Humble, Nimble and Hawkish

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Equity markets had another volatile week, with sizeable intra-day swings particularly in the US. But unlike the previous week, when global equities fell a sizeable 4%, they ended down a modest 0.6%, buoyed by a strong finish in the US.

The focus of attention was very much the Fed meeting mid-week. The Fed confirmed it would finish its QE program in March and also signalled it would start raising rates then. Chair Powell said its highly accommodative policy was no longer appropriate with the economy now operating at full employment and inflation well above its 2% target.

Powell also emphasised that the economy was far stronger than at the start of the last tightening cycle. Far from committing the Fed to a particular path, the new mantra is that the Fed will be humble and nimble. Quite how rapidly policy will be tightened is far from clear but the market is now pricing in five 0.25% hikes over the coming year which would take rates up to 1.25-1.5%.

Given the rapid reappraisal of how fast policy is going to be tightened, the recent weakness and volatility of equities is hardly a surprise. Indeed, as we have pointed out before, it is the norm at the start of Fed hiking cycles.

Equally normal, however, is that markets re-coup any such losses over the subsequent six to twelve months and we believe this should be the case this time too. We raised some cash from our fixed income holdings in November with the intention of reinvesting it in equities if they were to see a significant correction.

Global equities are currently down some 6.5% from their early January high and where appropriate, we will be adding moderately to the equity holdings in Kingswood client portfolios. We will be buying Continental Europe in most cases. It is one of the regions hit hardest in the sell-off, valuations are supportive and both fiscal and monetary policy look set to remain more expansionary for longer than elsewhere.

While a potential Russian invasion of the Ukraine clearly poses some short-term risk, most geopolitical flare-ups and military conflicts in the past have only had a short-lived impact on markets. It is also worth noting that the more defensive French and Swiss markets both account for a larger share of the European index than the more cyclical and higher risk German market. Indeed, while German GDP posted a 0.7% decline in the fourth quarter, French GDP was up by the same amount.

Last week saw a deluge of economic data with US inflation numbers taking pride of place. Core PCE inflation (the Fed’s favoured measure) rose a little further to 4.8% while wage growth increased to 4.5%. Both are now running at the highest level for 30 years or more.

Meanwhile, US GDP posted a strong 1.7% gain in the fourth quarter. However, a one-off rebuilding of stocks was behind much of the rise and Omicron looks set to lead to a considerably weaker performance in the first quarter. Even so, any such weakness should prove temporary and looks unlikely to dent the Fed’s new-found zeal to tighten policy.

Last but not least, the US earnings season continues. Estimates have edged up since the start of reporting, with the consensus now looking for a 25% rise in S&P 500 earnings on a year ago. Apple and Microsoft both beat expectations last week, showing at least two of the tech behemoths remain in rude health.

The tech sector will remain in the headlights this week with Alphabet (Google), Meta (Facebook) and Amazon all reporting quarterly results. But for UK investors at least, all the attention will be on the Bank of England meeting on Thursday. A 0.25% rate hike to 0.5% looks a done deal (famous last words). Of much more interest will be whether the Bank sticks to its line that only a modest tightening of policy will be required to get inflation back under control.

Rupert Thompson

Chief Investment Officer