Market Update - February 2022
- Shunil Roy-Chaudhuri
- 18 March 2022
- 10 mins reading time
On 3 February, we hosted a webinar in which we reviewed the events of January 2022 and discussed the investment and economic outlook for the months ahead. This briefing is based on that content.
You can view the slides from the webinar here.
The new year opened with a milestone as Apple became the first company ever to reach (briefly) a stock market value of $3 trillion (£2.2 trillion). But this event was overshadowed by the build-up in December 2021 of more than 100,000 Russian troops near the Ukrainian border, which led to global stock market turbulence in January. This turbulence reflects uncertainty about the Ukrainian situation. But we believe markets could recover once this uncertainty is removed, even if the human cost could still be uncertain.
Such market turbulence is reflected in the performance of the VIX index, which attempts to measure market sentiment. In normal market conditions it usually hovers around the 15-20 range, but it rose to 35 or 40 on some days this year, reflecting market nervousness. However, to put this in context, it reached levels of 75-80 at the height of the Great Financial Crisis (GFC) in 2008.
Markets now seem focused less on the threat of COVID-19 and more on traditional economic factors. In particular, the spotlight now is on the outlook for inflation, which is a measure of the cost of living. Inflation rates reached 7% in the US and 5.4% in the UK, levels not seen for decades. (For more on how inflation works, see our article ‘How could rising inflation affect me?’)
High inflation has emerged as the world came out of lockdown. People have been competing to buy goods, as some had been paid to stay at home, spent less than usual, and built up excess savings (see chart). In consequence, many personal bank balances are generally good, which benefits the economy.
Source: Refinitiv DataStream, Schroders, GR87, 22 December 2021.
So consumers wanted to spend more on goods, but there was limited supply, creating the conditions for higher inflation. The supply contraction was due to the pandemic. This had led to lower production in China and created shipping bottlenecks, with goods delivery times rising from around 45 days in 2018 to around 70 in 2021. (1) Thankfully delivery times have recently started to fall, which could hopefully help reduce inflationary pressures.
People leaving the US workforce
However, the employment participation rate in the US has declined. In other words, a significant number of people have left the workforce, partly due to early retirement. So employers have had to pay higher wages to attract staff, and they may pass these costs on to consumers. This could lead to a rise in the price of goods and services and to high inflation.
The inflationary backdrop and tensions in Ukraine have driven US and European equities down by around 7% so far in 2022. Germany is a noteworthy victim of these tensions, as it is vulnerable to a possible shutdown of its Russian oil and gas supplies should an incursion into Ukraine take place.
These equity declines have hit some types of companies more than others. So there were double-digit falls in the share prices of so-called growth companies, such as US technology giants Apple, Netflix and Facebook-owner Meta (see table). Competition from Disney+ and Amazon Prime was a key factor in the negative share price performance of Netflix. But there have been double-digit increases in some more traditional US firms (so-called value companies), including financial services provider Wells Fargo and oil and gas group ExxonMobil. (For more on market performance and growth and value companies, see our article ‘Looking beyond the market downturn’.)
Some diverging share performances seen at the start of the year
Source: FactSet, 31 December 2021 to 27 January 2022. Returns in local currency. These figures refer to the past and) past performance is not a reliable indicator of future results.
Is Omicron less dangerous?
Regarding COVID, there was a big rise in people infected with the Omicron variant in the UK and the US in the second half of 2021. Mercifully, fatalities haven’t been as high as they were in March 2020 and March 2021. So Omicron seems to be more infectious but less dangerous than the Delta variant, and the global economy has made something of a return to normality.
In this vein, the Pret Index for the City of London has increased in recent weeks. So people are once more buying sandwiches and coffees from the Pret a Manger chain, and this suggests working practices in London’s financial district may be getting back to normal. But this index is not yet back to pre-COVID levels.
Looking globally, surveys of supply chain managers across the world indicated a greater decline in economic activity during the pandemic than during the GFC. But the decline was less long-lasting than in the GFC (due to supportive measures such as furlough schemes), and it was followed by a strong and swift recovery. Emerging markets typically do well in an economic upswing, although this isn’t guaranteed, but these surveys suggest supportive policies have led developed economies to do better on this occasion.
