Human nature means we are often swayed by recent news and history.
This recency bias means quite often people approach market volatility and investment decision-making with a rather narrow viewpoint.
We are seeing this play out at the moment, where much of the talk on financial markets and in the media has been about the prospects of a recession and when it is likely to hit, rather than if it is.
Some indicators, such as the US yield curve inverting and rising, and sticky inflation, suggest a recession at some point in the near future is imminent. With war raging in Ukraine and the consequences this has for the supply of commodities, as well as interest rates rising across the developed world as central banks attempt to contain inflation, there is naturally a lot of pessimism out there that growth is going to be severely impacted.
However, much of this rhetoric is overblown and only driving more volatility into the market. The S&P 500, at the time of writing, is only off its highs by around 4 per cent to 5 per cent, while the Euro Stoxx 50 is off between 8 per cent to 9 per cent, year to date. During times of equity bull markets it is not surprising to dip into correction territory and see falls of 10 per cent before recovering strongly again.
With markets now attuned to the impacts of Russia’s invasion of Ukraine, and more aware of the Federal Reserve’s tightening cycle, there should be fewer shocks for the rest of the year. Peak pessimism may have been reached.
Looking ahead
Entering 2022 it was clear global growth was going to be slower. Inflation was rising and we had the overhang from the Covid pandemic. Given the strength of the economic bounce back from lockdowns, it is no surprise to see growth a bit more sluggish. But growth remains okay and in a better position than the sluggish low-growth years of the 2010s.
Ultimately, Europe will suffer the most given its proximity to the conflict in Ukraine and its reliance on Russian fossil fuels for energy, but in more important regions, such as North America, we are seeing positive signs.
The labour market remains buoyant and wages are going up. Clearly this could contribute to inflationary pressures, but rising wages usually means more discretionary spending from consumers.
While some of the data is flashing red, there remain many reasons to stay optimistic.Towards the end of the year there is a good chance US wage growth will start to outpace inflation, meaning consumers will have more money in their pockets even after accounting for price rises.
What will decide the fate of the possibility of a recession is what the Fed does. It has pivoted in recent months to a more hawkish tone as it tries to get inflation under control without choking off the economy. This is more important for markets than Vladimir Putin’s next move (absent a sudden material escalation in Ukraine), and May’s interest rate decision will be watched extremely closely.
If rates get up to 2.5 per cent this year and inflation subsides, as is expected, to around 3 per cent, then as a global economy we will be doing just fine. Equity revenues should grow in line with the economy and this scenario should not result in growth being stymied.
Furthermore, corporate earnings growth, while clearly falling back towards more sustainable rates post-Covid, are showing no signs of collapsing as a result of higher inflation.
Reasons to be cheerful
Valuations do remain toppy, but this is another metric that people have a fixation on. They are better at predicting long-term returns rather than the short term, where there are more accurate indicators.
So, while some of the data is flashing red, there remain many reasons to stay optimistic. Given the volatility that has entered the market, equity returns are unlikely to be hugely exciting, but remain the place to be in this market for returns. Fixed income will continue to be challenged while alternatives will increasingly come into their own as a source of diversified returns.
Global growth is slowing, yes, and markets are increasingly volatile, but a global recession still feels like a remote possibility. Some regions may experience one or suffer economically more than most, such as Europe, but this is where it pays to be selective and adaptive.
It is time for patience – shut out the noise and sit on your hands. Better opportunities will present themselves once the talk of recession blows over.
Ian Jensen-Humphreys is a portfolio manager at Quilter Investors
