Quarterly Investment Update

Stocks and bonds had a bad first quarter as central bank tightening, high valuations and persistently hot inflation have applied new pressures to the global financial system. The S&P 500 fell almost 5% in Q1, while European and Emerging markets equities lost 9% and 7% respectively. Government bonds came under significant selling pressure as investors priced in an aggressive pace of interest rate rises. The Bloomberg Global Treasuries index fell 6.2% in Q1 and many participants believe there will be more pain going forward. The current military action is raising concerns about the potential impact on financial markets and the real economy as sanction-hit Russia is a major producer and exporter of oil, gas, wheat, metals and fertilizers. The war has brought considerable volatility and uncertainties but it is also creating opportunities for active investors as stock dispersion is currently well above its average since the Great Financial Crisis.

The Federal Reserve raised interest rates for the first time since 2018 and officials signalled that they expect to lift the rate to almost 2% by year end. This would represent the most aggressive pace of rate hikes in more than 15 years. Inflation in February as measured by PCE was 6.4%, with energy prices surging almost 26% from a year earlier. CPI inflation came in at 7.9%. The pricing in the bond market points to an end of the hiking cycle in the middle of 2023, suggesting that market participants believe that the Fed will manage to combat inflation. Many participants however question the Fed’s ability to normalize monetary policy and reduce its balance sheet holdings without hurting the real economy given the disruptions in global supply chains, geopolitics and world order.

The war in Ukraine is having a profound effect in the European economy, given the continent’s dependence on Russian energy and resources. The European composite PMI fell to 54.5 in March from 55.5 in February, with raw-material and energy prices soaring and confidence weakening. A subindex that measures costs rose to 81.6, well above the previous record high of 76 in November 2021. Inflation in the economic union surged to 7.5%, a significant increase from the 5.9% recorded in February. For now, the economy is still strong, with unemployment rate at 6.8% and economic activity still expanding. The ECB announced that it will phase out its asset-buying program sooner than expected and said that it will ‘’ take whatever action is needed to pursue price stability and to safeguard financial stability’. The yield on the two-year bund which is the most sensitive to changing interest rate expectations turned positive for the first time since 2014, suggesting that the market expects negative interest rates in Europe to end soon.

Although Brits spent more money shopping since the start of the year, the quantity of goods bought vs. a year ago fell, highlight how households are getting squeezed by the effects of inflation. The squeeze is also evident in consumer confidence readings and in the sharp decline in the purchases of large-ticket items like furniture and other consumer durable goods. Moreover, house prices rose at their fastest pace since 2004, hitting a 14.3% YoY increase in March. The CPI index rose at an annual rate of 6.2% in February, the highest since 1992.

Despite having eased from recent highs, Swedish PMI readings for both the manufacturing and services sectors remained well within expansionary territory in January and February amid improving business confidence. Moreover, in February the unemployment rate fell to its lowest level since the pandemic began, which, combined with improving economic sentiment, bodes well for consumer spending. CPIF came in at 4.5% in February, mainly due to the rapid increases in energy prices. The Riksbank kept the interest rates at 0% in its February meeting and reinstated its commitment keep its bond holdings unchanged in 2022 and then decrease gradually.

Retail sales growth in China was better than expected in Q1 in a sign that the economy is recovering from the real-estate-induced slowdown. Industrial production was also up by 7.5%, versus expectations of 3.9% growth. Fixed asset investment rose by 12.2%, well above the forecast for a 5% increase. Within fixed asset investment, high-tech manufacturing saw one of the largest increases, up by 42.7%. On the negative side, the unemployment rate edged up to 5.5% in February with that of those aged 16 to 24 remaining far higher at 15.3%. Vice-premier Liu He said the government would “actively introduce policies that benefit markets boost the economy complete the reform of the internet sector as soon as possible, and generally promote stability and predictability’’.