May was another negative month for global equities, but an impressive recovery into month-end meant the MSCI All Country World Index recouped the vast majority of its losses, finishing with a 0.2% decline. US Treasuries and core eurozone government bonds also bounced off the recent lows with yields pulling back from their peaks, although UK Gilts underperformed, especially those linked to inflation.
Supply chain challenges remain one of the chief concerns for investors and while there has been some easing on this front, protracted hostilities in Ukraine and lockdown measures in China have presented new issues for both manufacturing and food.
Following a solid first quarter earnings season there has been a lull in company reporting. Overall, guidance to analysts remains pretty good despite cost pressures, and earnings estimates are marginally higher since the start of the year. This, coupled with the fall in share prices seen year-to-date, has pushed global forward valuations cheaper than the 10-year average. That said, there is some scepticism regarding how sustainable rising earnings are, given slowing growth and rising costs.
A basket of leading US growth stocks now trades at around 20 times forward earnings, significantly lower than a peak near 30 times, while value shares are in the region of 15 times. Compared to previous stock market corrections these levels are still not that cheap, and as we believe the de-rating still likely has further to go, we have decided to scale back risk recently.
US: inflation peaking?
While rising inflation and hawkish central banks still feature prominently in investors’ thinking, there is an increasing focus on economic growth and how it will hold up in the face of aggressive monetary policy tightening. The Federal Reserve delivered its first 50 basis point rate hike since 2000 at the start of May and markets are firmly pricing in increases by the same amount at the next two meetings. Markets have the end of year fed funds rate at approximately 2.8%, significantly higher than the current 1.0%. However, the debate around Fed policy is now centred on the possibility of a slower pace of tightening, with a possible pause in the hiking cycle touted for September.
This narrative shift is bolstered by encouraging signs that US inflation is at, or at least near, a cyclical peak. The annual consumer price index slowed to 8.3% in April, down from a 41-year high of 8.5% in March, and the latest core personal consumption index, believed to be the Fed’s preferred inflation metric, came in at 4.9%, below March’s 5.2% reading.
The labour market continues to go from strength to strength with employers adding 390k nonfarm jobs in May, comfortably above the consensus forecast of 320k. What is more, the unemployment rate held steady at 3.6% while average earnings growth ticked down to 5.2% annualised from 5.5% in April - also suggestive that broader cyclical price pressures could be close to a peak. US large-cap shares managed to eke out a small gain for the month after falling to new lows for the year. Growth and tech stocks remain laggards but bounced significantly into month-end to end with modest declines of just under 2%, after trading as much as 10% lower.
UK: activity slowing
In contrast to an easing in US inflation, there was a further increase seen in the UK, as the consumer price index jumped to a 40-year high of 9.0%. Along with higher commodity prices, a tightening labour market is imparting upward pressure on prices. The unemployment rate for the three months to March, fell to its lowest level since 1974 at 3.7% and for the first time on record, vacancies exceeded those seeking jobs. The tight labour market may continue as the pool of participants has declined since pre-pandemic due to a combination of aging demographics, early retirements, immigration and a significant increase in long-term sick/awaiting medical treatment.
Andrew Bailey, Governor of the Bank of England, has said the bank can do little to prevent double-digit inflation later in the year. Still, the bank moved to raise rates for a fourth consecutive policy meeting, with the Monetary Policy Committee unanimously supporting a 25 basis point hike to 1.0%. The interest rate futures market is currently pricing a year-end bank rate in the region of 2.4%.
While there is currently little sign of economic weakness in the US, the same cannot be said of the UK where data releases have begun to show a slowdown in activity. Flash purchasing managers index readings, seen as leading indicators of economic activity, came in lower than expected for both manufacturing and services last month. A composite reading slumped to its lowest rate since January 2021, when the country was in full lockdown.
Gilts fell significantly on the month as yields ramped higher and the inflation-linked gilt index suffered an even larger decline due to its longer duration. One positive development to note was the announcement of a £15bn package to help households cope with rising domestic fuel bills. The economic stimulus will be funded in part by a 25% “energy profit levy” which will raise an estimated £5bn this year and increase the tax rate paid by North Sea oil and gas producers from 40% to 65%. Chancellor Rishi Sunak has said the measures will have a “minimal impact” on inflation and the Office for National Statistics (ONS) has revealed its treatment of the rebate might actually reduce headline inflation figures.
The ongoing conflict in Ukraine has kept upwards pressure on the oil price, with international benchmark Brent Crude rising over 12% on the month. UK large caps rose more than 1% on the month, taking the year-to-date gain for the benchmark to just shy of 4%, reflecting the significant contribution from energy stocks. The European equivalent enjoyed an even better May, adding 1.3%, though for 2022 the index is still down almost 10%.
Eurozone inflation rose to a new record peak in May, jumping more than expected to 8.1% from 7.5% previously. Energy is the chief cause of this cost-push inflation for the bloc, a situation exacerbated by events in Ukraine. This is aptly demonstrated by a more than 4% spread between the headline inflation figure and the core reading, which strips out energy and food prices.
The European Central Bank (ECB) is yet to move away from record-low interest rates, although expectations are growing that it will do so imminently. Philip Lane, the ECB’s chief economist, signalled a 25 basis point rate rise in July and the same size move in September, saying this margin was the governing council’s “benchmark”. Markets are pricing in approximately 100 basis point of rate increases by the end of 2022, with the deposit rate currently still at -0.5%.