Market situation: background, analysis, impact on the portfolio’s
The world has changed profoundly, in a brief period. Today, we live in a context of exceptionally high inflation rates, interest rate hikes, a tightened money supply, disrupted supply chains and a war. Stock markets have to digest the fresh news day by day. This creates nervousness and volatility. The long-term investor's challenge is to look past those temporary uncertainties.
- Inflation and higher interest rates put sticks in the wheels of economic growth
- Equities and bonds go down in solidarity
- Outlook for 2022 and 2023
- Managing your portfolio: volatility creates smart buying opportunities
Inflation and higher interest rates affect economic growth
Inflation rates remain very high. After a surging post-covid demand and continuing supply-side problems, the war in Ukraine makes things worse. The peak of inflation may be pushed towards the second half of the year. There is a good chance that by 2022 European inflation will be well above the 2% mark (the ECB target).
The central banks will use their monetary policy to curb inflation, preferably without excessively impeding economic growth. The Fed is taking the lead. It raised its base rate by 25 basis points for the first time in mid-March. In early May, it raised its rates again, this time by 50 basis points, to a level between 0.75% and 1%. Such a strong move has not occurred in 22 years. The Fed also announced to reduce its (huge) balance sheet, by not reinvesting all bonds at maturity. The ECB will accelerate its bond purchases and stop them in the third quarter. There, too, more voices are calling for faster interest rate increases, namely in June.
The engines of economic growth are slowing down: high energy prices and supply problems are depressing consumption, rising interest rates are dampening investment, the war in Ukraine weighs on household and business sentiment. In the US we saw negative growth quarter-on-quarter, for Europe it remained positive for the time being. China, still struggling with the coronavirus, will see its economy slow down as well.
Equities and bonds suffer losses
The stock markets are very volatile these days. Technology stocks (particularly in the US, Nasdaq in euro terms down 19% since the beginning of the year) and European stock markets (-12%) are suffering from interest rate and growth fears. The stock markets in China take a dive as well: the MSCI China index fell 19%. Over there, fears of faltering economic growth are increasing as major cities such as Shanghai and Beijing are plagued by covid outbreaks, causing them to go into lockdown to a greater or lesser extent.
Bond markets are also hit hard, because of the faster or more substantial interest rate hikes by central banks in response to rising inflation figures. Both corporate and government bonds are down, with interest rates rising in both segments.
Outlook 2022 and 2023
Currently, stock market sentiment is very negative, and is dominated by uncertainty. High inflation, the negative effects of the Ukraine conflict and the precarious situation in China are putting stock markets under high stress. When will come the tipping point, and will sentiment turn positive again? At some point the market will see a return to normalcy. It is certain that normalization will come. The big unknown, however, is when. Visibility into the near future is very limited due to the exceptional situation we are in, post-pandemic and during a war. Every news event and every figure that comes out is therefore judged with great scrutiny. It takes an extra dose of discipline as a long-term investor to look past those temporary uncertainties and tensions.
What are the expectations for 2022-2023?
- Inflation: remains high in 2022. The peak is expected in the second half of the year. In 2023, the average inflation rate should normalize, to 2-3%.
- Interest rate policy obviously follows inflation. The current strict stance of central banks is aimed at bringing the high inflation rate quickly under control. The market takes into account that the Fed will stop its interest rate hikes during 2023.
- Economic growth: growth expectations for 2022 were revised downward due to exceptional inflation, the war and supply problems in China. The question is whether the slowdown will become a recession. Year on year, growth rates in the major economies are still positive (2.7% global growth for 2022), but a local recession cannot be ruled out (two quarters of negative growth). Looking ahead to 2023, the engines of economic growth should kick in again: global growth of 3.7% is in the cards.
- Corporate earnings: were generally better than expected for the first quarter of 2022. Families and businesses began to consume and invest again, armed with a fair amount of cash they had saved during the corona years. High employment figures also bolstered confidence. Earnings expectations for all of 2022 also look good for most companies.
In summary, 2022 will be an exceptional year (again) in many respects, and the situation in terms of inflation and growth should normalize in 2023. As soon as there is more clarity on the timing of this ‘return to normal’, optimism is very likely to return to the stock market.
Managing your portfolio: volatility creates buying opportunities
The market has already priced in many uncertainties but remains highly volatile. Our fund manager, Cadelam, is sticking to its long-term vision and will not be thrown off balance by short-term crises. What does this mean in concrete terms?
Exposure to the Russia-Ukraine region is negligible.
Direct exposure to China was sharply reduced last summer, from roughly 8% to barely 4%.
Cadelam is taking advantage of the current high volatility to pick up quality stocks at lower prices. For example, some growth stocks have corrected sharply since October 2021 and now offer buying opportunities for companies that match Cadelam's convictions on long-term themes. They prefer companies with strong brands that can pass on price increases to their customers. Purchases are very diversified.
Equities are the best way to protect against inflation in the long term. Therefore, Cadelam remains overweight in equities.
The optimal diversification of the portfolios (more than 200 companies across sectors and regions) creates greater resilience.
The interest rate sensitivity of the bonds remains relatively low (4.3 years duration)
Rising interest rates put pressure on bond prices. Even so, we know that the prices of the existing bonds in the portfolios will eventually evolve back to their original levels – unless the issuer is no longer creditworthy. In case of our portfolios, that seems very unlikely, as Cadelam chooses very creditworthy and highly liquid bonds. Therefore, it would not make sense to sell the bonds at a loss today.
Let us not forget there is also a positive side to the higher interest rates: the new bonds in the portfolios now enjoy higher yields, and this benefits the portfolio's return, also for the more defensive investor.
Contact your relationship manager
When you invest in the stock market, you know that price fluctuations, upwards and downwards, are inherently linked to equities. Share prices react to the latest information, and when there is a great deal of uncertainty, this reaction can be fierce.
Inflation, interest rate hikes and the conflict in Ukraine weigh on returns in recent weeks Nevertheless, we must not lose sight of the long-term perspective. History shows that abrupt panic responses to crises usually do not pay off. Those who exited the stock market in March 2020 or in the fourth quarter of 2018 missed a fantastic stock market ride. Keeping calm and maintaining a long-term perspective is the best strategy in the long run.
On the other hand, if you are feeling anxious or uncertain about the current stock market situation, this is a good opportunity to have a word with your relationship manager. So, feel free to get in touch.