Equities and bonds went down again in August. The month started positive but turned negative in the last days of the month following a meeting of central bankers in Jackson Hole, Wyoming.
*As at 31.8.2022
So, what happened? In our view equity markets had gotten ahead of themselves since their low point in mid-June. Central bankers have now come out very strongly everywhere saying they will do what it takes to cool inflation even if that means causing pain for economies.
Equities (MSCI ACWI local currency): 1.1.22 to 31.8.22
It was particularly noteworthy that one of the “lessons” the Fed chair, Jay Powell, referred to in his speech was the need to manage inflation expectations. He quoted Paul Volcker (a former Fed chair credited with taming very high inflation in the US in the 1970’s and early ‘80s) who had said “inflation feeds in part on itself… so part of the Fed job is to break the grip of inflationary expectations”.
This is important. Central bankers understand that the current inflation problem is not just demand driven. After all rising interest rates in the EU will do little to lower inflation when a big driver of inflation here is energy prices.
While the market might have expected Central bankers to pause or even reverse interest rate increases as economies weaken, the clear signal now is that they will keep raising interest rates until something breaks! This is a very hawkish stance by central bankers.
So, rates will continue to go up. The ECB will raise rates again on the 8th of September – the question is whether it will be by 0.5% or possibly by more.
Euro & US dollar Parity
The other notable move in August was the fall of the Euro, reaching parity versus the US dollar. The weaker Euro is more bad news for Euro area inflation as imports cost more (remember gas and oil are both priced in US$). On the plus side, our clients who own US equities on an unhedged basis have enjoyed a positive currency return of circa +8% when they translate those US assets back into Euros, somewhat offsetting the falls in equities over that time.
Wholesale electricity prices in Europe are now over 10 times higher than the average over the five-year period prior to 2021. This huge increase, which is now feeding into household and company energy bills is simply unsustainable and, in our view, will surely force governments to intervene in some way.
Natural gas is a key driver of electricity prices in Europe. Russia, who is the major supplier for Europe, has weaponised the supply of gas. They had curtailed supply to 20% of normal capacity of the Nord Stream 1 pipeline but in recent days stopped supply altogether.
We are now at risk of governments needing to ration supplies over the winter, notwithstanding that the likes of Germany are currently ahead of schedule in filling up storage ahead of winter. We can hope for a mild winter to help but it may not be enough.
Acuvest’s investment committee meets at least four times per year. The meeting is held over two days and is an opportunity for us to look at market information and listen to the views of global managers. This time around we heard from two large global assets managers: Blackrock who manage $10 trillion of assets and Schroders who manage just under $1 trillion. The summary coming out of our recent meeting, taking on board external views and the views of our investment committee, is as follows:
- Difficult times ahead as we face into the winter amidst a potential energy crisis.
- Central banks raising interest rates notwithstanding that economies are slowing and likely to slow further.
- Recession is now almost a given for markets. The question is how long will it last and how deep will it be?
- The jobs market is still tight, but this will likely change.
- Long-term indicators of inflation still pointing to inflation coming back into line. While we will see inflation fall next year for some technical reasons our sense is that actual inflation may prove sticker than authorities would like. Quite simply energy costs feed into almost everything else and it will take time for Europe to build alternatives sources of supply. Long-term Europe needs to prioritise energy security, something it clearly has failed to do up to now.
The question then – given that equity markets are forward looking – how much of this is already in the price? It seems to us that markets like to be optimistic, and we also know that long-term the gravitational pull for equities is upwards. We don’t know if markets will retest the lows of mid-June but there are dark clouds overhead and the resolve of central banks to break inflation is causing markets to reassess as I write. As a result, we are currently observing bonds and equities going down again. Expect volatility to continue!
For short-term investors, this is not a market to be in but for our clients who are long-term investors, we continue to advise them to follow their plan and use market weakness to build on positions.
John Tuohy is Chief Executive of Acuvest, an Irish-owned, independent advisory firm specialising in wealth management, pensions, and investment advisory services for individuals, companies, pension schemes, charities, and institutions. John is a Chartered Financial Analyst (CFA) and a Fellow of the Chartered Association of Certified Accountants.