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Inflation Warnings Hit Stocks

  • Apr 13, 2022
  • Andrew Gillham

(Cover Image Source: Sara Kurfeß)

Global stocks started the new quarter on the back foot as central banks turned markedly more hawkish in the face of higher inflation. The blue-chip S&P 500 fell 3.7% and the technology focussed Nasdaq fell 7.7%.

Growth and technology stocks are particularly sensitive to the prospect of higher interest rates which negatively impact the present value of long-term future cash flows. The FTSE 100, however, was again an outlier due to its higher exposure to energy and materials stocks and gained 0.8% last week.

The drawdowns and volatility in financial markets this year have been difficult for most investors and whilst the broad-based Russell 3000 Index is down almost 8%, the average stock has lost more than 30% of its value.

However, cheaper valuations and a long-term investment horizon provide opportunities for investors holding cash and Warren Buffett’s Berkshire Hathaway revealed last week it had acquired a $4.2 billion stake in HP Inc. Shares in the PC and printer manufacturer jumped 15% on the day of the announcement.

Buffett, the most famous proponent of value investing, had refrained from making any notable deals for the past six years and once again lamented a dearth of attractive investment opportunities in his annual letter to shareholders in February. Berkshire Hathaway was sitting on nearly $150 billion of cash going into 2022.

Times have changed in a short space of time and the HP deal is the third in just 3 weeks for Buffett. Berkshire has also acquired the insurance company Alleghany Corp for $11.6 billion at a 25% premium above its share price and announced it has built up an $8 billion stake in oil producer Occidental Petroleum.

Elsewhere, good news for stocks was in short supply as inflation and war remained dominant themes. In a speech in Geneva last week, Augustin Carstens, the general manager of the Bank for International Settlements, warned the world is on the cusp of a new inflationary era with persistently high consumer prices.

Carstens pointed to disrupted supply chains, amplified by the war in Ukraine, which have driven a rebound in commodity, energy and food prices, and the emergence of a retreat from globalisation, which has underpinned structurally lower inflation throughout this century. He added workers are demanding higher wages as living costs rise sharply.

The March food price index published by the UN Food and Agricultural Organization rose by 34% year-on-year, the third consecutive monthly record. The US will report its consumer price index data this week which is expected to rise to 8.5% year-on-year, the fastest pace since 1981.

The message isn’t lost on central banks who are now scrambling to regain control of their price stability mandates. After insisting higher inflation would be a short-term, transitory phenomenon throughout most of last year, the doves have had their wings clipped and the rhetoric is increasingly hawkish.

The big challenge for central banks is to navigate an interest rate hiking cycle without choking economic growth and the near inversion of the US Treasury yield curve, historically a harbinger of an upcoming recession, suggests markets are sceptical. Interest rate futures point to the Federal Reserve hiking rates by half a point at each of its next two meetings. The Bank of England may move a bit slower and its base rate is expected to reach 2.5% by this time next year.

One glimmer of hope for the inflationary outlook is the retreat of Brent Crude back to below $100 a barrel for the first time since the start of the Russian invasion in Ukraine. Prices have dipped as on expectations of lower demand from China as it extends Covid lockdowns in its financial hub Shanghai.

TEAM Asset Management is a trading name of Theta Enhanced Asset Management Limited which is regulated by the Jersey Financial Services Commission.