The US Federal Reserve and the Bank of England both raised interest rates by 0.25% during March in response to soaring inflation and tightness in labour markets, and they face a headache in the months ahead. Inflation is likely to remain stubbornly high, exacerbated by Russia’s invasion of Ukraine, which has sent the prices of vital resources on a wild ride. The price of a barrel of oil increased from around $90 before the invasion to over $130, but has since fallen back. It has been a similar story for many industrial metals and agricultural commodities.
Policy makers' conundrum is that elevated energy prices could seriously dent consumer confidence, particularly if petrol stays expensive and borrowing rates go even higher, so the central banks won’t want to compound the problem by raising rates too quickly and risk a recession. But if they do too little then inflation could embed itself, risking a vicious cycle. The most important factor will be wages as workers try to outpace inflation in negotiations, something our strategists are keeping a close eye on.
The outcome seems finely balanced. Sadly, we may not see a swift and peaceful resolution to the conflict in Eastern Europe and the harrowing scenes of the humanitarian crisis unfolding there. If negotiations continue to stutter it could mean high commodity prices continuing to impact inflation and growth for some time. In any case, sanctions on Russia are likely to remain for as long Putin remains in power. Some are even worried about the return of the 1970s economic monster, ‘stagflation’ – high inflation and stagnant growth, or worse – though data suggests the US economy in particular seems to be powering on for the time being.
Ultimately, we see only echoes of the 1970s era. After a peak in mid-2022, we anticipate overall inflation will most likely ease as supply-chain holdups smooth out and labour-market participation rises. Our base case assumes central banks will gradually and carefully tighten financial conditions, and will be assisted by far less alarming inflation numbers as the year progresses, but as interest rates rise and conditions tighten it remains a tricky backdrop for investors.
After a difficult February, some market confidence returned during March. European stocks have now recovered almost all of the roughly 10% drop that followed the invasion of Ukraine, although both American and European indices are still down between 5% and 8% year to date. The UK market is the outlier, still slightly up over the first quarter of the year, assisted by its large energy weighting.
With the odds of inflation persisting at a rate higher than we have become used to, there is a growing case for asset classes and strategies with the potential to protect against or take advantage of inflation. Direct beneficiaries in the form of commodities stocks certainly had a strong period over the month, building on February's gains. As well as energy and mining specialists, precious metals funds were resurgent as underlying commodity prices made further ground in many cases. Meanwhile, Latin American equites, a significant component of which is represented by the commodity complex, were buoyed.
Other areas seen as resilient to inflation fared well too. For instance, infrastructure assets which tend to have some inflation linkage or otherwise some pricing power built into revenues, attracted investors. Healthcare stocks were also in favour owing to the non-discretionary nature of spending in that sector and the relatively low impact of rising commodity prices on input costs.
In contrast, government bond markets remained weak with yields – which move inversely to prices – higher in anticipation of the continuing tightening of major central bank policy. The 10-year US Treasury yield hit 2.5%, its highest level since May 2019. Shorter-dated bonds – which are sensitive to the path of short-term interest rates – came under the most pressure. Longer-term bond yields have also risen given uncertainty about how long inflation will remain a persistent problem.
It was also a poor month for Chinese equities amid a surge in new cases of Covid-19 in Hong Kong, Singapore, South Korea, Thailand and parts of mainland China. Hong Kong and some other Chinese cities have been in lockdown once again with vaccination programmes not as comprehensive and as successful as in the leading western countries. This has caused significant disruption to production and has worried markets about interruptions to supply of components to manufacturers and has added to congestion in ports.
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 March 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 February 2022: 28/02/2021 to 31/03/2021. 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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