GLOBAL MARKETS
Many had doubted whether the US Federal Reserve (the Fed) would prove to be as hawkish as it had at times suggested it might, but the Jackson Hole symposium dispelled some of these doubts. In fact, if investors had been listening rather than in wishful thinking mode for the month of July, Fed Chairman Powell’s statement that they would keep going until the job was done on inflation was not that surprising. Equity markets sold off heavily on the news, however, and confirmed that headwinds for risk assets were likely be considerable in the near term. The markets are still likely to engage in an extended game of chicken with the Fed to test how serious they are about containing inflation, which continues to be stubbornly high in the US and elsewhere (data from earlier this month confirms this even at the ‘core’ level, excluding food and energy prices).
Rallies such as the one we saw in July are undoubtedly going to be seen again in this market cycle, but the overall volatility looks set to continue given the ebb and flow of economic data, with bets on the market increasingly binary in nature. Every major rally is a form of easing of financial conditions and therefore threatens the Fed’s project to tighten monetary policy, meaning a sustainable rally is more difficult to achieve. The employment market in the US remains strong on most measures and this reassures those who feel a recession is unlikely, but here again, it may of course mean that the central banks have to do even more to bring inflation under control. The potential outcomes in terms of market direction seem rather stark at the moment – if the Fed pivots, then risk assets will perhaps inevitably enjoy a brighter spell. But if the Fed does not, or if they do but markets lose faith that inflation is adequately under control, then the bearish trend is likely to continue or even gather steam. Then of course we have the mighty dollar. Its strength saps risk sentiment in multiple ways (diminishes US corporate earnings, weakens emerging markets) and a reversal of the currency’s strength (probably on lower rate expectations) would undoubtedly be a relief for markets. If it strengthens further, things could get ‘interesting’ (in the Chinese curse sense of the word!) and cause more problems for already beleaguered investors. And does anyone truly know what the impact of quantitative tightening will be, aside from the rate rises across the globe, in terms of the Federal Reserve running down their balance sheet?
The apparent escalation in the Russia-Ukraine war (Putin’s declaration of a partial mobilisation) is hardly good news for investors and the geopolitical backdrop looks pretty dire with China-US relations less than rosy. So much uncertainty resides here and in other areas that our stance remains one of caution for the time being.
JAPAN
Always something of an enigma, Japan is continuing to confuse investors. The yen has been incredibly weak against the dollar (unsurprising given the rate policy divergence) which one might think to be uniformly beneficial for Japanese equities but it is causing some consternation. Large Japanese exporters with sales overseas will benefit from the weaker currency but others reliant on importing expensive commodities (food producers for example) face real headwinds. Aside from equity markets, inflationary pressures – actively sought for so long in a country weighed down by deflation – are causing political tensions and putting pressure on the authorities to initiate a policy response. The yen is usually strong in times of global stress in markets, but its decline versus the dollar and other currencies is likely to result in the Bank of Japan at least tweaking its monetary policy. This will need to be done with some care – a disorderly upwards move in the yen could cause outflows from other markets, not least the US bond market, and potentially wider issues. For what it is worth, Japan remains a cheap market, but the uncertainty means we are holding tight for now.
Investment Line is written and edited by members of the Mattioli Woods Group investment committee 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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