The impact of global events on investments
In 1919, Winston Churchill wrote how day by day 'the opposition of events' can profoundly change the challenges we face. This has rarely been more appropriate than it is now. Our investment managers have identified a number of areas where the new, more dystopian investing world is likely to change.
What the post COVID-19 investing world might have looked like before Russian tanks, artillery, missiles and planes began their onslaught on Ukraine a few weeks ago is very different to what the new realities on the ground now mean. The impact of Russian aggression has accelerated trends that were already simmering under the surface but are now bubbling furiously on top.
Global economic and investment trends surfacing in 2022
1. Interest rates rise
The onset of the pandemic saw official interest rates in most of the developed world brought down to lows never seen before – either close to zero or, in the case of Europe, well below. Before the invasion of Ukraine, we had assumed that interest rates would go back up to more normal levels, even in Europe. It was a process already underway in the US and the UK. Indeed, the market wobble early in 2022 was down to the speed at which investors had begun to factor in rate rises, driven in part by inflation that was higher and more persistent than previously anticipated.
Now that a war is raging in Europe, central bank calculations are far more complex. On the one hand, economic activity will be lower due to a shock to confidence; on the other, inflation will be higher (see below). The spectre of stagflation – weak growth and high inflation – is stalking central bank corridors. Outside of outright deflation (i.e. a decrease in the general price level of goods and services) this is one of the worst environments for policymakers.
Under these circumstances, we now expect interest rates to rise, not as far as previously predicted, but possibly to stay high for longer.
2. Continued inflationary pressures
As COVID-19 spread, inflation initially plunged. Later, as the response to the pandemic developed and people successfully transitioned to working from home or were given furlough money or direct transfers from their governments, consumers started to spend heavily on goods, typically using online retailers. This surge in demand alongside COVID-19 disrupted ports, and placed supply chains under severe pressure. Many goods became scarce, from semiconductors to building products; from new cars to washing machines. This drove up prices, in some cases very sharply.
Prior to the Russian invasion, most experts predicted that the spike in inflation would start to moderate as supply chains readjusted, consumers began to rebalance their spending towards travel and leisure rather than goods, and capacity was added to the system.
The deep shock to supply chains from the Russian invasion has seen this thinking reversed. Russia and Ukraine are major suppliers across a wide array of commodities, from wheat to crude oil, natural gas and a variety of key industrial metals. The prices of these are soaring, which means earlier hopes that inflation would start to moderate from April onwards have been dashed.
As a result, we now believe that inflation will peak much later in 2022 and at a significantly higher level, and that uncomfortable levels of inflation will persist for longer, as the impact of price rises spreads through the economy.
3. What is the outlook for bond yields?
After falling sharply at the start of the pandemic, since the middle of last year bond (fixed interest asset) yields rose strongly, as markets priced in a return to normality and robust economic growth. Now, however, the picture is much more complicated. Higher inflation argues for higher bond yields, but weaker economic activity argues for lower. We still expect the former sentiment to prevail and that bond prices are likely to remain weak.
4. Could it still be worth holding equities?
An environment of higher bond yields, persistent inflation and rising interest rates isn’t a good one for equity valuations. As a result, more highly valued areas of the market may continue to struggle until there is clarity on where interest rates may peak. The wider market is not expensive, however, and as growth moderates, we believe worries over interest rates will reduce. As a result, we still think it might be worth holding equities in portfolios.
5. Government spending, borrowing and taxation
Prior to the Russian invasion, we had foreseen continued falls in government spending as the extraordinary measures put in place to combat COVID-19 were removed. Now, however, there is clearly room for a marked increase in defence spending, while greater economic uncertainty may mean a tempering of previously announced tax rises and weaker corporate tax revenue.
This means improvements in government fiscal positions are likely to take longer to come through than expected, meaning that borrowing is likely to stay somewhat higher than previously forecast.
6. Impact on climate change transition
With Europe clamouring to wean itself from Russian energy, one result of the invasion of Ukraine could be a postponement of climate targets to enable a swift transition away from Russian supplies. By the same token, increased energy costs will make renewable alternatives more competitive against carbon-based fuels.
Investing in 2022 - confidence amid confusion
We had previously anticipated a healthy return to more normal financial market conditions: we saw interest rates moving progressively higher and bond yields rising steadily, but neither in a way likely to derail economic activity. Hence our confidence in equities persisted, even if the rotation away from growth stocks¹ into value stocks² appeared set to continue.
The invasion of Ukraine has clouded these expectations with uncertainty. Much higher interest rates are now in doubt, while inflation seems certain to rise higher and last longer than previously forecast, which argues against fixed interest assets. We have seen a big shift towards more defensive areas of the equity market while this uncertainty persists. Nonetheless, as valuations adjust downwards for the more exciting sectors, like technology, we are beginning to see glimpses of good value emerging. As awful as the events in Eastern Europe are, the volatility such times cause often throws up investment opportunities for those brave enough to seek them out. While we recognise that this may be a deeply concerning time for investors, history supports our continued belief in equities.
If you have any questions or concerns about how you can navigate this period of uncertainty and higher inflation, please get in touch with us. Our wealth managers would be very happy to discuss your options with you.
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Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.
The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.
This is not a recommendation to invest or disinvest in any of the companies, themes or sectors mentioned. They are included for illustrative purposes only.
The information contained herein is based on materials and sources deemed to be reliable; however, Canaccord Genuity Wealth Management makes no representation or warranty, either express or implied, to the accuracy, completeness or reliability of this information. Canaccord is not liable for the content and accuracy of the opinions and information provided by external contributors. All stated opinions and estimates in this article are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information.
¹Growth stocks are companies that are expected to deliver better than average organic revenue and earnings growth over the medium term.
²Investors looking for ‘value’ seek out stocks which they believe have been undervalued by the market and are trading for less than their intrinsic worth. They are viewed as trading at a lower price than justified when measured against metrics such as earnings, profit margins or sales.
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Investment involves risk and you may not get back what you invest. It’s not suitable for everyone.
Investment involves risk and is not suitable for everyone.