I felt now was an opportunity to update the global economic and political situations that are affecting portfolio performance.
The US dollar’s meteoric rise over the last six months was expected to come to an end, but in the last month alone it has increased by 7% against the New Zealand dollar, the Norwegian Krone, Japanese Yen and more than 5% against Sterling, Euro, the Swiss franc and the Swedish Krona.
A rising US dollar tends to tighten financial conditions and this reflects in the availability of funding. Emerging Markets tend to have high levels of dollar debt and several emerging market central banks have increased their interest rates over the last month, and really, given that most emerging markets have high exports, now is not the best time to be tightening. There is also the flip side that a higher dollar increases these emerging markets debt servicing costs.
Normally a firmer US dollar makes dollar denominated commodities costlier for consumers who use other currencies, eventually subduing demand and prices. However, this is not currently the case as tight supplies of major commodities have prevented that equation from taking place as the Ukraine- Russia war has hit exports of oil, grain, metals and fertiliser, keeping prices elevated.
The Federal Reserve Bank of the United States may well welcome a rising dollar, as this can calm imported inflation. It is estimated that a 10% dollar appreciation causes US consumer inflation to decline by 0.5% over a one-year period of time. If this gain in the dollar continues, the Fed would not need to tighten monetary policy as aggressively as anticipated, which would mean that interest rates would stay lower and inflation rates would ebb. This could create a positive feedback loop for other geographical locations such as the UK and the Euro zone, due to the high proportion of import and exports that these areas have with the US.
The International Monetary Fund (IMF) has lowered expected global growth rates from 4.4% to 3.6%, which is still a big plus, but it has warned of a significant increase in projected inflation. This is mostly due to the effects of Russia’s invasion of Ukraine. This may well prompt the IMF to further downward revisions to its growth projections later in the year, but this will (I think) be mainly aimed at mainland Europe due to its physical location from the war zone. For the sake of completeness, the IMF’s growth expectations for 2023 have been lowered from 3.8% to 3.6%, with those revisions applying to both advanced and developing economies.
There can be no doubt that globalisation has been evolving in ways that make it difficult for international trade and for countries foreign direct investment; the pandemic raised questions about the capabilities and vulnerabilities of “just in time” cross-border supply chains, which were already seeing restrictions due to the US-China trade war. The return of high tariffs and other protectionist measures are generating far-reaching knock-on effects throughout the global economy.
One of the world’s most highly respected economists, Mohammed El-Erian, explained in a paper he wrote that the developments that we are seeing coincide with a period of low productivity growth in many countries (in which I must include the UK), which is a function of past system failures to invest in the drivers of genuine growth, including physical infrastructure and human capital.
The reason I position the above paragraph where I do in this report, is simply that it totally follows on from the paragraph before it. Whilst being technically difficult to achieve from both a political and economic backdrop, it is not rocket science. Unfortunately, in Western democracies, the jousting that you see between opposition parties make the necessary conditions for the improvements I mention above very difficult to achieve. A perfect example of this would be the Democratic Party vs the Republican Party in the United States. Countries like China do not have the same problems, due to being an autocracy, however, it is really interesting to see the second largest country in the world (by gross domestic product) having the problem is that it is the moment.
It is also interesting to note that in the United Kingdom the problems highlighted by Mohammed El-Erian, have been partly addressed by none other than Boris Johnson. I hasten to add that as yet he has done nothing about it, but the fact that he is aware of it is a positive for the country. And, other countries will follow.
In closing this report, I should add that global markets have had a pretty torrid time in April, this is due mainly to heightened expectations for interest rates and inflation rates in the United States. Here, we believe that some of the market’s expectations are in excess of the likely realities. In particular, we do not feel that interest rates in the US are likely to go to 3.75% and we do not believe that inflation will continue climbing at the rate that it has been. Markets have been getting spooked and when they do they tend to overreact. It is worth noting that last week all 11 of the S&P 500 company sectors fell at the same time and included its largest one-day decline since June 2020. Other indices in the US Fed faired just as badly with large companies and technology companies all being marked down in price.
It appears we are in a scenario where just the slightest bit of bad news creates high levels of volatility within the markets and this was certainly evident last week when it was rumoured on Tuesday that Apple and Amazon’s quarterly results were going to be well below analysts’ expectations. On Friday this proved to be the case and all the major indices on Wall Street were sharply down. To me this is clear nervousness as 2022’s first quarters earning season is already halfway through and of the S&P 500 companies that have reported so far, 81% of them have topped Wall Street’s expectations, while typically only 66% of companies beat expectations. The reason for centering on US statistics is basically that US stock-market performances often have a knock-on effect on global indices and we feel that some of the markdowns and prices are overdone.
Colin Fogwill, Investment Director
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