For example, we forecast China to have economic growth of just 4.5% in 2022. But this is driven by its economically constricting zero-COVID strategy, as it didn’t want to cancel the Winter Olympics.
In the UK, the Bank of England (BoE) has raised interest rates in an effort to quell inflation, this led the price of UK government bonds to reduce and yields to rise (the price and yield of a bond always move in opposite directions). However inflation is around 5%, which is far higher than the interest payments on gilts, making them less attractive currently.
The UK is also experiencing wage rises, sometimes significantly above the level of inflation, as companies increase salaries to attract and retain staff at a time of low unemployment. These wage rises might increase corporate costs and drive higher inflation. We will keep a close eye on how this situation develops, but expect further modest interest rate rises from the BoE and believe high inflation will be transitory.
Turning now to investments, the performance of equity markets has been better than expected given the impact of the pandemic. Some so-called old economy companies, such as banks and oil groups, have performed well. But we have concerns that the share prices of some technology firms reflect high performance expectations that the companies may struggle to meet.
Strong economic rebound
There was huge economic growth in 2021, with the US economy growing by 5.4% and the UK by 6.9%. Growth remains good in China, although it is still in a slowdown. In the UK, the large-scale lockdown led to the strong economic bounceback. However, a favourable UK economic outlook does not ensure that financial markets will perform strongly. But, from a social point of view, it’s clearly a good thing that we at Schroders Personal Wealth are forecasting UK economic growth of 5.2% for 2022 and are not predicting a recession over the next two years.
In the UK we have low unemployment, low interest rates in historic terms and some people are spending excess savings. So we still expect reasonably good economic growth rates and believe this could feed through to markets. We think equity returns in 2022 will be good, but not as good as in 2021, when global equities (as captured by total returns from the MSCI AC World ex UK index) returned 20.1%; and UK equities (as measured by total returns from the MSCI UK IMI index) returned 18.1% (2). Consequently, we still have high investment weightings to equities, but not as high as previously.
Emerging market opportunities
China and other emerging markets have been performing less strongly than developed stock markets. We see this as an opportunity and are investing in some new emerging market holdings. We have also increased our allocation to value companies.
Regarding fixed interest investments, the prospect of rises in interest rates generally has a negative impact on bonds. This is because the interest payments on bonds will then typically need to rise to attract potential new investors, which would lead to a decline in bond prices. So we still have low investment weightings to bonds, although not as low as previously.
We expect values of commodities, such as oil and gas, to fluctuate markedly in 2022. A Russian incursion into Ukraine could lead to greater fluctuations and a rising oil price. Even so, we have high investment weightings to commodities as they can provide some protection against inflation.
Market declines can, understandably, raise concerns among investors. But they aren’t necessarily a bad thing, as they can open up new investment opportunities, particularly as portfolio allocations can be adapted to changing conditions. Indeed we are currently positioning our portfolios to cope with more turbulent markets.
Benefits of holding diverse assets
We consider that owning a diverse range of holdings within individual classes of assets, such as equities, is key to providing some investment protection in changeable market conditions. And we also believe in the importance of holding a diverse range of investments across different classes of assets, such as equities, bonds and commodities. This is because, while we can have a view on which asset classes could perform well in 2022, we don’t know this with certainty. So there are potential investment benefits in spreading our investments across all asset classes where this is appropriate.
In our view, there are three drivers of stock market performance: sentiment, fundamentals, and valuations. We try to look beyond sentiment and consider fundamentals and valuations. Fundamentals refer to such things as economic growth and the ability of a company to increase profits. Meanwhile, valuations concern such things as how one company or market compares with another. We believe market sentiment is driven by short-term investor emotions. The key for us is not to be driven by these emotions and to always try to manage the diverse holdings in our investment portfolios in a controlled way.
(1) Refinitiv, Schroders Economics Group. 31 December 2021 (2) FactSet, 31 December 2020 to 31 December 2021.
Past performance is not a reliable indicator of future results. The value of investments and the income from them can fall as well as rise and are not guaranteed.
Any views expressed are our in-house views as at the time of publishing.
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