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WeekWatch -‘Volatility continued in equity markets last week’ May 22

WeekWatch -‘Volatility continued in equity markets last week’ May 22

Volatility continued in equity markets last week, as economies struggled with ongoing inflation.

In the UK, the Office for National Statistics revealed that CPI Inflation rose by 9.0% in the 12 months to April 2022, the highest rate recorded in 40 years.

The Bank of England (BoE) has warned that inflation is likely to continue to rise in the near-term, potentially breaking 10% this year.

The FTSE 100, which has been amongst the most resilient markets so far this year, declined by -0.4% over the week.

Oliver Wayne, Senior Vice President – Manager Research, at investment consultancy Redington explained why high inflation can cause issues for equities: “Inflation presents challenges for companies. It impacts their sales, margins and the multiple they trade on. It erodes consumers purchasing power which reduces their ability to spend, which impacts company sales. It increases costs which reduces margins.”

Wayne notes the current environment is likely to see a different style of shares perform better: “In low inflation environments, value style investing has underperformed the market, which is what we have experienced over the last decade. However, in high inflation environments, defined as over 4.4%, it has meaningfully outperformed the market. This shouldn’t surprise us because these value companies are by definition lower duration investments where you own more levels of cash, earnings and assets for every pound invested.”

This is an important reminder of the importance of diversification, as those heavily concentrated on one style of investing might do well in some circumstances, but could struggle when the market changes. Someone heavily invested in tech stocks will likely have had a tough year, with the likes of Apple, Alphabet, Microsoft and Tesla all down over 20% year-to-date. This is why we seek to invest in a variety of shares and asset classes, to help smooth out some of this volatility.

It is also a useful reminder of the value of active managers, who can identify trends such as this, and invest accordingly.

In the US, a bleak economic outlook as a backdrop caused equity markets to retreat again last week. In the US, the S&P500 slumped by -3.1% after Federal Reserve Chairman Jerome Powell stated that the Bank is prepared to take action if needed to tame inflation. The S&P 500 has now fallen for seven consecutive weeks, its worst run since 2001.

This included a 4% drop on Wednesday, its largest one-day drop since the start of the pandemic in March 2020, as large traditional retailers Target and Walmart both fell after posting disappointing results.

The situation wasn’t helped by unemployment data released towards the end of the week, which revealed 218,000 initial jobless claims, almost 20,000 above expectations. This fed into fears that the US could experience a recession this year.

Since the start of the year, both the S&P 500 and NASDAQ are notably down. While this short-term volatility might be concerning for investors, it is important to remember that ups and downs are to be expected. Adrian Frost from Artemis points out: “Since 1957, a five-month decline of over 15% in the S&P has led to a median return a year later of +20% (though not in 2001 and 2008).”

While past performance is not indicative of future performance, this statistic serves as a useful reminder that while it might be tempting to leave the market during tough times, periods of heightened volatility are temporary, and exiting the market could see you miss out on any bounce effect at the end of it.

Dan O’Keefe, Lead Portfolio Manager at Artisan notes: “We have the tendency to look into the market at times of extreme volatility and feel that things are highly uncertain. But they’re equally uncertain at any point in time, and equally as unknowable as any other point in time. When the market is volatile, and stocks are going down, it’s an unpleasant experience.”

“But in my 25 years of investing, one thing just continues to ring true, and that is when things feel very bad and unpleasant, it’s usually the right time to be allocating capital. And that’s usually when the greatest returns (prospectively), will be earned. And it’s not easy to do, but it requires discipline. And I think that’s a lesson that everyone needs to keep in the forefront of their minds in times like this.”

 

Artemis and Artisan are fund managers for St. James’s Place.

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