US stocks suffered their worst first half of the year since 1970 as investor sentiment was shaken by concerns that remedies to cure runaway inflation will push economies into recession. The blue-chip S&P 500 and technology focussed Nasdaq indices moved into bear market territory, falling 21% and 30% respectively.
It was a similar picture globally and European stocks also suffered heavy declines. However, the UK’s FTSE 100 was the best performing major global index and fell just 3% in price terms, boosted by its higher exposure to energy, basic materials and consumer staples stocks.
The sharp depreciation of the pound, including a 10% fall versus the US Dollar, also provided a strong tailwind to FTSE 100 companies which in aggregate generate around 70% of their revenues overseas.
Throughout much of last year, policymakers insisted higher inflation was a ‘transitory’ phenomenon but as it ran hotter, the narrative changed. The outbreak of war in Ukraine amplified inflationary pressures further, forcing central banks to take more assertive action.
Annual consumer price inflation in the UK reached a new 40-year high of 9.1% in May and Bank of England officials expect it to move into double digits by October. In the Eurozone, which has been at risk of slipping into a period of deflation for much of the past decade, inflation has risen to a record high 8.6%.
Other countries are suffering even more, including Turkey where consumer prices rose 78.6% from a year earlier in June. President Erdogan has steadfastly opposed using conventional monetary policy tools such as higher interest rates and as a consequence, the lira has plummeted, fuelling runaway inflation.
The Bank of England was the first G7 central bank to raise interest rates in December 2021 but the US Federal Reserve has led the charge in 2022. Interest rate increases in March and May were followed up with a 0.75% hike in June, the largest single uplift in 28 years.
The Fed has also started to shrink its $9 trillion balance sheet by selling down the bonds it acquired during past crises. ‘Quantitative tightening’ aims to curb inflation by reducing the money supply.
Investors took heed of the long-standing mantra “don’t fight the Fed” and fled risk. The sell-off has at times been indiscriminate but overall there has been some order, reflected by the divergence in returns between sectors.
Energy is the sole sector in positive territory (+24%) this year but investors in utilities (-6%) and consumer staples (-10%) have outperformed the broader market. In contrast, sectors most exposed to higher interest rates and slowing economies, consumer discretionary (-32%) and technology (-30%) stocks, fared the worst.
Bonds typically perform well in times of heightened geopolitical risk and market stress, attracting inflows from investors seeking shelter from the storm, but not this time around. Higher interest rates and inflation are kryptonite for bonds and UK Gilts have fallen 14% so far this year.
Gas and oil prices had been on an upward trend as OPEC, and its associates, kept a tight grip on production despite surging demand after pandemic-era restrictions eased. The war in Ukraine has deepened the supply-side deficit and Brent crude has risen nearly 50% to $115 a barrel.
The flight from risk has been felt most acutely in speculative assets, including cryptocurrencies. Mid-November when Bitcoin peaked at more than $67,000 feels like a long time ago. The ‘crypto winter’ was at its bleakest when the Terra (LUNA) token collapsed in May.
Perhaps the biggest surprise so far this year is the performance of the Russian Ruble. The currency crashed immediately after the West imposed a raft of sanctions on Russia but in a stunning reversal, it has climbed to a 7-year high of 54.4 to the US dollar. The country continues to rake in billions of dollars from the export of gas and oil.
(Cover Image Source: Donna Ruiz)