Market update - May 2022
- Shunil Roy-Chaudhuri
- 26 May 2022
- 10 mins reading time
On 3rd May, we hosted a webinar in which we assessed the continuing tragic events in Ukraine, their inflationary impact, and the outlook for the months ahead. This briefing is based on that content.
The start of the year has not been good for the majority of markets. Most asset classes, with commodities a notable exception, have fallen in the year to date. European equities stand out with an 8.75% decline (1). Even so, UK equities have risen slightly in 2022, due to the UK having many more defensive companies than Europe. Defensive companies are those whose earnings are unlikely to drop significantly during an economic downturn.
In the past five years, equities markets across the world (excluding the UK), have generally performed strongly, as have commodities (2). Thankfully, we have increased holdings in overseas assets in our portfolios over the years. In our view, overseas equities could potentially perform more strongly than UK equities in the next five to 10 years.
Global economies and stock markets were generally performing strongly before the onset of the pandemic in 2020. There was an economic dip in the first quarter of 2020, as the COVID-19 threat increased, with UK economic growth falling by 19% (3). But vaccine development has meant that most major economies have now returned to pre-pandemic levels of economic performance. This helped drive robust stock market returns in 2021. But these returns were a bounce back from the steep declines of 2020 and we would not expect such returns to be repeated in 2022 and 2023.
Emerging from lockdown
Developed economies have started to reopen as the impact of the virus has reduced. Google mobility data shows that, as we have emerged from lockdown, we’ve returned to the workplace, but not to the same extent as before the pandemic (4). So many of us are still working from home. Google data also shows people are more prepared to go out and socialise than return to the office (4).
But the virus hasn’t gone away and we are having to live with it. Thankfully, COVID-19 vaccines continue to be effective. There’s been a rise in UK cases of the virus recently, but, mercifully, this hasn’t led to increased fatality rates.
Sadly, a new threat has arisen, in the form of the tragic events in Ukraine. Russia and Ukraine comprise a small part of the global economy, but the invasion has had a big impact on commodity prices (see Chart 1). These two countries are large producers of wheat, and the prices of wheat, corn and grain have gone up since Russia invaded. This, in turn, has driven increases in food prices and inflation in the UK, with bread up by around 7% since December 2021. Against this backdrop, UK prime minister Boris Johnson recently visited India, to see if it can increase grain production.
Food and oil prices over 20 years
Source: Refinitiv, OECD, Schroders Economics Group, 24 March 2022.
Moreover, Russia is the world’s third largest producer of oil, but only consumes around 5% of it, making the country a net oil exporter (see Table 1). So the sanctions that have been imposed on Russian oil have a global impact. The European Union (EU), which is an importer of oil, is looking at alternative sources of the commodity, with African countries, such as Nigeria and Angola, potentially able to produce more oil. Meanwhile, Boris Johnson has visited some of the oil-producing OPEC nations, to see if they can increase their oil supplies. The EU is now reviewing whether it can exit completely from Russian oil.
Oil production and consumption by region
Source: BP statistical review.
*CIS refers to the Commonwealth of Independent States, meaning all countries that were in the Soviet Union.
Even so, the oil price had already been rising as economies emerged from pandemic-induced lockdowns. Oil traded at around $78 (£62) a barrel at the end of 2021 but is currently around $105 (£83, as of 23 May 2022). This has had an impact on inflation, as it now costs more to transport goods, heat homes and make goods, leading to rises in the cost of living.
Rising inflation is now the key challenge for global economies. In the past 10 years, inflation has been stable and benign, at between 0% and 2% in the UK, US and EU. But it has picked up dramatically since 2020, rising by 7% or 8% (see Chart 2). This is partly due to a knock-on effect of pandemic lockdowns, as unlocking has led to a pick-up in demand and supply chains haven’t yet caught up.
Inflation (CPI) and wage growth
Source: FactSet, April 2022 (for CPI inflation data) and Federal Reserve Bank of Atlanta (for US wage growth).
