A turbulent start to 2022 for the investment markets
Quarter in brief
U.S. stocks had their worst month since the start of the pandemic and many stocks have frequently experienced large intraday price swings
Yields on UK gilts continued to climb sharply
The Bank of England announced on February 2 that it was raising interest rates from 0.25% to 0.5%
Investment markets saw large and volatile moves throughout January as investors worried about the various challenges facing global economies and markets. Snowballing levels of inflation have forced central banks to prepare to tighten monetary policy at a faster pace than previously thought.
US stocks had their worst month since the start of the pandemic; the tech-heavy S&P 500 and Nasdaq fell 5.3% and 9%, respectively, which would have been worse had it not been for the sharp rise in stocks over the last two days of the month. Many stocks have seen sharp intraday price swings and the selloff has been particularly strong in technology and growth stocks, where valuations have long been seen as stretched, although broader sectors have not been spared. Companies such as Netflix, Spotify and Tesla all saw double-digit price drops during the month. UK equities, whose valuations have been significantly lower, have generally fared better.
Investors have seen a marked change in tone from the US Federal Reserve (“the Fed”), which has become increasingly hawkish on inflation. At his January meeting, Fed Chairman Jay Powell made a strong signal that he planned to begin the rate hike cycle in March. He also confirmed that he would end his bond buying program in early March. The speed of this gradual reduction in bond purchases and its refusal to rule out a series of more aggressive interest rate hikes surprised investors. Markets are now pricing in nearly five U.S. interest rate hikes in 2022, up from three previously. Higher interest rates reduce the value investors place on future earnings, which can affect stocks, as well as bond markets.
Geopolitical tensions, particularly in Europe, also weighed on market sentiment. The West remains at an impasse with Russia, which appears to be using the threat of an invasion of Ukraine to obtain a series of “security guarantees”. The outcome of this situation remains uncertain and could have significant repercussions on the world, both politically and economically.
Corporate bond credit spreads widened, reflecting an increased perception of default risk. Coupled with rising gilt yields, this led to a difficult month for investment grade and high yield corporate bonds.
GDP data released in January for the UK showed the economy surpassed its pre-pandemic level for the first time in November. While global growth continues to be strong, there are still signs of slowing. The continued spread of Omicron around the world is likely one of the factors contributing to this slowdown, although the impact will be more limited in countries with high vaccination rates.
Yields on UK gilts continued their remarkable rise seen since early December as investors changed their expectations about the policy measures needed to fight inflation. The 20-year gilt yield ended the month up 0.6% pa from its December 2021 low. The Bank of England raised interest rates in its announcement in February from 0.25% to 0.5%. CPI hit 5.4% in the UK in December.
The estimated overall funded position of UK DB pension schemes, on a long-term basis, deteriorated in January, but ended slightly higher due to higher gilt yields.
Source: XPS Database: United Kingdom www.xpsgroup.com/services/xps-pensions/xps-dbuk-funding-watch
The charts above are based on data from The Pensions Regulator, PPF 7800 Index and XPS Data Pool. The assumptions used in the UK:DB long-term target basis include a discount interest rate on gilt returns plus 0.5%. Assumed asset allocation is 16.9% equities, 20.0% corporate bonds, 6.9% multi-asset, 5.1% real estate, 3.8% private markets and 47.3% liability driven investing (LDI), with the LDI overlay providing a 60% hedge against inflation and interest rates.
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