Markets struggled in September and the third quarter more broadly, despite an exceptionally strong July, with both global equity and bond markets falling during the period. July proved to be a very good month for markets, after a challenging first half of 2022 global equity and bond markets rallied strongly during the period. Somewhat paradoxically, it was concerns over global growth (and increasing recessionary fears) that helped to provide support to risk assets, as slower growth expectations helped to temper the extremely high interest rate expectations, as did Federal Reserve chairman Jerome Powell’s comments, at the July Federal Open Market Committee (FOMC) meeting, recognising that the US economy is “softening”. In a sense ‘bad news’ on the economy, was ‘good news’ for markets.
Sentiment then changed in the second half of the quarter when focus shifted to the further deterioration of Europe’s energy situation (with record high electricity prices in most countries), increasing the prospect of much slower economic growth and even higher inflation (stagflation) and higher interest rates – a rather toxic mix! The situation was exacerbated with what can only be described as very hawkish comments from US Federal Reserve chairman Jerome Powell, at the annual Jackson Hole gathering of central bankers towards the end of August. This increased interest rate expectations sharply, upsetting both bond and equity markets.
September only added more ‘fuel’ to the negative market tone, with higher-than-expected US inflation numbers, even more hawkish central bank rhetoric, a poorly thought through (farcical) ‘mini budget’ in the UK, and an escalation of the Russia-Ukraine conflict. A successful counteroffensive by Ukrainian forces led President Putin to call a partial military mobilisation and a ‘referendum’ in four occupied Ukrainian regions. The results of the ‘vote’ led to the annexation of these regions, and with it the increased threat of tactical nuclear weapons by Russia. Towards the end of the month, the UK’s ‘mini budget’ was another ‘shoot yourself in the foot’ moment by the government. Markets unsurprisingly questioned the unfunded nature of the wide-ranging tax cuts, on top of the previously announced government financed freeze in energy bills. This put upward pressure on bond yields, led to a sharp fall in sterling, and an increased probability that the Bank of England would have to raise interest rates substantially. A broad market sell-off of UK-listed assets ensued, made worse by the adverse reaction in some UK pension funds when long-dated bond yields jumped higher.
These events weighed on risk assets during what was a volatile quarter. Equities fell sharply with global equity markets down -4.9% on the quarter (-21.7% year-to-date), with emerging markets the weakest area declining -8.2%. Market weakness was nonetheless broad-based with US and Europe (ex UK) down between -4% to -5%. Only Japan and the UK stood out, with more moderate losses in local currency terms, with the latter reflecting the higher exposure to energy stocks in the index. While all sectors fell during the period, energy was again the best performing sector (in fact remains the only positive sector year to date), at the other end of the spectrum communication services stocks (such as Alphabet and Meta) were the weakest area. In terms of style, value stocks marginally underperformed growth stocks, although year to date the more interest rate sensitive growth stocks are clearly suffering / lagging.
Unfortunately, unlike normal risk-off situations, there was no place to hide within ‘safe-haven’ fixed income markets, as concerns over higher central bank interest rates and inflation meant both government bonds and high-quality credit fell over the period. Looking at the detail, global government bond prices fell by -2.6% (-10.1% year to date), on higher interest rate expectations, as did global investment grade credit falling -4.3%. UK government bonds fell a staggering -8% in September alone and are now down -25.1% year to date. At the ‘risker’ end of the credit spectrum, global emerging market debt (-4.2%) and global high yield (-1.0%) were also weak during the quarter, but notably not as much as the more interest rate sensitive bond markets.
Real assets, such as listed property securities fell sharply, especially when compared with equities over the quarter, with the global Real Estate Investment Trusts index down -11.6% over the period, due to the combination of higher interest rate and slower economic growth expectations. Listed infrastructure was also not immune to the sell-off declining -8.5% over the quarter. Commodities (-4.1%) also lost ground, however, this masked big divergences in the underlying subsector performance. Crude oil (-21.0%) and industrial metals (-7.3%) fell on the back of global demand concerns, while at the same time gold (-7.9%) was weak because of a very strong US dollar and higher interest rate expectations. Although continued supply concerns because of the Russia / Ukraine war supported both wheat and natural gas prices.
While the broad asset class declines paint a rather miserable picture, it’s not all bad news. We believe that for sentiment to change, markets will need to see an improvement in the current long list of concerns, especially inflation given its importance to the monetary policy outlook. Though a substantial part of the increase in inflation is due to supply side issues impacting oil (Russia / Ukraine) and other goods (COVID-19 related lockdowns in China), which are completely out of central banks control, we expect to see some improvement in inflation in the latter part of this year / early next year coming from better base effects and tighter monetary policy. This should allow central banks to ‘pivot’ and become less hawkish which should support markets, especially given the substantial amount of negative sentiment already discounted.
|INDEX||END AUGUST VALUE||END SEPTEMBER VALUE|
|DJ Ind. Average||31510.43||28725.51|
|£ Base Rate||1.75||2.25|
This month’s values quoted as at 30/09/2022. The above values are sourced from Bloomberg and are quoted in the relevant currency.
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