It has been a volatile week for equities as markets fret over the potential for a policy error as central banks attempt to regain control over a sharp spike in inflation to levels not seen in forty years. On Wednesday, the US Federal Reserve raised rates by 0.5%, a quantum not used in over twenty years, whilst communicating to the market that the same should be expected over the subsequent two rate-setting meetings. This led to a sharp rally in equities, as this seemingly ruled out a 0.75% increase, whilst also largely being priced in. However, all of this move and more was swiftly undone on Thursday, as markets rotated sharply by a level not seen since March 2020 when lockdowns were first introduced in response to the Covid pandemic. US Treasury yields, which move inversely to price, rose above 3% for the first time in more than three years. Investors are now waiting for the release of the US non-farm payrolls later today, with expectations that wage growth will have exceeded 5% year-on-year for the fourth month in a row.
As of 12pm on Friday, London time, US equities were up 0.4% over the week, whilst the US technology sector recorded a small loss of -0.1%, although futures markets are currently pricing in further falls when the market opens later today. European equities were down 4.2%, whilst the UK dropped 2.0%, although this masked a 4.7% fall in UK mid-cap stocks. Japanese equities rose 0.9%, whilst Australian stocks fell 3.1% and Emerging markets lost 1.6%.
10-year US Treasury yields traded up to 3.08% by the end of the week and German bunds also sold off, with bund yields touching 1.08%, a level not seen in seven years. UK gilts were somewhat more stable, as the Bank of England acknowledged that simply raising interest rates may not solve the UK’s inflation problem whilst so much of it is imported in. 10-year gilts fell in value, now trading at 1.94%, having exceeded 2% earlier in the week. UK rates were raised rates by 0.25% on Thursday to reach 1%, the highest level since February 2009, with the bank forecasting inflation to top 10% in the fourth quarter. The Reserve Bank of Australia had set the tone earlier in the week, as it too raised rates by 0.25%. Australia’s 10-year bond traded up to just shy of 3.6% mid-week, a level not seen since 2014.
Gold fell 1.6%, now trading at $1,882 an ounce, as did copper, falling 3% to $9,512, whilst iron ore fell by 6% over the week. Crude oil bucked the trend as the EU stepped closer towards a plan to ban Russian oil imports, although Hungary looks set to vote against the policy. Brent crude traded up 3% to $112.6 a barrel, whilst US WTI (West Texas Intermediate) traded 5% higher at $110 a barrel.
It has been a difficult year for markets so far, as stimulus policies put in place during Covid have supercharged demand whilst supply chain bottlenecks and the Ukrainian war have only served to compound the rise in inflation. And now the siren of recession risk grows ever higher as central banks attempt to regain control of the narrative. However, if we take a step back and look dispassionately at markets, in reality, what has really happened is a rebalancing in valuations. Expensive stocks have become cheaper, whilst cheaper stocks have become more expensive. Valuation dispersions had become extreme and an increasing discount rate on the risk-free asset i.e. government bonds has led to the market reappraising prices.
Looking forward, how much further this readjustment has to run is always difficult to judge, however, what is unlikely in the immediate term is for the investment winners of the last decade simply to reassert themselves. The market is much more sensitive to valuations today and this is likely to endure, at least until the inflation genie has been put back into its bottle. Whilst the increasing risk of a recession due to a policy mistake by central banks means that we are increasingly looking to move up the quality spectrum in terms of the companies we invest in, rather than just focus on ‘value’ or ‘growth’. Companies with strong balance sheets, solid earnings, low gearing, and defendable competitive positions married with lower valuations are becoming much more attractive places, increasingly referred to as the ‘forgotten middle’.
Lawsons Equity Limited is a company registered in Malta with company number C49564 and Licenced by the Malta Financial Services Authority as Enrolled Insurance Brokers under the Insurance Intermediaries Act 2006, and to provide Investment Services under the Investment Services Act, 1994. Lawsons Equity Ltd have passported their services across the EU. To see a full list of countries click here
In the United Kingdom, Lawsons Equity Limited is deemed authorised and regulated by the Financial Conduct Authority. Details of the Financial Services Contracts Regime, which allows EEA-based firms to operate in the UK for a limited period to carry on activities which are necessary for the performance of pre-existing contracts, are available on the Financial Conduct Authority’s website.
Copyright 2020 Lawsons Equity Ltd | Designed by Echo
Disclaimer: The information provided on this website is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning investments or investment decisions, or tax or legal advice. Similarly, any views or options expressed on this website are not intended and should not be construed as being investment, tax or legal advice or recommendations. Investment advice should always be based on the circumstances of the person to whom it is directed, which circumstances have not been taken into consideration by the persons expressing the views or opinions appearing on this website. Lawsons Equity Limited has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website. You should always take professional investment advice in connection with, or independently research and verify, any information that you find or views or opinions which you read on our website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. Lawsons Equity Limited does not accept liability for losses suffered by persons as a result of information, views of opinions appearing on this website. This website is owned and operated by Lawsons Equity Limited.