The timing seems appropriate to comment on the ongoing volatility we are currently experiencing in global markets. The shock of the invasion of Ukraine by Russia is still being felt and will continue to be so for a prolonged period by the look of it, but this is not the only, or even the most negative, headwind the world economy is facing at this time.
There are three main themes that are playing out simultaneously and they are inextricably linked.
Global Inflation
The impact on the global economy of decades high inflation is the primary investment concern we are facing at present. The potential for elevated levels of inflation post-Covid was not unexpected, bearing in mind the excess liquidity pumped into the World Economy by Governments and Central Banks. The rationale for the support made perfect sense when Covid first appeared but there was always going to be implications with that amount of liquidity being transfused into the real economy. When the world economy started to tentatively re-open in the Summer of 2020, supply and demand imbalances, due to supply chain disruption, led to higher prices and this looked like it would be an ongoing issue unless the global supply chain was able to normalise fairly quickly. Ongoing lockdown restrictions, as Covid variants came to the fore in 2021, did not allow for that normalisation in supply chains to take place, which has caused inventories to be depleted significantly, which in turn keeps prices elevated.
Central Banks, primarily the Federal Reserve and the Bank of England, are tightening monetary policy to try and address the elevated inflation we are facing. The balancing act they have to achieve, to bring about normalisation without creating recession, is a difficult trick to pull off and policy mis-steps can occur if the pace of tightening is too aggressive. It may well be that the fear of creating a recession will actually be a catalyst for interest rate policy to be more measured than initially assumed. The slowing of headline inflation in the US indicates that July might signal a reduction in the rate of interest rate tightening. It is important to caveat this comment by saying that real time data will determine the eventual decisions made. At present the view being expressed by many Economists is that there is a 25%-30% chance that the US will go into recession in 2023/24. A more positive way to assess that view is that there is a 70-75% chance that the US will avoid recession.
As last weeks Consumer Prices Index (CPI) figures illustrated, inflation in the UK is still rising and could potentially reach 10% by the last quarter of 2022. Consumer confidence levels are lower which in normal times may have helped to curb spending and help in the battle against inflation. This time round the inflationary pressure is not coming from discretionary spending but rather from food and shelter costs. Just like the Fed, the balancing act for the Monetary Policy Committee of the Bank of England is to navigate a reduction in inflation and avoid a recession at the same time.
The Russian invasion of Ukraine
2022 was expected to be year when a normalisation of the global economy finally took hold. Just as the year started the situation on the Ukraine – Russian border started to become something that demanded attention. It would be fair to say that the invasion caught most people on the back foot. The human tragedy of what is unfolding is terrible to see and the hope that diplomacy would prevail and bring hostilities to a quick end has shown to be unrealistic. Sanctions are crippling the Russian economy but are also having an impact on the global economy. Ukraine is a significant exporter of wheat, barley and other fundamentally important crops and base metals. The inability to harvest, mine and ship these basic goods is feeding into the inflation spiral.
Russia is also a significant provider of oil and gas to many European countries and it is not a simple strategy to try and replace Russian oil and gas from somewhere else at short notice. The squeeze on energy prices due to relatively low strategic reserves has contributed to the significant rise in the cost of living being experienced across the World, which in turn is feeding into the significantly elevated inflation we are witnessing.
There is no clear end point to the conflict in Ukraine and whilst this is the position there will be an ongoing impact on the global economy in economic terms never mind the humanitarian and geopolitical impact it is causing.
China- Zero Covid Policy
The policy being adopted by the Chinese Government to lockdown areas where Covid infections are being reported is having a detrimental impact on the Chinese economy. Economic data released last week points to slower growth with retail sales and industrial output lagging. The current policy is exacerbating supply chain disruption which in turn feeds into global inflation being pushed higher.
The Government are trying to stimulate the economy by instructing the People’s Bank of China (PBOC) to cut their five-year loan rate with the aim of stimulating the housing market and, in turn, the wider economy. Indications are that further stimulus will be deployed as felt relevant as President Xi is due to be re-elected this year and will want this to happen against a backdrop of China achieving its stated GDP growth target of 5.50% in 2022.
In summary we feel that volatility will continue to be a feature of investment markets in the short-term. We know that Central Banks are committed to the task of reducing inflation, even at the cost of a mild recession being created.
Corporate fundamentals still look positive and despite the dire warnings about consumer discretionary spending contracting due to the cost of living squeeze, this has not been reflected in the actual data that has been published thus far. As evidence of this, retail sales volumes in the UK and the US rose more than expected in April. Share prices could continue to whipsaw in the short-term based on positive and negative news-flow, so the best way to trade this type of market is to stay invested to be in the best position to benefit from the positive days when they come. Time in the market has always proven to be a more sensible investment strategy than timing the market. Our advice would be to stay invested and allocated to multi-asset investment portfolios that give you the best possibility of making money over the medium to longer-term.
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