There are several factors that are causing markets to be volatile currently. We still have the hangover from the Omicron variant in the West, though in the UK the markets are pricing the fact that that is now largely behind us.
Inflation, and in particular the nature of it, whether it is transitory or more embedded, is also a major concern. If inflation remains high there is little doubt that central banks with have to raise interest rates. The markets are already factoring that into some extent but there is much speculation around how many rate rises there will have to be.
Rising rates have a broad effect of slowing the economy (and thus hopefully inflation). But their effect is not equal on all assets or all parts of markets. Bonds will suffer if rates rise but longer duration bonds suffer more.
There’s some concern in markets about how fast the US Federal Reserve is going to go in terms of tightening monetary policy. Both with interest rate rises but also slowing and reversing the amount of Quantitative Easing (called Tapering) that has pumped billions of dollars into markets.
Rising rates also impact equities (if rates are higher then the value of future profits is lower) and have greater impact on “growth” companies that have low profits now, but bigger potential later. That’s why we have seen bigger falls in technology stocks.
The market is nervous about corporate profits and whether they can be sustained (can they pass the inflation costs onto customers).
In Eastern Europe the “standoff” between Russia and the Ukraine and NATO and the U.S. are putting upward pressure on gasoline prices, not only in that region, but also globally. And that’s all again feeding into inflationary pressures that we’re feeling.
On the plus side it looks like Omicron virus is now largely being controlled and economies can start to get back to normal – most economists are predicting reasonable growth going forward.
Institutional investors have large cash balances, this tends to support markets. And there is a lot of Merger and Acquisition activity which again supports markets.
So, our view is there is likely to be continued volatility in the short term as these factors play out. We think equities offer better long-term value than bonds (because our view is that inflation is more likely to persist forcing interest rates up).
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