24 May 2022
Equity markets experienced ongoing instability last week, as economies continued to battle with inflation.
In the UK, the Office for National Statistics (ONS) disclosed that CPI Inflation soared by 9.0% in the 12 months leading up to April 2022 – the highest rate recorded in four decades.
The Bank of England (BoE) has forewarned that inflation is set to continue to rise in the near-term – possibly even breaking 10% this year.
The FTSE 100 has counted among the most resilient markets so far this year, yet it declined by -0.4% over the course of the week.
Oliver Wayne, Senior Vice President – Manager Research, at investment consultancy Redington, detailed why high inflation can be problematic for equities:
“Inflation presents challenges for companies. It impacts their sales, margins and the multiple they trade on. It erodes consumers purchasing power, which reduces their ability to spend, which impacts company sales. It increases costs which reduces margins.”
Wayne states that the current environment will potentially witness a different style of shares perform better:
“In low-inflation environments, value style investing has underperformed the market, which is what we have experienced over the last decade. However, in high-inflation environments, defined as over 4.4%, it has meaningfully outperformed the market. This shouldn’t surprise us because these value companies are by definition lower duration investments where you own more levels of cash, earnings and assets for every pound invested.”
This scenario serves as a useful reminder of how crucial it is to diversify – those keenly focused on one style of investing might fare well in certain circumstances, but could otherwise find themselves in difficulty once the market changes. An individual heavily invested in tech stocks will no doubt have had a difficult year, with the likes of Apple, Alphabet, Microsoft and Tesla all down over 20% year-to-date. This is precisely why we look to invest in a range of shares and asset classes, to help balance out some of this instability.
It is also an important reminder of how valuable active managers are, as they can identify such trends, and invest accordingly.
In the US, a dismal economic outlook saw equity markets retreat once more last week. The S&P 500 dropped by -3.1% after Federal Reserve Chairman Jerome Powell shared that the Bank is ready to take action, if needed, to tackle inflation. The S&P 500 has now slumped for seven consecutive weeks – its worst run since 2001.
This comprised a 4% drop on Wednesday – its largest one-day drop since the pandemic broke out in March 2020, as large traditional retailers Target and Walmart both fell after posting discouraging results.
Unemployment data released towards the end of the week only added fuel to the fire, in that it revealed 218,000 initial jobless claims – nearly 20,000 above expectations. The ensuing concern was that the US might experience a recession this year.
Since the beginning of 2022, both the S&P 500 and NASDAQ have been markedly down. Investors may well be fearful about this short-term volatility, yet it’s important to remember that ups and downs are part and parcel.
Adrian Frost, from Artemis, notes:
“Since 1957, a five-month decline of over 15% in the S&P has led to a median return a year later of +20% (though not in 2001 and 2008).”
Indeed, past performance isn’t necessarily significant in terms of future performance. However, this statistic rightly demonstrates that, while the notion of leaving the market during tough times might be appealing, periods of heightened instability are but temporary, and exiting the market could mean missing out on any bounce effect at the end of it.
Dan O’Keefe, Lead Portfolio Manager at Artisan, observes:
“We have the tendency to look into the market at times of extreme volatility and feel that things are highly uncertain. But they’re equally uncertain at any point in time, and equally as unknowable as any other point in time. When the market is volatile, and stocks are going down, it’s an unpleasant experience.
“But in my 25 years of investing, one thing just continues to ring true, and that is when things feel very bad and unpleasant, it’s usually the right time to be allocating capital. And that’s usually when the greatest returns (prospectively), will be earned. And it’s not easy to do, but it requires discipline. And I think that’s a lesson that everyone needs to keep in the forefront of their minds in times like this.”