation should also help.”

Similarly, Chris Iggo, Chair of AXA IM Investment Institute and CIO of AXA IM Core, noted: “In the US, there are signs that demand is slowing and that some parts of the economy are seeing a build-up in inventories and price discounting. Signs of easing price pressures and slower growth are necessary to get the Fed to suggest that enough is enough. Keep in mind that the Fed wants to get inflation back to target over the medium term but also to achieve a soft landing. That means it will pivot at some point, once the data shows the economy slowing meaningfully. Avoiding a housing market collapse or a financing crisis in the corporate sector is very much in the Fed’s thinking.

He added that if the Fed is able to avoid a recession, equity returns will likely re-bound and if inflation turns lower over 2023-24 it will be growth stocks that lead the way. “After all, labour market tightness, more aggressive unions, higher wages and supply chain issues make even more of a case for technology and automation,” he noted.

While this might all make for positive reading, it is important to remember the market currently remains volatile. With so much uncertainty, it’s important to remain well diversified, and ensure you are not taking any unnecessary risks in your portfolio.

A number of commentators warned that, while in the longer term, there are reasons to be optimistic markets could begin to recover, the future is hard to predict. For example, John Higgins, Chief Markets Economist at Capital Economics, said he found it hard to envisage the stock market recovering much more ground so long as there remain concerns “that the Fed will drive the economy into the ground in an effort to bring down inflation.”

 AXA and Invesco are fund managers for St. James’s Place.