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08 Apr 2022
Making sense of market challenges in 2022
COVID-19, inflation, and Ukraine: understanding the underlying issues that impact the markets.
In writing this article, I wanted to ensure I covered all the key factors currently afoot in global markets. Usually, the challenges we discuss tend to have an impact for short periods. However, as I listed these, it became apparent that they have been present - or developing - for several years.
It may feel like COVID-19 lockdowns were just yesterday, but in actuality, we’re more than two years on from the sharp market correction of March 2020. The continuous onslaught of these challenges has, perhaps, eroded the perception of time. Regardless, here are some insights into the issues currently impacting asset prices.
It is no secret that since the correction in March 2020, technology ‘stay at home’ equities have skyrocketed. Consumers have been forced to interact with the world, both professionally and leisurely, electronically. This has accelerated the broader adoption of technology into our lives, with habits that will be retained even when the pandemic is behind us. In contrast, sectors that rely on real-world footfall and travel (restaurants, retail, airlines, etc.) have struggled.
While there are renewed concerns over an outbreak in China (as roughly 40 million people are placed in lockdowns) COVID-19 developments now garner less airtime than they once did. Similarly, the market has become increasingly forgiving with each new wave. The market has matured to ‘see through’ COVID-19 risks and, as global vaccination rates continue to rise, COVID-19-related volatility will likely decrease compared to the past two years.
Inflation and interest rates
Concerns around inflation, the economy, and rising interest rates existed well over a year ago - driven by the dual forces of pent-up consumer demand (after higher levels of savings during lockdowns) and supply chain constraints - but discussions have intensified in the past few months.
With inflation now at multi-decade highs, it is little wonder that central banks are raising their funds rate to bring it under control. With the US Federal Reserve (Fed) committing to a 0.25% rate hike in March 2022 and further rate rises at each of the remaining six meetings this year.1 Besides the reduction of asset purchases, manipulation of interest rates are the main weapon in the armoury of central banks.
Although some commentators have also noted another tactic the Fed appears to be deploying: ‘directing the narrative’ to combat the rise of higher inflation readings, without actually making any monetary policy amendments.
The wider US indices have fallen into correction territory following rhetoric and inaction from the FED during a six month period before the recent rate rise. Many investors feel that the Fed has been too slow to act, perhaps by design, and the resulting depression of asset prices has had a deflationary effect on the economy, by making consumers and corporates more cautious and therefore reducing the demand element of the inflation equation. They have effectively nudged themselves in the right direction without any action - and perhaps were able to introduce a smaller rate rise than what would have otherwise occurred if they didn’t ‘direct the narrative’. It’s an interesting take on how the Fed can achieve its end goal by simply ‘talking’ the market into a more deflationary scenario.
As the Russian invasion continues, there has been broad upheaval and collective condemnation from the world. Many corporates have cut ties with Russia, including the likes of Apple, who paused the sale of their products, and even oil giants like BP, who disinvested a portion of their Russian oil exposure.
The economic ostracism of Russia is having its intended effect, as fears now loom on their capacity to repay debt obligations. There is initial concern relating to a $117million debt interest obligation. Russia says it has assigned funds for repayment, reported to be from assets frozen in Europe (although the payment will be allowed).2
Commodity prices rose following the invasion on 24th February, with Brent crude oil jumping c.42% over the following trading sessions to its highest point of c. $138 per barrel, but later tracing backward.3 This has brought into question the strategic advisability of Europe’s reliance on Russian energy and driven a desire to move away from this reliance. While the United States has banned all Russian energy imports, Europe’s issue remains a bit stickier. However, broadly, there has been a renewed focus on longer-term solutions in renewable energy sources.
These multiple and interlinked challenges bring into view the necessity of sound investment due diligence, diversification, and a well-structured portfolio focused on long-term growth or protection.
The investment management team and the wider research department at Investec remain diligent and attentive to the rapidly evolving investment landscape around us, aiming to provide the best .client outcomes. Despite the challenging times, pockets of value remain present within financial markets, which we will always strive to unlock.
1 The Fed Might Raise Rates by a Half-Point. How It Could Play Out. | Barron's (barrons.com)
2 Russia appears to have avoided default as it makes a $117 million bond payment. - The New York Times (nytimes.com)
3 Brent Crude Oil – Factset Charting
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