Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
The S&P 500 Index has now had six consecutive weeks of declines; the first time this has happened since 2011. However, the sell-off has not been limited to equity.
Until last week, equities and bonds were both selling off. The primary concern for markets was inflationary risk, not a good environment for equities, but certainly not for bonds.
Indeed, the chart below shows that US government bonds are at their most volatile since the Global Financial Crisis, and for a sustained period. The same cannot be said for equities (S&P VOL) and currencies (FX G10 VOL), which have also both had higher volatility of late but nowhere near to the same degree relative to their history.
Equity, bond and currency volatility: US Treasuries experiencing materially higher volatility
Source: Bloomberg, 14.01.2008 – 17.05.2022.
The performance information presented in this document relates to the past. Past performance is not a reliable indicator of future returns.
The uncertainty around inflation, and therefore central bank policy, expressed through higher bond yields and higher bond volatility, has led to quite a bit of froth being taken out of equity markets, most notably tech stocks. However, the dynamic is much broader than that, including bitcoin and the like, which are down materially. Meanwhile, corporate bond and emerging market government bond spreads have widened materially, reflecting a broader concern around risk assets.
Price movements in commodities have been more mixed, but for good reason. Copper, noted for its economic sensitivity, has fallen sharply, reflecting a poorer economic growth outlook. Energy, meanwhile, remains close to recent highs, due more to its tighter supply outlook, in large part due to the ongoing conflict in Ukraine. For similar supply reasons, in part at least, many agricultural commodity prices remain high too.
So, it seems that concerns about inflation have been damaging across assets, with the exception of areas like commodities. However, more recently this dynamic has changed. Last week, for example, we still saw frothy equity and bitcoin continue to be punished but developed government bonds rallied, and defensive equity performed relatively better.
Pulling those more recent asset class moves together, markets are increasingly focusing on recession risk, rather than inflation risk. We believe there is some logic in focusing on recession risk, with central banks raising rates and China’s draconian lockdowns hurting the world’s second largest economy. However, markets seem to increasingly believe that US inflation is peaking and that inflation will move back to very low single digit levels.
We have some sympathy that inflation will peak in the shorter term but are less convinced that inflation will return to where it was pre-Covid. Too many dynamics have changed, not least, a trend for de-globalisation rather than globalisation.
We think inflation and recession risk remain elevated. Importantly, whether or not the US Federal Reserve can manage a soft landing will depend on how persistent inflationary pressures are. So, we remain focused on inflation.
Our broad exposure across multiple asset classes, for example including energy and agricultural commodities, has provided a decent balance to our portfolios this year, including during the recent sell-off.
More recently, we have adjusted our equity sector exposures, reflecting our view that whilst inflation risk remains elevated, recession risk has increased. For example, we have significantly reduced our exposures to cyclical areas like banks, and reduced exposures to materials, industrials and consumer discretionary. At the same time, we have been adding to consumer staples and utilities.
