Quarterly Investment Review – Q2 2022
At the start of 2022 optimism was building as the lockdowns imposed by Covid were being lifted, and financial markets started to anticipate the release of pent-up demand from the global economy emerging out of the pandemic. Since then a biblical combination of war, famine, pestilence and death have drowned this sentiment, and financial assets have been pummelled. It has been particularly unusual to see the bond and equity markets fall in tandem. For the last forty years whenever the equity market tumbled the bond market provided a safe haven, but starting from record highs, and the arrival of much more inflation than was anticipated, bonds have collapsed. Equities have entered bear market territory, but even the poor performance of the indices has disguised the real damage which has been suffered. Many stocks have fallen more than 60%. Underlying this decline were three unexpected outcomes. First inflation, which was expected to be transitory, has proven to be more persistent, leading to a sharp rise in bond yields and one of the fastest rises in mortgage rates in history. Second China has not ended its harsh policy on omicrom leading to multi-month lockdowns in Shanghai and partial ones in Beijing. For most of this year about a quarter of China’s economy has been impacted, compounding the supply chain problems that have built up over the past two years. Third the full-scale invasion of Ukraine by Russia created shortages, almost overnight, of numerous commodities. About the only good thing that can be said about the Ukraine situation is that the worst-case scenarios have been avoided so far, but the huge supply shock of losing the world’s biggest producer of energy, industrial metals and agricultural commodities at just the moment that the world was grappling with deglobalisation, and exiting macroeconomic profligacy, combined to create considerable inflationary pressures. This leaves every major economy facing an unpalatable choice of either accepting much higher levels of inflation, or imposing much tighter monetary and fiscal policies than have prevailed in the post 2008 period, which in most cases means recession. The uncertainty of this situation has unsettled markets, and they are unlikely to regain their poise until there is more clarity on what choice policy makers will make.
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