Market update – April 2022
Equities rebound despite rising inflation and higher bond yields.
Russia fails to achieve a quick victory
As the conflict in Ukraine enters its second month, there are signs that Russia and Ukraine may be moving closer to a negotiated settlement. This remains far from certain, however, and there has still been little improvement on the ground. Cities and towns have been destroyed and the humanitarian crisis worsens by the day. The global economic burden is also becoming clear, with higher energy and food prices creating cost of living crises in many countries around the world. Despite the additional pressure on consumers and businesses, equity markets have rebounded, though remain slightly below recent peaks. There has been greater volatility in bond markets, with yields moving sharply higher as central banks signal their commitment to raising interest rates to tame inflation.
Worrying signals from bond markets
Historically, high inflation and rising interest rates have preceded economic contractions. Bond market investors are becoming increasingly concerned this will be the case again. Shorter-dated US treasury yields have risen quickly, with the two-year note now yielding 2.3%, compared to just 0.3% six months ago. Longer-dated bond yields have also risen, but not by as much, reflecting concern about the longer-term growth outlook. Investors are now on the look out for yield curve “inversion” which is often regarded as a signal that a recession is on the way. While the risk of a slowdown is higher than it was, we do not expect a recession in the US over the next year. This is based on our view that savings accumulated during the pandemic will provide consumers with a significant cushion to absorb higher costs. Schroders' economists estimate these savings at $2 trillion in both the US and Europe.
Renewed focus on energy transition
The invasion of Ukraine has exposed the flaws in an energy system that is still very dependent on autocratic regimes. This is especially true for Europe, which imports roughly half of its gas and a quarter of its oil from Russia. Just two weeks after the invasion, the European Commission announced a high-level plan to become fully independent from Russian fossil fuels by 2030, with much of the reduction to come this year. This call to “accelerate the clean energy transition” will boost the long-term demand outlook for many companies involved in renewable power and electrification. However, the near-term outlook for these industries could remain challenging as companies grapple with supply chain bottlenecks and rapidly rising raw material costs.
Recent developments have raised the risk of stagflation – a period of high inflation and low or negative growth. We have therefore made some adjustments within our equity allocation. We have sold a Europe ex-UK growth fund, given that European economies are likely to face the greatest pressure from high energy prices alongside our desire to increase the "quality" bias within portfolios. We have also reduced our allocation to funds focused on small and mid caps, tilting portfolios towards larger companies with stronger balance sheets and greater ability to pass on cost increases. We maintain our underweight position in conventional fixed income, which has served us well as yields continue to rise. We prefer to diversify portfolios using alternative assets such as gold, broader commodities and absolute return funds.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.