September Issue 2022
Summary
The inflation narrative continues to wrongfoot global equity markets. The first full week of October saw softer than expected US manufacturing data swiftly followed by a stronger than expected jobs report. Stocks whipsawed as a result, surging with hopes of a Fed pivot and falling as these were soon dashed.
Equity Snapshot
| United States | • | US equities slumped as hawkish statements from the Federal Reserve (Fed) and a gloomy outlook from bellwether FedEx weighed on sentiment. The S&P 500 Index retreated to levels last seen in mid-June, marking a drop of around 20% from its peak in early-January. All areas of the US market recorded negative returns, with value stocks holding up slightly better than growth-oriented companies. |
| • | Inflation data topped expectations, with consumer prices rising at an annual rate of 8.3% in August. While this was down from a peak of 9.1% in June, it topped expectations, dashing hopes that the Fed might take a less aggressive stance. The Fed raised interest rates by a further 75 basis points in September, the third successive increase of that magnitude and marking a run of the most aggressive tightening of monetary policy since 1981. US policymakers’ “dot plot” of future interest rate projections indicated that US rates were expected to rise to 4.4% by the end of 2022 with a peak of 4.6% forecasted in 2023. Currently, the range for the Fed funds rate is 3.00-3.25%. | |
| Europe | • | European equities fell (in EUR terms) over September as the economic outlook darkened. The decline took European equities into a bear market, having fallen at least 20% from their peak in early-January 2022. The EU proposed a windfall tax on energy companies to help pay for lower-income household bills, even though the proposals were met with severe reservations from some member states. In political developments, a coalition of far-right parties won Italy’s general election, with Giorgia Meloni set to become Italy’s first female prime minister. |
| • | Economic activity continued to weaken. The flash estimate of the S&P Global eurozone composite purchasing managers’ index fell to 48.2 in September, the lowest reading since January 2021, with both services and manufacturing activities well into contraction territory. Eurozone inflation continued to accelerate, reaching a fresh high of 10.0% in September. The European Central Bank (ECB) became more aggressive in raising rates, implementing a 75-basis-point (bps) increase and signalling that interest rates will likely be raised further in subsequent meetings. | |
| Asia | • |
Asian equity markets tumbled over September, weighed down by concerns over persistent inflation, the global economic outlook and aggressive tightening by the US Federal Reserve. While general inflation in Asia Pacific is lower than most G7 economies, several central banks in the region continued to hike rates. The Reserve Bank of Australia raised rates to the highest levels since January 2015, while the Australia market reached a new low since mid-June. Chinese equities fell sharply over ongoing weak domestic economic conditions. Hong Kong shares also weakened as rates were increased to 3.5% to maintain Hong Kong’s currency peg with the US dollar, but the city’s decision to end mandatory hotel quarantine brought a more positive outlook. South Korea and Taiwan markets also lost ground as tech companies were hit by fears of weaker demand given the slowdown in global growth. Overall, ASEAN markets outperformed the broader region. Indian stocks also remained relatively resilient, with the more robust domestic economic activity. |
| Bond | • | US bonds retreated sharply over September as stronger-than-expected US inflation data for August and a series of hawkish statements from US policymakers dispelled any hopes of less aggressive hikes in interest rates. The yield on the 10-year Treasury reached a 12-and-a-half year high towards the end of September, before closing the month just above 3.8%, a rise of around 70 basis points (bps) over the month. European bonds also sold off sharply in September as the European Central Bank became more aggressive in raising interest rates, and indicated it would start to talk about shrinking its balance sheet. |
| Outlook | • | The inflation narrative continues to wrongfoot global equity markets. The first full week of October saw softer than expected US manufacturing data swiftly followed by a stronger than expected jobs report. Stocks whipsawed as a result, surging with hopes of a Fed pivot and falling as these were soon dashed. |
| • | This pattern is becoming all too familiar. With valuations having pulled back so much, skittish equity investors are searching for signs of relenting central banks. Yet there are signs that not only is inflation dropping slower than expected, but that underneath the headline decline some prices continue to rise. | |
| • | Energy, the biggest driver of inflation this year, has softened with a barrel of Brent crude now 25% cheaper than its March peak. Yet with unemployment at historic lows, service costs continue to grow, and the effect of hedging means many other price increases have yet to be felt by consumers. Similarly, longer-term inflationary forces, such as demographic change and long-standing underinvestment in infrastructure, not only precede Russia’s invasion of Ukraine but may also outlast it. | |
| • | Equity investors are thus grappling with a world in which central banks remain fully committed to monetary tightening even as economic indicators sour. At a fundamental level, many companies are now facing a decline in revenues and earnings expectations. The question is to what extent analysts and management have correctly priced this in? | |
| • | At the same time, markets continue to be highly sentimental and short term in focus. Russia’s invasion prompted a risk off move that has been prolonged by a European energy crisis, broader geopolitical tensions and the prospect of global recession. Equally, when inflation is high it has historically also tended to be volatile. Markets as a discounting mechanism are increasingly likely to misprice securities on the basis of extrapolating short-term data. | |
| • | As active equity investors, it behoves us to take a longer-term view. In a lower growth environment, many stocks with strong balance sheets and sticky revenues have seen an excessive collapse in their valuations, relative to peers. Similarly, companies with exposure to structural drivers that are not correlated with the broader economy – such as digitalisation, electrification and ageing populations – offer greater growth visibility for investors. We believe that opportunistically adding to such high conviction names will lay the necessary foundation for performance when fundamentals are once again in focus. | |
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October Issue 2022
Summary
Global equity markets continue to be volatile, sentimental and focused on the short-term. Leading the dance is the US Federal Reserve (Fed), which is marching markets along to a tune of elevated inflation data and ever tighter monetary policy.