26 Apr 2022
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Q1 2022 review: a quarter to both remember and forget
The March quarter was a quarter to both remember and forget. Memorable in that market volatility and adversity presented critical learning experiences of how markets react to certain news and events. A period to forget in that markets broadly fell (with sharp monthly falls for some asset classes), inflation continued to rise to uncomfortable levels, energy shortages impacted the world, whilst the war in Ukraine saw lives lost.
The quarter is best understood through a timeline of events
December: the conditions leading up
The first significant event was triggered before the quarter even started, in the middle of December. The US central bank turned very hawkish (ie. rhetoric regarding the need to fight inflation) very quickly due to a combination of inflation data looking significantly stickier than previously thought and the receiving of the green light to start removing stimulus as covid-era restrictions appeared to have come to an end.
January: the beginnings of a risk-off environment
The events of December culminated in the beginning of a risk-off environment in January. Risk-off environments are characterised by investors tending towards selling off riskier assets in favour of actual and perceived “safer” options. January’s risk-off conditions resulted in falls in the Aussie dollar, Australian equities and property, growth equities (e.g. technology), and bonds. Interestingly, bonds usually perform well in risk-off periods but not when inflation and the potential for rising cash rates are the cause of the risk-off environment.
Strong economic growth and tight labour markets were a feature in January whilst inflation continued to rise in most countries. This is a function of some excess demand given the extraordinary amounts of both fiscal and monetary support we saw over the last 2 years, but mostly a function of the continued disruption in supply caused by the Covid-related health policy responses. In saying that, high inflation needs to be addressed given the risks of prolonged inflation becoming economically damaging and/or entrenched for longer than would be preferred.
February: the Russia-Ukraine conflict
Just as markets began to take inflation and supply issues in their stride, an ongoing Ukraine/Russia conflict which began way back in 2014, escalated when two eastern Ukrainian regions declared their independence and sought assistance (protection). Russia came to their aid, originally in a limited capacity, but this morphed into a full-blown invasion with Russian troops entering Ukraine from all directions.
This resulted in a broader risk-off environment, with both market and economic sentiment turning sour given the economic implications of war (likely recessionary for Europe), the impact of Russian sanctions on a globally integrated financial and economic world, the additional stress on supply chains given the significant amounts of production conducted and commodities extracted from both Ukraine and Russia, and the broader inflationary impacts putting even more pressure on central banks to act sooner and more aggressively than they would otherwise like with the backdrop of war.
This time it was global equities turn to fall sharply given the growth company sell-off continued to impact the US equity market with central bank rhetoric continuing to turn more hawkish, European equities fell given the region’s proximity to the war in Ukraine, and broader risk-off sentiment and ongoing Chinese government regulatory concerns saw Asian equities also fall. Bonds also fell again given inflation concerns were further exacerbated by the war, particularly rising and high energy costs, whilst Australian equities attempted to reverse the strong falls seen in January with the resources sector benefiting from supply shortages and inflationary conditions.
March: escalating conflict and persistent inflation
March was largely a continuation of February with the war in Ukraine escalating whilst inflation concerns remained. But March did see the first US rate rise from the Fed, with the accompanying statement issued with more hawkish rhetoric than expected. Surprisingly, equity markets actually rose post the announcement, focusing on the clarity provided by the statement regarding the forward period rather than the rate rises that will follow.
We also saw the Chinese government announce a 5.5% economic growth target for this year and a range of supportive measures to assist in meeting that target. Importantly, they also announced they were dropping their focus on technology and payment giants bringing an end to the almost 2-year regulatory crackdown on the power they had supposedly accumulated and were exerting. Also from a Chinese perspective, rising virus cases in Hong Kong and then through mainland China saw the government revert back to locking down large cities, a continuation of their Covid-zero policy response, with disastrous effects on Chinese economic growth, household consumption, and business investment.
March saw the Australian equity market get plenty of support from both local and foreign investors, with the resources sector surging, putting upward pressure on the Aussie dollar at the same time that the US dollar was also rising. Global equities finished flat, thanks to US equities which rallied post the Fed’s rate rise, whilst bonds suffered their worst monthly fall in some time as government bond yields rose aggressively as the market priced in an extraordinary amount of central bank rises over the course of this year.
Outlook for Q2 and beyond
Overall, our outlook is mixed, in that:
- Inflation will fall slower than previously expected given the ongoing war in Ukraine
- The market is pricing in a significant amount of rate rises from central banks this year in order to fight that inflation, which we don’t think economies are strong enough to absorb, especially with the backdrop of war
- Raising rates to fight inflation largely caused by supply-side issues seems pretty silly and goes against basic economics
- There remains plenty of stimulus in the system – rates are very low, central banks have printed a significant amount of new money, and governments have provided fiscal stimulus that has yet to be all spent and invested.
- Labour markets are tight globally which means low unemployment rates and rising wages.
- Corporates look in exceptional shape, many with balance sheet strength, sustainable earnings, high margins, and growing revenues.
For every positive there is a countering negative. That confirms that the recent period of higher volatility is likely to continue, but it doesn’t give us much in the way of certainty regarding the forward period and likely outcomes.
The two things we will be watching closely, as will most others, are;
- how the inflationary environment evolves from here (ie. stays high; falls slowly; falls fast) and,
- how aggressive central banks will (or can) be in trying to fight inflation (ie. not enough fight and high inflation becomes entrenched; too much fight and inflation falls too quickly risking recession).
As central banks try to engineer a soft landing, which is more difficult the higher inflation is, there will be ample risks to navigate around and opportunities to take advantage of. This makes for an interesting period ahead.
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Any advice included in this article has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs.
