A relaxed read on the issues of the day
UK and global equity markets have recorded strong returns over the last three months, although as is often the case in sport, the final score doesn’t tell us everything about the match. The emergence of the new omicron covid variant at the end of November led to a spike in market volatility, which continued into December. Markets began to settle again as data emerged indicating omicron is less dangerous than its predecessors, with investors also willing to take advantage of the market falls to move money off the sidelines, buying in at lower levels.
December also saw a change in tone from central banks, as both the Bank of England and the Federal Reserve expressed concern about inflation. The BoE raised UK interest rates to 0.25%, much to the irritation of bond markets, which had been prepared for a rise in November and disappointed by the BoE’s delay. The BoE, which had been waiting for new employment data after the end of the furlough scheme, got a green light to raise rates as furloughed workers had found new positions with ease. Meanwhile in the US, with inflation running close to 7%, the Fed has opted to accelerate the wind-up of its quantitative easing program. This had been expected to end in June 2022, but will now finish at the end of the first quarter, allowing the Fed more flexibility on interest rate decisions thereafter.
Some of the big contributors to inflation in 2021 (used car prices, energy) are expected to be less significant in 2022, but central banks are wary of some types of inflation, eg housing, which have been creeping up and tend to be ‘stickier’. With close to full employment, there is also the risk of higher wage inflation this year.
As central banks in the UK, US and Europe all look to withdraw stimulus, China’s central bank is moving in the opposite direction. Having withdrawn stimulus early in 2021 and with government regulations slowing the economy and deterring investors, China has been prompted to change course and has begun to increase stimulus, which could improve the prospects for equity investors in the region.
Overall, equity asset classes continue to be preferred to bonds, with portfolios tilted to reflect this view. The current environment of inflation and interest rate rises presents a sizeable headwind for bonds and the challenges of last year look set to continue into 2022. As we enter a new year, developed market equities are no longer at bargain levels, but there is scope for businesses to keep growing their earnings, which may support further returns. Chinese equities (and by extension, Asian and emerging markets) are on more appealing valuations and with the support of easier financial conditions, have the potential to perform well this year. With some volatility expected along the way, our preference is to retain a broad spread of assets and diversify portfolios wherever possible.