FINANCIAL ADVICE CENTRE NEWS
Your Winter Newsletter 2022
Market Overview
The fourth quarter of 2021 picked up much where the third quarter ended, with COVID-19 and inflation dominating markets. The two themes were inextricably linked; the pandemic continued to disrupt global supply chains, which then impacted the costs of goods and services. On the demand side, price pressures were also evident, and were again linked back to the recovery from the pandemic-induced recession (in the UK for example, the furlough scheme protected the labour market from the worst of the pandemic). Therefore, consumer demand remained higher than it would have during previous recessions. This combined demand-supply dynamic has led to the higher inflation rates that are currently evident.
US Inflation
In the US, inflation as measured by the Consumer Price Index (CPI) reached 6.8% in November, a level not seen since the early 1980s. However, back then the US was in recession, whereas fourth quarter estimates for gross domestic product (GDP) were on an improving path after the more downbeat third quarter. Forecasts indicated that US GDP would grow 6% on a quarterly basis to end 2021, and that growth would stay above its average trend in the first half of 2022. While the prospect of heightened inflation remains a key risk for markets, this risk should be mitigated to a large degree provided economies continue to grow. As it stands, the possibility of a slowing US economy coupled with high inflation, or ‘stagflation’, should be averted.
UK Inflation
In the UK, prices accelerated considerably in the fourth quarter. CPI inflation reached 5.1% in November, the highest level since September 2011. The contributions to inflation were broad-based, and therefore could not be pinpointed to any single ‘reopening effect’ after lockdown restrictions were eased. Nevertheless, the Office for National Statistics described base effects as playing a significant role, given how low prices were during 2020 at the height of the pandemic.
The inflation spike prompted the Bank of England (BoE) to be the first major central bank to raise interest rates in the post-pandemic era. With inflation management the BoE’s only mandate, it was not surprising that it thought it necessary to raise interest rates to combat inflation. The implications for asset prices could be profound, particularly in the UK’s crucial housing market. If this marks the beginning of a rate hiking cycle in the UK, economic activity is likely to decline.
Omicron
Although global inflation remains high, it did not lead to significant market volatility during the fourth quarter. However, the emergence of the Omicron strain of COVID-19 in November produced a mini-repeat of the March 2020 market sell-off.
Initial data on the Omicron variant suggested it was more transmissible than Delta and, crucially, that current vaccines would prove less effective. Although global infection numbers reached all-time highs, in the UK at least hospitalisations and deaths did not increase in tandem with the rising case numbers.
While it is too early to draw conclusions, a COVID-19 strain that is less deadly, albeit more transmissible, could be a major and positive development.
Despite the continued risks associated with COVID-19 and inflation, businesses largely continued to trade well and earnings growth remained high.
The largest US companies grew earnings by almost 50% on aggregate across the full year, and early estimates suggested a further 21% growth in earnings in 2022. This indicates that global economic demand will remain strong. The FTSE 100 capped the fourth quarter with a 4.2% rise, and ended the year up 14.3%. The Stoxx Europe 600 rose 22.3% during 2021, showing that the corporate sector is also robust in mainland Europe.
Inflation in the European Union did not reach the same levels as in the US or UK in 2021, which gave the European Central Bank some flexibility on its interest rate policy.
This, together with data that suggested the Omicron COVID-19 variant was milder in terms of hospitalisations, helped European assets to finish the fourth quarter on a strong footing.
News from Japan and China
Economic data from Japan was less positive when compared to Western developed markets. ‘Real’ GDP (which accounts for inflation) grew only 1.2% in the third quarter, and this was expected to fall to 0.5% for the fourth quarter. Japanese equities gave back most of their third quarter gains after new prime minister Fumio Kishida took office promising ‘new capitalism’. This drew criticism from Japan’s corporate sector, with the policies compared to those of the Chinese Communist Party. The appointment of Kishida resulted in Japanese stocks falling for eight consecutive days in what was referred to as the ‘Kishida Shock’. The prime minister subsequently backtracked on some proposals, including changes to capital gains and dividend taxes.
News flow in Emerging Markets was again dominated by China. The MSCI Emerging Markets index returned -1.7% in the fourth quarter, although excluding China’s constituents would have seen the index return 1.1% over the same period. Regulators suspended the shares of heavily indebted property developer Evergrande Group as it continued to address its debt issues. However, there were no indications of contagion across other emerging market countries, although the risk remains.
Meanwhile, Chinese regulators stepped up their scrutiny of overseas listings, announcing that all companies seeking to list abroad would have to register with the Chinese security regulator. Any company considered to pose a national security threat would also be banned from listing overseas. An index of Chinese companies listed in the US fell 15% during the fourth quarter, capping a fall of 44% across the whole year.
The volatility and weakness in Emerging Markets and Japan appears to be idiosyncratic. Japan’s election and its new prime minister, did not lead to the usual rally in equity markets. Ongoing issues within China should be contained, but with greater regulatory scrutiny expected to create further weakness in Chinese companies listed abroad. Nevertheless, exposure to wider emerging nations and select Chinese companies remains an area of interest due to the expanding middle classes and economic growth potential.
The Benefits of Diversification
Our diversified portfolio multi-asset approach again mitigated the isolated risks within Japan and Emerging Markets in the fourth quarter. The prospects of a milder strain of COVID-19, and a strong demand side economy, presents significant opportunities in the months ahead.