Global Equities
We had warned for some time that moving from a world of ultra-low interest rates (even zero/negative at times) to more normalised ones would have significant consequences but crucially that the consequences would be felt in unpredictable areas of the markets. The lagged effects of rate rises have now started to be felt across the global financial system and recent developments leave investors wondering what the next source of market stress will be.
The falls in the equity markets over 2022 were signs of an obvious adjustment being made but the concerns that are most alarming in a tightening cycle often relate to financial stability. After the gilts crisis in September of last year, we now have the bank failures in the US to contend with. Some of the reasons for the failure of Silicon Valley Bank (SVB) and others are highly idiosyncratic but there is no getting away from the fact that this sort of thing has a horrible habit of occurring in bear markets and in a rising rate environment. Regulators have moved quickly to shore up the banking industry and although it is possible that the back stopping of the depositor system ultimately proves sufficient to calm markets, investors are proving difficult to reassure and some additional measures may be necessary. The effect on bank lending may be long lasting – higher deposit rates and more cautious lending practices – and this may only serve to exacerbate any economic downturn ahead.
Expectations for more rate rises in the US have started to evaporate as the Federal Reserve is expected to prioritise its mandate for financial stability over inflation but this does not mean the equity markets will automatically rally. The collapse in two-year yields is unprecedented outside a crisis and Wall Street clearly thinks the central bank will have to halt its tightening of monetary policy. However, as we wrote previously, it is crucial to assess what else is happening at the time of any Fed ‘pivot’ and some of that is clearly not great. A recession still looks like a likely outcome and with the banking sector under pressure, it is possible this is not going to be a mild one. Remember too that the Fed also must be true to its inflation mandate and with inflation yet to be controlled (though a downturn would probably help here), the options for injecting more money into the financial system might be very limited indeed. The tensions between the various competing mandates of the central bank will now be crucial in determining how this period of the market cycle resolves. Predictably, volatility (having been very low) has picked up dramatically and the change in investor sentiment since January has been quite overwhelming.
Again, we must ask if current valuations in equity markets reflect the challenges ahead and it is difficult to answer yes to this question. The current banking sector woes could yet precipitate the next leg down in the bear market, given the potential for earnings to be impacted and sentiment to deteriorate further. A more dovish Federal Reserve may be enough to lift valuation multiples on stocks and therefore stabilise indices but this is not guaranteed. To us, being cautious remains the most sensible course of action. Cash, high-quality fixed income, focused equities, gold, and alternative strategies all retain their importance in helping us negotiate what looks to be a difficult path ahead.
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Investment Line is written and edited by Chief Investment Officer Simon Gibson and Investment Strategist Richard Smith and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.
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