A brutal month for the markets
June brought no respite from the challenges of 2022 with the markets falling by almost 8%, one of the worst months since March. There’s no sugar-coating it - market news just continues to get worse at the moment, with the falling market driven by some key factors:
- Contrary to expectation, inflation continues to push higher in the US, now at 40-year highs. It is becoming clear that Central Banks around the world will need to push interest rates higher than initially expected to stamp out inflation.
- Consumer sentiment has fallen dramatically in the US, which is hardly surprising given rising mortgage costs, fuel and food prices and everything else in between. But this does increase chances of a recession in the US and it is now more a question of how deep a recession will be, rather than whether it will happen or not.
- European energy supplies is back on the watch-list, with increasing fears that there might not be enough Russian gas to power the German and Italian economies through the winter, and government officials already starting to talk about energy rationing.
On a sunnier note, China appears to be emerging from its slump with the prospect of the economy reopening, a loosening of Covid restrictions and warmer exchanges with the tech sector.
In the Crypto currency world, the month was dominated by the leverage spiral, which pushed crypto currencies down 30 – 40% in the month. How far through the leverage spiral we are, and how far there is yet to go, is the big question right now in the Crypto world.
The one thing we can be certain of, is that uncertainty is here and there is nothing on the horizon that suggests it will dissipate any time soon. As has been the case for the past few months, every economic announcement will be scrutinised, with wild predictions and market moves (up and down) expected to follow those predictions.
Whilst we acknowledge this market update is pretty negative, it is a backward looking report and therefore what you would expect after a fall in global equity markets this month. Please don’t read this and think you need to change your investment strategy or move to a conservative KiwiSaver option, the damage has already been done and all of this news is already priced in.
The inflation (and interest rate) conundrum
Economist predictions around when inflation will peak have been persistently wrong for the past nine months, and unfortunately continue to be wrong. Just as it looked possible that inflation was nearing the peak, aided by improvements in supply chains, June dashed those hopes and we saw inflation roar ahead once again.
It’s notoriously difficult to eradicate high inflation once it becomes embedded in the economy; the expectation of increasing prices (driven by inflation) gets priced into everything (goods, services and of course wage decisions) in something akin to a self-fulfilling prophecy.
So, the theory is, that to tackle high inflation, you have to go hard and go early. And we have seen this in the stance taken by Chair of the Federal Reserve, Jerome Powell, whose words and actions have led people to fear that the only real solution to inflation is going to be a recession induced by eye-wateringly high interest rates.
After announcing that he would “do whatever it takes” to drive inflation back to the 2% target, Powell’s first action was to increase interest rates by 0.75% on 15 June - something that was previously thought of as impossible - and his messaging at the time made it clear that a further 0.75% would probably be necessary in July.
If this additional interest rate hike is realised, the US Federal Funds rate will have moved from 0.25% to 2.00% in a staggering three-month period. All eyes will be on the July announcement, which will be a key indication as to the Fed’s resolve to further use substantive interest rates hikes to combat inflation.
The recession fears
Economists and analysts are increasingly of the view that a recession is more likely than not in the short term. Consumer sentiment around the world is falling through the floor, and unfortunately the expectation of a recession (like inflationary pressure) can often become a self-fulfilling prophecy.
Whilst not yet in analyst base case estimates, Goldman Sachs and other investment banks have significantly increased their probability of a recession hitting. And markets were not helped by Elon Musk voicing his opinion in the Twittersphere, that the US is currently sitting in a recession.
If we are in or are close to a recession, and still have high inflation, there is an increasing possibility that we may enter a world of Stagflation. Stagflation is when we have low to no growth and high inflation. In a Stagflation environment, people’s spending power is quickly eroded as the lack of growth means unemployment rises, wage growth slows, but at the same time, every day prices for goods and services continue to increase.
