Equity markets experienced a challenging start to the year as volatility increased due to concerns around inflation, tightening of US central bank policy and rising geopolitical tensions between Russia and the Ukraine. Although returns were negative across most asset classes in January, global bonds outperformed equities, emerging market equities outperformed developed markets, and value stocks outperformed growth. Robust performance from financial and energy stocks, which are well represented in the FTSE 100, resulted in the UK being the best performing developed equity market in January.
Highly rated growth stocks, often valued on future profit expectations, including those favourably positioned during the pandemic and in the technology sector, were negatively impacted by a shift in investor sentiment. This was largely due to a discounting of the value of future earnings given the rising interest rate outlook. Sectors which are sensitive to rising interest rates and where high levels of profit are already being generated performed well, such as financials and energy.
Commodities provided some of the best returns as oil reached its highest price since 2014 driven by falling oil stockpiles in the US and rising geopolitical risks. Equity markets with high commodity exposure such as the UK, Latin America and the Middle East outperformed significantly.
In the US, the Federal Reserve Bank is set to end its bond purchase programme in March and markets started to price in two additional interest rate increases to a total of five in 2022. In this environment, value stocks may continue to be favoured. US producers continue to face supply constraints and consumer inflation has risen to 7% year on year, its highest level since 1982. The labour market is currently in a much stronger position compared to 2015, the previous interest rate hiking cycle, which may impact the pace of policy normalisation this year.
UK equities significantly outperformed developed markets in January due to the composition of the market, which has a greater weighting to commodities and financials and less exposure to technology. Inflationary pressures remain a concern and rising energy bills and taxes may place pressure on consumers in the coming months. The less severe impact of the Omicron variant may support overall economic activity however. The Bank of England has raised interest rates from 0.25% to 0.5% and some further modest tightening in monetary policy is likely in the coming months.
In Europe, economic activity was resilient despite rising COVID infections. The impact of Omicron was less severe than previous waves though and resulted in only a marginal decline in consumer confidence. Supply restrictions are gradually easing which should benefit European equities going forward however, energy prices and gas supply remains a key risk for the region. It had been considered unlikely that the European Central Bank will raise interest rates this year but their approach is flexible depending on the strength of the economy and labour market. Inflation in the Eurozone increased by a record of 5.1% in January which may start to place pressure on the European Central Bank to act.
Slowing economic growth in China alongside tighter regulations and property sector issues, resulted in a sharp decline in the overall performance of global emerging market equities in 2021. Chinese equities may find support from current levels given their attractive valuation levels and looser monetary policy from the authorities in an attempt to boost economic growth. After being the best performing equity market in 2021, India remained in positive territory in January, alongside several countries in Latin America. Higher inflation and rising interest rate expectations could weigh on emerging equity market sentiment this year although valuation levels are generally attractive.
As some of the longer term effects of the pandemic are easing, including supply issues in certain parts of the world, and the impact of Omicron is less severe than expected, global growth is expected to be relatively strong this year. Despite a weak start to the year for equities and the background of monetary policy tightening and rising costs, companies with pricing power appear to have more favourable prospects in comparison to bonds and may continue to outperform.
|2022 Year to Date|
|FTSE World ex-UK||-4.35%|
|FTSE Actuaries UK Conventional Gilts All Stocks||-3.85%|
|FTSE Actuaries UK Index-Linked All Stocks||-2.67%|
Total returns in GBP to 31/01/2022
|Bank of England Base Rate||0.50%|
|Inflation (Retail Price Index)*||7.50%|
* December 2021
Source of data: FE Analytics, www.bankofengland.co.uk, www.ons.gov.uk The content contained in this article represents the opinions of MacIntosh & James Partners Ltd. The commentary in no way constitutes a solicitation of investment advice and should not be relied upon in making investment decisions. Past performance is not a reliable indicator of future results. The value of your investments can fall as well as rise and are not guaranteed.