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Overview: Positivity Hindered by Sticky Inflation
- the global stock market (MSCI World Index) gave back 2.3% in February, following a near 7% rise in January
- the bond market (Bloomberg Global Aggregate Index) declined and is now flat for the year
- recent data suggests central banks’ fight against inflation is not yet over
Key Themes
February proved something of a mixed bag following very strong performance from risk assets in January. Some stock markets declined, while others continued to rise.
The bond market returned to 2022 form, with yields marching higher (prices declining) across the globe.
The market had hoped inflation was yesterday’s news, but month-on-month data for January came in higher than expected in the US. Professional fund managers are reconsidering the ‘declining inflation’ narrative, as employment rates and wage increases remain incredibly strong. From October to January, inflation had been slowing and markets had been rising. Markets are now trying to decide which way inflation will go from here, while recession risk remains elevated.
UK
UK stocks kept grinding higher in February. The FTSE 100 large-cap index was one of the few markets to generate a positive return in 2022 and it extended January’s 3% gain with a further rise of 1.9%.
The mid-cap and small-cap indices were relatively flat for the month, while AIM lost ground (-1.5%). The AIM All-Share index remains 35% below its high from September 2021. This serves as a reminder of its inherent volatility, even though there has been a general improvement in the quality of the companies listed on AIM in recent years.
United States
The US stock market conquered all for an entire decade following the financial crisis of 2008-09, but there is a growing school of thought that the trend may now be over.
What is clear is that the US market has become exceptionally sensitive to inflation expectations and the future path of interest rates. Perhaps this is related to its relative lack of fundamental support: the S&P 500 trades on 18x forward earnings expectations, while the UK & Europe trade on 12.5x earnings – making them much cheaper with higher dividend yields on top. The US fell to the bottom of the developed markets leaderboard in February, with declines for the S&P 500 (-3.0%) and Nasdaq (-3.5%).
Europe
European stock markets continued their recent leadership by outperforming most other equity markets once again in February.
The Spanish market rose 4.0% with the Italian (2.9%), French (2.7%) and German (1.2%) markets chasing along behind. Manufacturing data also shows that, for once, the ‘peripheral’ Eurozone economies are outperforming the Franco-German core.
Largely neglected for the majority of the 2010s, Europe has become one of the more popular investment allocations for fund managers recently, due to its attractive valuations and diversity.
Emerging markets
Emerging markets have been another popular theme, although those who jumped on the bandwagon too early suffered a 5.6% decline in the past month.
China’s post-covid reopening was meant to provide a windfall for emerging markets and global commodity prices. However, some are now saying the full economic effects won’t be seen until later this year.
The US dollar rose in value and commodity prices declined throughout February, both of which are generally negative for emerging market economies. Most emerging markets remain cheap by historical standards.
Bonds
The 2022 bear market was characterised by a strong US dollar, rising bond yields and declining stock markets.
In October, inflation peaked and all three trends reversed. However, February saw 10-year UK gilt yields rise from 3.0% to 3.8%, with overseas yields rising to a similar extent. This represents a ‘big move’.
The trend shows no sign of abating and UK yields could soon approach the 4.5% level associated with the September mini-budget debacle. Yields are basically tracking inflation and interest rate expectations and are warning us not to be complacent on that front. Note that bond yields move inversely to their prices.
Points of Interest
On 22 August, European natural gas prices peaked at €342/MWh. Today, they are €46/MWh and declining. Energy prices skyrocketed in the months following Russia’s invasion of Ukraine, with the Nord Stream pipelines becoming a flashpoint between Putin and the West. Leading into the winter, analysts had serious concerns about Europe’s ability to maintain its power supply if temperatures plummeted. Fortunately, an exceptionally mild winter has ensued with the third-warmest January on record. With any luck, domestic energy bills will follow a similar trend and settle back to their previous norms.
UK house prices fell for the fifth month in a row with average selling prices declining 0.6% in January. This has lent credence to those forecasters who have called for a 10% – 20% decline in house prices from their recent peak. The Bank of England has now raised interest rates at each of its last ten meetings and is expected to do so again on 23 March. Governor Andrew Bailey did provide some comfort by saying he now expects a ‘much shallower’ recession compared to the doomsday forecast provided in November, although such vacillation doesn’t exactly enhance the Bank’s reputation.
Summary
Markets celebrated the new year in style and partied on throughout January. February has brought the first signs of a hangover, as bond markets have taken fright at inflation once again. The UK and European stock markets have remained steadfast so far, but the US & Emerging Markets quickly retreated.
The beginning of 2023 brought claims that a new bull market was being born: February could simply represent the first bump along that road, or it could mark the resumption of the 2022 downtrend. Much will depend on the future level of inflation and whether a hard recession is avoided. As someone once said, “it is difficult to make predictions, especially about the future”, but we do at least know that valuations are reasonable and there are more high-yielding investments than there have been in many a year.
