A Look at Global Financial Markets 24.01.22
This Investment Strategy update aims to provide clients with a comprehensive picture of the global economy and regular updates on current stock market and fixed income trends, in order to assist investors in making informed investment decisions. It is headed by Tom Elliott, deVere's International Investment Strategist, who produces regular updates on a wide range of topical investment issues. Please find below the update from 24th January 2022.
- Value stock continue to outperform in nervous environment
- All eyes on wage growth!
- Investing through the mid-cycle blues
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Market sentiment: Another bout of instability. This week’s market nervousness was triggered by comment from, Jamie Diamon, head of JP Morgan, that the Fed may have to raise interest rates ‘six or seven times this year’. Markets had been pricing in four rate hikes from the Fed in 2022, a month ago it had been just one. We are seeing increasing nervousness over the durability and the pace of inflation across the developed world, and with this comes expectations of a tougher response from central banks than had been priced in. Investors in risk assets are understandably nervous.
But even as interest rate expectations rise, along with bond yields, stock market investors benefit from the continuing global economic recovery. The World Bank is forecasting world GDP growth of over 4% this year, which will help drive corporate earnings growth. Meanwhile, with bank account cash, and most government bonds, offering negative real returns (after inflation is taken into account), stock markets will continue attract money by default. Mature, profitable companies in ‘value’ sectors look set to continue to benefit from the risk-off environment.
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Wages and inflation: Central banks are hoping that wage growth will remain lower than inflation. In the UK, this has had the effect of forcing average real earnings back to a level last seen in 2007. Theory has it that this will depress demand, particularly for discretionary goods, and so ease inflation. Sadly for many on low incomes, it also hits the ability to make some essential goods unaffordable also.
It is expected that, if wages do not rise significantly over the coming months, that inflation in the major economies will peak in April and roll-over quite quickly over the following quarters. This reflects weaker demand, as mentioned above, the year-on-year statistical effect as price rises over winter 20020/ spring 2021 fall out of the calculations, and an unblocking of many of the supply-side blockages as labour and logistics markets return to normal thanks to vaccine rollouts etc.
But if wages rise at the level of inflation, or higher, then central banks will have a demand-driven pressure on prices that can quickly become an embedded problem. A much longer, and tougher, tightening of monetary policy will be needed to eradicate inflation. We have seen a small rise in long-term inflation expectations over the last year, in all the major western economies, but so far we have seen limited pay growth outside of a few key sectors (such as transport, hospitality etc).
This, then, is why financial markets are keeping a sharp eye on labour market data: because it as a key indication as to the direction of travel for inflation, and hence for central bank monetary policy.
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Investors should sit through the mid-cycle blues: Every economic cycle has its peak, and the current cycle of global GDP growth probably peaked in early summer of 2021. Once GDP and corporate earnings growth begins to decelerate, investors become very sensitive to speculation as to how long before the next downturn, and what may cause it. Hence the nervousness over the outlook for inflation and interest rate policies.
The nervousness is seen in higher levels for the VIX index (‘the fear index’) in recent weeks, and the relative underperformance of tech and other ‘jam tomorrow’ growth sectors compared to the value sectors of energy, industrials, materials and financials.
But investors should be wary of taking fright. We have seen some very long economic cycles in recent decades, for instance in the UK between 1992 and 2000, that were all filled with warnings of imminent recessions which never happened. (And, interestingly, the bursting of the dot,com bubble -which was the big stock market correction of the period- had little to do with fundamental macro-economic conditions). Financial history suggests that a long term investor with a multi-asset portfolio should stay put, and not try to ‘time the markets’.
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Stay well!
deVere's International Investment Strategist