Another month, another uptick in inflation on both sides of the Atlantic. In the US the headline rate was forecast to fall a bit and the higher-than-expected number was a nasty surprise for markets. In the fight against inflation, the US Federal Reserve was in the vanguard, delivering its first 0.75% rate hike since 1994.
The surge in inflation to 40-year highs in Europe and the US is forcing central banks to tighten monetary policy aggressively at a time when real economic growth is already losing momentum. Shares and bonds sank on the worries, with misery compounded by reimposed Covid restrictions in China and peripheral European bond market concerns. Remarkably, it has been the worst first half of a calendar year for the market (using the US S&P500 index) since 1970.
Summer of discontent
The ongoing surge in energy and food prices, coupled with still severe supply constraints, is dealing a major blow to the economic outlook. High energy and food erode the real purchasing power of consumers, which in turn starts to squeeze corporate activity and profits. Combined with higher interest rates, which mean increased borrowing costs and the chances of economic contraction are increasing.
For some, the current mood evokes memories of the 1980s when Fed chair Paul Volker didn’t hesitate to tip the US economy into recession as he tried to defeat stubborn inflation. There are some tentative signs that price rises might be losing momentum. Home sales are slowing down as higher mortgage rates start to take their toll, second-hand car prices are in retreat, various commodities have started to fall away from highs, and even some shipping rates have come down a bit after months of elevated costs and a shortage of capacity. Yet Fed Chair Jerome Powell has stated he needs to see firm proof higher rates are working before he eases off the brakes.
The US is at least expected to see an earlier peak in inflation than other countries, during the third quarter of this year. The UK is likely to experience a double peak in inflation due to the increase in the energy-price cap in October 2022, while energy supply remains a risk, particularly in the European Union. We believe a return to the 2% inflation target in most developed economies is unlikely within the next two years. Instead, central banks will regard inflation as being under control if it returns to the low single digits (2% to 4%). At the same time, we expect growth to slow with a high chance of some economies experiencing a shallow recession.
China on top
With most markets in retreat, the one bright spot came from China where shares bounced following an awful run. The Chinese authorities indicated a more supportive stance towards business and markets, having become more interventionalist towards listed companies over the past year, looking closely at issues such as competition, data protection, consumer rights, employee rights, and wellbeing. The sentiment was at such a low ebb that an apparent softening was enough to produce a strong rally, which overcame worries about a potentially shaky recovery from Covid-19 lockdowns.
The latter perhaps explains a sharp decline in the price of copper, often seen as a bellwether for economic health, and perhaps a broader, global slowdown under the surface. Indeed, concerns over slowing global growth have started to take their toll on the previously strong energy and mining sectors with investors looking for an inflation hedge having second thoughts as the risk of recession, and ultimately falling demand looms larger.
The main positive we can take right now is that so many appear to be sceptical and bearish. Google searches for the term ‘recession’ have surged to an all-time high. Yet with markets still trying to come to terms with how far interest rates might rise, and how deep any recession might be, headway may be limited for the next few months at least.
Although investors should be aware past performance is not a reliable indicator of future results, here are the top and bottom ten Investment Association (IA) funds and sectors* for June 2022 in full:
Top 10 funds:
Bottom 10 funds:
Top 10 sectors:
Bottom 10 sectors:
Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, data for June 2022: 31/05/2022 to 30/06/2022. Onshore and retail open-ended funds only.
*There are several thousand funds on sale in the UK. The Investment Association divides these into over 40 sectors, broad groupings that help investors and advisers compare funds of similar types before looking in detail at individual funds.
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