A relaxed read on the issues of the day
For investors who had been left feeling bruised by the opening months of 2022, May offered some respite. The declines in global equities slowed and most regions ended the month fairly flat. For UK investors, the domestic equity market rose and most overseas equity regions also offered a positive return, although not the US, where moves in the exchange rate left Sterling investors down at the end of the month.
The overriding challenge facing markets now is the difficulty central banks are facing in trying to tackle high inflation without destroying economic growth. Labour markets have been strong across the UK, continental Europe and the US, but there has been a deterioration in consumer confidence and business surveys have indicated economic weakness. In the first quarter businesses were reporting strong earnings but more recently we have begun to see profit warnings in some high-profile US businesses that have begun to struggle with supply chain disruption and rising costs. Some of those businesses have indicated that where they can, they intend to pass on increased costs to consumers through higher prices. In the UK, growth has already shown signs of stalling and the risk of recession continues to rise, both at home and overseas.
Both the Federal Reserve and the Bank of England pushed ahead with interest rate rises in May, although as investors were expecting these moves there was minimal disruption to bond markets as bond prices had already adjusted. The market also anticipates interest rate hikes in June and July.
So far in 2022 markets have been making a painful adjustment to higher inflation, requiring the prices of both bonds and equities to reset. The moves have been most pronounced in government bonds, which see the largest price falls when inflation and interest rates rise, but other types of bonds have also been affected. In equities, businesses that fare best in an environment of rising interest rates and inflation have begun to perform for the first time in a decade, while those that are more sensitive to these conditions have begun to lag, having driven equity market returns in previous years.
In portfolios, we believe the best approach is to keep risk to minimum levels and to tilt exposure within equities and bonds towards those parts of the market that benefit from (or are least affected by) the turbulence. We expect markets to continue to be challenging over the coming months until inflation starts to come under control, however, we are encouraged that some opportunities are opening up, although in the short-term headwinds remain.