World Market Review January 2022

Global stock markets underwent a severe style rotation in January, driven by expectations that the Federal Reserve would hike interest rates to combat inflation. This punished stocks, particularly growth stocks and small-cap stocks, and allowed value stocks – such as banks and oil majors – to outperform. The rotation was reinforced by the Omicron variant proving less severe than initially feared, prompting investors to switch out of stay-at-home stocks. According to JP Morgan’s calculations, January saw the worst relative performance of growth stocks in more than 20 years, as they dropped -10%.

In the UK, the latest data shows the economy slowing down, albeit partly for temporary reasons, as work-from-home guidance and higher inflation hit consumer demand. Headline inflation rose to 5.4%, while the unemployment rate fell to 4.2%, suggesting the labour market has resiliency.

In contrast to the slowing economy, the UK stock market was the best-performing of the major countries in January. The London market benefitted from its high weighting towards mining, oil, tobacco, and banks, and its dearth of technology stocks. To protect against future rate rises, we recently shifted some of our small-cap UK exposure from high P/E (price-to-earnings ratio) to low P/E stocks.

Over the Atlantic, business surveys suggest the economy remains in expansionary territory, but there was a sharp decline in travel. Retail sales dropped as Omicron spread across the country, but already look to be bouncing back.

Like here, the US is experiencing a wave of inflation, which in the most recent figure hit 7%. Prices have been rising across the board; in goods, services, commodities, transportation, and wages. The labour market looks strong, with a 3.9% unemployment rate and 10.6 million job openings. The inflation and strong job numbers will give ammunition to Federal Reserve to begin hiking interest rates; the market is pricing in four-to-five hikes in 2022. America’s stock market, which tends to have more growthy stocks, fell sharply.

Since we added Baillie Gifford American in May 2020, the fund has delivered over 30% gains, but has recently exhibited vulnerability to interest rates, so we took the decision to bank our long-term gains in early February, and switch into better value alternatives.

Business and consumer sentiment was surprisingly resilient on the continent, helped by various governments taking a more relaxed approach to Omicron than previous waves. Inflation has risen to 5%, and the gas supply remains a key risk. Despite the inflation, at its last meeting the European Central Bank hinted it was unlikely to raise rates in 2022. This is in stark contrast to the Fed, which has said it will, and the Bank of England, which already has.

Our core holding in Europe, Lightman European, was the star performer of January, bucking the market to end in positive territory.

Emerging markets delivered negative returns in January. Latin America was a bright spot, as countries like Brazil exhibited economic resilience in the face of Omicron. In the Far East, temporary demand slowdowns from the West hit exports. Russia was one of the worst performers, as investors fled its stock markets as tensions mounted over the Ukraine. Our EM bond fund managed to deliver positive returns in January, helped by China easing monetary policy.

China’s latest GDP figures show 4% year-on-year growth, the weakest for years. The figure was dragged down by weak consumer spending and the ongoing turmoil in the property market. The external-facing economy looks strong, however, with exports rising over 20% on the year. Chinese stocks have been the worst performing emerging market of the last year, but now look cheap, having dropped in valuation from a forward PE of 18x to 12x.

Unlike the rest of the rich world, Japanese inflation remains subdued, at 0.5%. The energy and electricity components did rise sharply, but the remainder of the basket has seen little price pressure. Food inflation is still negative. Partly this is due to Japanese wages, which have remained stagnant for years.

Our portfolios are tilted towards fast-growing small-cap stocks, which have delivered strong returns over the longer run, but which can have painful setbacks along the way, particularly during monetary tightening. Higher interest rates reduce the net present value of future cash flows, making growthier and smaller stocks vulnerable to valuation shifts.

In early February we took action to protect some more exposed areas of portfolios from higher rates. For instance, we added a new Vanguard Equity Income tracker, which provides low-cost diversified exposure to stocks with attractive yields and valuations. Ultimately, we believe in buying good companies at attractive prices, and we think that the recent falls, together with actions we have taken to protect portfolios, have made the risk/reward ratio more attactive going forwards.