By Jan Faure
Global equity markets ended May mostly flat after staging a late rally in another turbulent month of trading. In the US, S&P 500 index finished the month with a marginal gain of 0.01%. Fears that mis-calculated Fed rate hikes could tip the US economy into a recession saw markets trade under intense volatility.
In Europe, the Euro Stoxx 50 declined by 0.4% while the UK’s FTSE 100 gained 0.8% for the month. Markets were positive in Asia with the Hang Seng gaining 1.5% while Japan’s Nikkei advanced 1.6%. Chinese equity indices were broadly positive as sentiment improved on an easing of Covid lockdowns and as fresh stimulus measures were introduced.
Inflation is reaching new highs globally, largely due to the effects of high energy prices. In the US, inflation has shown signs of peaking while in Europe and the UK inflation has not yet peaked. US consumer prices rose to 8.3% year-on-year in April, slightly lower than the 8.5% increase in March. In Europe, inflation in May increased to 8.1% y-o-y from 7.4% the prior month. The European Central Bank is expected to follow the UK and US with rate hikes beginning in July.
The US Federal Reserve raised rates by 0.50% at is May meeting, in line with expectations. It was the Fed’s first 50-basis-point rate hike in more than 20 years. Increases of the same magnitude are expected at the Fed's policy meetings in June and July. Minutes of the meeting emphasised how the Fed is struggling with the best way to navigate the economy towards lower inflation without causing a recession or pushing unemployment substantially higher. Fed chair Jerome Powell is confident that a soft landing can be achieved, saying, “This is a strong economy and we think it’s well positioned to withstand less accommodative monetary policy”.
Consumer prices in the UK increased by 9.0% y-o-y in April, the highest level in forty years. The Bank of England has warned inflation could peak above 10% and the economy may contract later this year. Policymakers in the UK and elsewhere face the same challenges in trying to tame inflation without harming the Covid recovery. The pound has weakened by close to 7% against the dollar year to date.
With the latest market turmoil, global equity valuations have trended back to historical average levels. In both the US and Europe, companies reported decent earnings numbers in the first quarter of the year. Forward corporate guidance has weakened, reflecting the challenging outlook, but consensus estimates in the US are still factoring in earnings growth for 2022 and 2023. This does not suggest a recession is imminent, however, that may change should the Fed poorly navigate its inflation response.
China has remained another headwind for global markets. Notwithstanding last years’ regulatory shift against internet companies that hurt investor sentiment, strict Covid lockdown policies have dented growth prospects for this year and further undermined manufacturing output and global supply chains. Global investors welcomed an easing of lockdown measures in major cities as well as a raft of stimulus measures. This came as recent data indicated a slowdown in growth for Q2, increasing the probability that growth will fall short of the Chinese government’s targets this year.
A European Union agreement to partially ban imports of crude oil from Russia sent oil prices to a two-month high in May. Brent crude rallied 12.4% to end the month at $122.84 a barrel. The easing of lockdown restrictions in China only added to the bullish sentiment. The EU ban sees Russian seaborne oil (two-thirds of European imports) being immediately banned, with a temporary exemption for pipeline oil. Pledges by Poland and Germany to stop importing pipeline oil by the end of this year will raise coverage of the ban to 90% of Russian imports.
The EU’s move follows bans by the US and UK on Russian oil, although buyers in Asia, particularly China and India, have stepped in to take much of the rejected oil. According to JP Morgan, Russia will be able to redirect most of its oil to other countries with a maximum of 1.5m barrels per day finding no market. There is now growing pressure on OPEC to meaningfully ramp up production to ease supply issues.
There are currently three primary concerns dominating investor sentiment:
As these concerns continue to linger we can expect markets to remain volatile. As it stands, uncertainty remains high and it seems markets have given the benefit of the doubt to bad news and outcomes. Since markets are constantly repricing risk (and opportunity), we believe much of the bad news has already been priced in. As history has shown, investors with a long-term view can afford to view downturns such as this as an opportunity.
We do expect aggressive rate increases in the US and Europe, but we do not expect these to be to the detriment of their economies. Chinese Covid lockdowns may continue but these should become less impactful as Chinese authorities introduce measures to better manage Covid outbreaks. The Ukraine war remains a concern, both from a humanitarian perspective and its negative impact on commodities and inflation. Here the outlook is more uncertain and has the potential to undermine efforts to rein in inflation and return confidence to markets.
GLOBAL INDICATORS: Local reporting currencies