During 2021 there was a lot of focus on inflation, especially in the United States. Market participants didn’t just debate whether inflation will be high or low but they also focused on whether it will be transitory or more persistent.
The latest US inflation numbers came in at 7% - its highest level in 40 years. Higher inflation is normally countered by an increase in interest rates but before the FED can start raising rates, they will have to reduce the amount of bonds that they buy on a monthly basis. Currently the market is expected that the FED will stop with their bond buying program at the end of March. The market is also pricing in four rate hikes before the end of the year.
The above speaks to tightening financial conditions for the US economy, something that the market didn’t need to worry about since the Global Financial Crisis in 2007/08. The equity market sell-off gathered momentum during the last week as investors became more worried about the knock-on effects that these conditions may have on highly valued companies.
Technology companies, which were the darling of the market after the COVID sell-off, lost more than 10% of their value since the start of the year. These companies have a large market capitalization and therefore they contribute a lot to US indices. The S&P 500 lost 8.6% since the start of the year and the tech-heavy NASDAQ is 13.46% negative. The rest of the world’s equity markets are also under pressure.
Another factor that explains the movements in the last few weeks is the tension between Russia and Ukraine. A potential invasion of Ukraine by neighbouring Russia would be felt across a number of markets, from wheat to energy prices, the region's sovereign dollar bonds to safe-haven assets and finally stock markets. Although no one is sure how this will play out, one thing is certain and that is that more uncertainty is created in the markets.
Investors may be concerned that these events may point to the end of the bull market. Optimum believes that there are still opportunities in global equities. The chart below shows the 10-year correlation that certain sectors have to a change in bond yields.
Our portfolios are already tilted towards sectors that might benefit from higher yields. These are the sectors that are normally able to increase profits during a higher interest rate cycle.
Optimum Invest Team