There’s also been a rise in wage costs. In the US, unemployment levels are low and there are widespread job vacancies. Employers are paying more to fill these vacancies, so wages go up, the costs are passed on to the consumer and this leads to higher inflation.
The rise in inflation at a time when economic growth has been hampered by the tragic events in Ukraine has raised the prospect of stagflation. This refers to a combination of high inflation and low economic growth. Stagflation poses a dilemma to central banks, as they want to raise interest rates to counter high inflation but would also like to reduce interest rates to increase economic growth.
The UK is not currently in stagflation, but inflationary pressures are building. And when you have higher inflation, standards of living often get squeezed.
Slowing global growth
Surveys of prevailing trends in the manufacturing and service sectors suggest the global economy is continuing to grow, but the pace of growth is slowing. We believe this is due to China and its approach to COVID-19. China has a zero tolerance policy regarding the virus and imposes full lockdowns in regions and cities experiencing outbreaks. This creates an economic stop-start effect, which puts more pressure on global supply chains.
Even so, China may provide economic stimulus by cutting interest rates and increasing infrastructure spend. We believe this should support the global economy.
We will, though, at some point see another recession, as recessions are part of the economic cycle. Indeed, in the US there have been seven recessions in the past 50 years (5). But according to research from Brookings, household savings rates have risen during the pandemic, and excess household savings amount to around $2.5 trillion in the US. This can provide a cushion against an economic downturn.
We are starting to see inflationary pressures increase. But central banks haven’t imposed high interest rates to limit consumer spending and potentially bring down inflation. US rates stand at just 0.75% to 1.0% and UK rates at just 1%, despite recent interest rate rises. But we do expect rates to continue to rise.
Global growth prospects remain good
What does this mean for global economic growth? Schroders recently announced expected global growth of around 3.7%, but we think that, following central bank rate rises, Schroders growth expectations are likely to fall to between 3% and 3.5%. Even so, this is still relatively good growth.
Some of our portfolios hold bonds, which are IOUs issued by governments or companies to investors, for income and stability. They are low risk but sensitive to interest rate changes.
Bond prices have been rising since 2008 and the Global Financial Crisis. This was partly due to low central bank interest rates, as bond prices often rise when interest rates fall. It was also driven by central bank bond-buying programmes. But prices have been falling since the start of 2022, as markets expect higher inflation and higher interest rates.
Government bond prices have fallen by 4.7% (6) and corporate bonds by 6.0% (7) since the start of the year, and lower risk portfolios contain a greater allocation to bonds than higher risk portfolios. We think interest rates will continue to increase, but will do so gradually. We expect central bank rates to reach 1.25% to 1.5% in the UK, and 2% to 2.25% in the US, but this is still low by historic standards.
Our outlook for asset classes
Regarding our three main asset classes, we moved to a neutral position on equities, as uncertainty built up around Ukraine. We have now adopted a cautious stance, due to high levels of inflation, and expect equity returns to be more muted in 2022 than in 2021.
We have been cautious on bonds this year, but have seen our caution diminish a little as bond prices have fallen. We may adopt a more positive stance on bonds if interest rates stay low.
We’ve been positive on commodities since the start of the year, as they can perform more strongly in an environment of higher inflation. We expect strong returns from commodities in 2022.
(1) FactSet, MSCI Europe ex UK total return, 31 December 2021 to 29 April 2022.
(2) FactSet, Schroders Personal Wealth, 28 April 2017 to 29 April 2022.
(3) Refinitiv, Schroders Economics Group, 21 April 2022.
(4) Google, Schroders Economics Group, 1 April 2022.
(5) Refinitiv, Schroders Economics Group, 4 April 2022.
(6) FactSet, Bloomberg Barclays Global Aggregate Treasuries index, 31 December 2021 to 29 April 2022.
(7) FactSet, Bloomberg Barclays Global Aggregate Corporate Bond index, 31 December 2021 to 29 April 2022.
Forecasts of future performance are not a reliable guide to actual results, neither is past performance 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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