These are unprecedented times: the impacts of the pandemic and now the current economic situation makes it very difficult to predict what a recession looks like in this new world and how the Federal Reserve and Government will respond. Over the past 13 years, they have been extremely quick to act to protect markets and consumers from a suspected recession, so we might expect a similar pattern here. But there is also the possibility that Central Banks have little to no room to move - with the primary objective being to bring inflation to heel – and therefore may need to continue to raise interest rates well into a recession.
Over the coming months, every job report, consumer sentiment, and inflation data point will be analysed to the nth degree to help us pick up on the trend and understand whether we are currently in recession, still heading toward one, or just maybe even coming out the other side.
European energy woes
Just when things started to improve in Europe, an energy crisis is looking increasingly likely; an event that would have a number of implications for European economies.
Fears are growing that Russia will turn off its supply of gas to Europe as retaliation for European sanctions against Russia’s invasion of Ukraine. Russian gas pipeline NordStream 1 is currently operating at only 40% of capacity due to “maintenance issues”, and there are concerns that Russia may extend the normal July maintenance period into a semi-permanent shut down as leverage to reduce sanctions.
European gas stores are currently at 57% of capacity, well off the mark for this time of year. European countries are required to reach 80% of capacity by early November, which off this low base will be close to impossible if there is an extended shut down of Russian gas supplies.
German economic minister, Robert Habeck, has already asked both businesses and consumers to consider what they can do to reduce energy consumption in the coming winter. Habeck has made it very clear that companies should expect rolling blackouts and gas to be shut off to any non-core critical industries during the winter. These capacity constraints and energy restrictions could have a significant impact on the German (and therefore European) economy.
Is China back?
The Chinese market was by far and away the best global performer in June, rising by over 9%. The rally was primarily driven by the prospect of the economy reopening; relaxation of Covid lock down rules; and equally important, the appearance of a cessation in the Government’s war on big tech.
Lockdowns in the major cities were lessened at the start of the month, alongside Government commentary that they would start to relax a number of the Covid regulations moving forward. Travel in and out of Hong Kong has been somewhat restored, and we even saw Chinese Premier Xi Jing Ping travel outside of China (admittedly only to Hong Kong) for the first time since the pandemic began. The Government has also made it clear that it will need to support the economy recover from what has been a tough start to 2022.
For the markets, a cessation in the war on the tech sector has been welcomed with strong rallies in all of the large tech stocks. Ride sharing app, Didi which kicked off the tech crackdown in 2021 after it listed in the US against Chinese Government wishes, appears as though it may get away with a fine (rather than having to close their business-doors) . And Jack Ma’s Ant Group may be allowed to resume its blockbuster IPO at some stage in the coming months.
The big question on the minds of investors and executives, is whether this is a short term truce reflecting the difficult economic environment, or a new longer term way of thinking by the Chinese Government. Only time will tell…
A brutal month for crypto?
When the equity market sneezes, it appears that Crypto catches the Delta variant of Covid. Over the past month we have seen Crypto prices plunge further, with Bitcoin falling over 37% in June and suffering its largest one-day loss since March 2020 – a fall of 16% on June 13.
Driven by higher interest rates and heightened investor-fear with the resulting exit from risk assets, this sharp and rapid fall in the price of many Crypto assets, has caused a leverage spiral in the industry.
Various companies had taken on debt to fund Crypto investments, and now with the value of their Crypto currencies plummeting, their debts need to be repaid. A number of crypto hedge funds, miners and other parts of the eco system, have fallen over during the month and this has resulted in an increased number of coins continuing to be placed on the market.
At this stage, it is unclear whether we are through the deleveraging phase or whether we have more to go.
That’s half time…
So that’s the first half of 2022 – and what a wild, bumpy and unpredictable six-months it has been. We’ll be back with our July Wrap in a few weeks to see what the first month of the second half delivers and what it might tell us about the road ahead.
But when it comes to KiwiSaver, remember, your road is your own. It’s all about making sure your KiwiSaver plan is purpose-fit for you. Check out our latest blog KiwiSaver in times of market volatility and of course, don’t hesitate to get in touch if you have any questions for the team at kōura.
