World Market Review August 2022

Thunderstorms marked the end of the long, dry summer of 2022. It was the same story on the stock market, with equities ending a two-month rebound in late August to drop sharply, unnerved by the risks of recession and inflation.

Meanwhile, the pound continued to sink against the dollar. The decline is negative for the currency’s economic power, but helped minimise losses for sterling-denominated investors.

Liz Truss took over as the new prime minister, appointing Kwasi Kwarteng as her new chancellor. Precise policy details are uncertain at time of writing, but her premiership seems to mark a shift towards more expansionary fiscal policy through measures such as unfunded tax cuts and energy bill subsidies. This will boost GDP and corporate earnings, but could also fuel inflation and raise fears about the sustainability of government debt.

There was little market reaction to Truss’s appointment, because markets had largely priced in her victory. The pledge not to raise corporation tax has been positive for UK companies, and Truss’s stance against energy windfall taxes has been a boon to large energy companies, which hold significant weight in the UK stock market. Both such measures will have benefitted our UK funds, especially our low-cost FTSE tracker, which has high weights to energy.

Away from politics, UK inflation rose to 10.1% in the latest monthly figures, the first time it has registered double digits in over 40 years. Investment bank Citi is forecasting inflation to top out at 18.6% in the winter, while Goldman Sach’s model suggests it could reach 22% if gas prices remain at current elevated levels.

The inflationary pressure has caused gilt yields to spike, with the two-year gilt topping 3% for the first time in 14 years. Our short-term bond index, which holds bonds with short maturities, helped cushion the blow from higher rates.

Figures showed that the US economy contracted for two consecutive quarters, a common definition of a recession.

However, other data was positive. Job creation came in twice as high as expected for July, and wages rose. Preliminary data also suggested the level of inflation had peaked; the US uses no Russian gas, so has only indirectly felt the energy price spikes that Europe is enduring.

This has been positive for the US consumer, which helped our CT American fund deliver a market-beating 4% return in the month.

Meanwhile, the dollar continued to surge, as investors bet that the Federal Reserve would push ahead with rate hikes. Fed chair Jay Powell used the Jackson Hole symposium to deliver a hawkish speech, echoing phrases from the late Paul Volker, the man who “broke inflation’s back” in the 1980s by pushing interest rates to eye-watering levels. Higher yields on US government bonds push the dollar up as investors sell other countries’ debt in favour of the superior yield on Treasuries.

Europe’s energy crisis intensified over August, as natural gas prices spiked, with continental gas prices topping 14x times their average of the past decade.

Part of the problem is that EU (and UK) energy prices are set through a so-called marginal pricing system, in which the most expensive power plant used in any day sets the wholesale price for all suppliers. This means expensive gas-generated energy tends to dictate the whole market, even though renewable power produces a significant portion of the energy at a much lower price. Leaked plans show the EU is preparing a scheme whereby energy profits over a certain price are redirected to consumers; essentially an elaborate windfall tax.

Despite the turmoil, there are areas of the European market which are resilient, and our Lightman fund bucked the market to deliver a positive return over August.

China’s domestic economy struggled over the summer, hit by ongoing Covid restrictions, an overextended property market, and poor weather. However, Chinese stocks held up well, as the Chinese central bank cut rates to prop up the economy. The rate cuts also sent Chinese government bonds higher, which we have direct exposure to through our L&G EM bond fund.

China is not experiencing the same inflationary shock as Europe or the US, so it has room for more accommodative monetary policy. This has been a boon for our dedicated T Rowe China fund, which rose 2% in August.

Emerging markets face pressure from the stronger greenback, which pushes up the cost of servicing dollar-denominated debt and importing goods and commodities priced in dollars.

However, the underlying growth story remains intact, as exemplified by India finally surpassing the UK economy on an absolute basis. (On a per capita basis the UK remains about 20x richer.)

In our portfolios we have a high weighting to emerging markets, which paid off in August as the Fidelity EM index led the market, rising 4%.

For several decades, Japan – as a rich, isolated, island economy – was seen as a safe haven with a currency that could be relied upon during times of strife; the Yen strengthened during the early 2000s recession, the 2008 crisis, and during Covid.

Since 2021, however, the currency has nosedived, reaching its lowest level against the dollar since 1998. Several factors have contributed; an impending slowdown in Japan’s export markets, higher yields drawing money away from Japanese bonds, and the country’s dependence on imported energy.

Queen Elizabeth II’s death left her people in mourning. For investors, it also provides an opportunity to step back and take a long term view.

The Queen’s 70-year reign, from 1952 to 2022, spanned every kind of economic environment; post-war austerity, the booming sixties, stagflation, industrial strife, the dotcom bubble, the mortgage crisis, and a pandemic. What should an investor in early 1952 have done?

If they had invested £1,000 in a typical building society savings account, it would have grown to £56,000 by September 2022. If they had invested in some British government bonds, the same £1,000 would have grown to £91,000. But if they had invested in a basket of British stocks, the £1,000 would have grown to £2.1 million.

A seven-decade timescale shows the unrivalled compounding power of equities.