For financial professionals only
The stories and images of suffering from the Russia/Ukraine conflict are horrifying and utterly abhorrent in today’s world. Our deepest sympathies and thoughts are with all the Ukrainian people.
The growing humanitarian crisis demands a diplomatic resolution urgently, but its political origination means drawing confidence in any outcome is prone to a high degree of error. We monitor developments closely to understand what is discounted in markets and frame investment decisions in line with our long-term investment philosophy.
The anticipated monetary tightening by central banks assumed by markets since the start of the year has notably eased, as seen in the chart below. In the US, just under 5 interest rate rises are now priced in for 2022, while previous expectations were close to 7. In the UK, this has moved from over 8 rate rises to less than 6.
Source: JP Morgan
Consensus GDP growth assumptions for 2022 were above 4% in the US, UK and EU before the Russian invasion. But significantly higher energy and commodity prices are acting as a tax on consumption, leading to widespread downgrades by economists. At this stage, these forecasts are little more than best guesses, but they illustrate the changing sentiment amongst investors.
Inevitably, inflationary fears are rising with growing expectations that peak inflation will now be over 8% in both the US and UK. There’s increased political pressure on the Fed to get a firm grip on this, as real disposable incomes get squeezed. The recent wage growth of 5.1% fails to keep pace with inflation, causing increasing angst amongst the electorate. With mid-term elections coming up in November, the Fed has the unenviable task of balancing firmness on inflation without undermining economic growth. This is far from easy. For now, looking at the 3 and 5 year forward inflation expectations chart below, investors believe the upward pressure on prices is inflationary in the short-term but deflationary over the longer-term, with forward inflation staying close to central bank targets.
Source: Alpine Macro 2022
With a number of central banks meeting in the next two weeks, investors will learn more about where their priorities lie, namely supporting growth or controlling inflation. It’s often said “the best cure of inflation is inflation”. As discretionary consumption gets pared back and corporate investment eases, central banks can be expected to show a greater tolerance of the upward inflation drift to avoid curtailing economic growth activity. If this doesn’t turn out to be the case, further market weakness and volatility can be expected.
As advocates of long-term investing, it’s important to remember that in recent geopolitical risk off periods, market weakness has tended to be short-term, as seen in the table below.
Source: JP Morgan and Deutsche Bank
Despite the elevated levels of uncertainty, we continue to encourage investors to remain invested, as missing vital strong market rebound periods will impact long-term portfolio outcomes. Yes, the outlook is deeply concerning with Russia as an important commodity exporter driving increased fears of a looming cost of living crisis. But the unity and resolve shown by NATO and the EU points to a determination to get through this and overcome the terrible plight being inflicted by the Putin regime.
With governments expected to support those in greatest need, a recession may well be averted, though if central bankers tighten monetary policy too much and too quickly, it remains a real possibility.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.