May was another negative month for global equities, but an impressive recovery into month-end meant the MSCI All Country World Index recouped the vast majority of its losses, finishing with a 0.2% decline. US Treasuries and core Eurozone government bonds also bounced off the recent lows with yields pulling back from their peaks, although UK Gilts underperformed, especially those linked to inflation.
Supply chain challenges remain one of the chief concerns for investors and while there has been some easing on this front, protracted hostilities in Ukraine and lockdown measures in China have presented new issues for both manufacturing and food.
Following a solid first quarter earnings season there has been a lull in company reporting. Overall, guidance to analysts remains pretty good despite cost pressures, and earnings estimates are marginally higher since the start of the year. This, coupled with the fall in share prices seen year-to-date, has pushed global forward valuations cheaper than the 10-year average. That said, there is some scepticism regarding how sustainable rising earnings are, given slowing growth and rising costs.
A basket of leading US growth stocks now trades at around 20 times forward earnings, significantly lower than a peak near 30 times, while value shares are in the region of 15 times. Compared to previous stock market corrections these levels are still not that cheap, and as we believe the de-rating still likely has further to go, we have decided to scale back risk recently.
US: inflation peaking?
While rising inflation and hawkish central banks still feature prominently in investors’ thinking, there is an increasing focus on economic growth and how it will hold up in the face of aggressive monetary policy tightening. The Federal Reserve delivered its first 50 basis point rate hike since 2000 at the start of May and markets are firmly pricing in increases by the same amount at the next two meetings. Markets have the end of year fed funds rate at approximately 2.8%, significantly higher than the current 1.0%. However, the debate around Fed policy is now centred on the possibility of a slower pace of tightening, with a possible pause in the hiking cycle touted for September.
This narrative shift is bolstered by encouraging signs that US inflation is at, or at least near, a cyclical peak. The annual consumer price index slowed to 8.3% in April, down from a 41-year high of 8.5% in March, and the latest core personal consumption index, believed to be the Fed’s preferred inflation metric, came in at 4.9%, below March’s 5.2% reading.
The labour market continues to go from strength to strength with employers adding 390k nonfarm jobs in May, comfortably above the consensus forecast of 320k. What is more, the unemployment rate held steady at 3.6% while average earnings growth ticked down to 5.2% annualised from 5.5% in April – also suggestive that broader cyclical price pressures could be close to a peak. US large-cap shares managed to eke out a small gain for the month after falling to new lows for the year. Growth and tech stocks remain laggards but bounced significantly into month-end to end with modest declines of just under 2%, after trading as much as 10% lower.
UK: activity slowing
In contrast to an easing in US inflation, there was a further increase seen in the UK, as the consumer price index jumped to a 40-year high of 9.0%. Along with higher commodity prices, a tightening labour market is imparting upward pressure on prices. The unemployment rate for the three months to March, fell to its lowest level since 1974 at 3.7% and for the first time on record, vacancies exceeded those seeking jobs. The tight labour market may continue as the pool of participants has declined since pre-pandemic due to a combination of aging demographics, early retirements, immigration and a significant increase in long-term sick/awaiting medical treatment.
Andrew Bailey, Governor of the Bank of England, has said the bank can do little to prevent double-digit inflation later in the year. Still, the bank moved to raise rates for a fourth consecutive policy meeting, with the Monetary Policy Committee unanimously supporting a 25 basis point hike to 1.0%. The interest rate futures market is currently pricing a year-end bank rate in the region of 2.4%.
