Avoiding the squeeze?

3 min read 16 Feb 22

Summary: Investor sentiment deteriorated in January, as risk aversion crept back into the markets. With inflationary pressures increasing input costs and goods prices, how are corporates and consumers responding? Investment Specialist, Kirsty Clark reviews recent market performance and the prospects for further price rises in 2022.

As swiftly as risk appetite picked up and equity markets rallied into year end, an abrupt reversal of sentiment saw risk assets plummet in the first month of 2022, with more hawkish tones from central banks on rate rises and growing geopolitical tensions dampening investors’ risk appetite. The MSCI AC World Index ended the month down 4.9% (total returns in US dollar terms), to deliver the weakest January in six years for global equity markets. Value outperformed Growth, and large caps performed better than their small cap counterparts.

We again saw correlated asset price moves with equities and bonds retreating in tandem. Defensives held up better than cyclicals – but financials were among the strongest sector performers, delivering positive returns supported by the steepening yield curve in the US. Healthcare and consumer discretionary stocks were the weakest performers in January.

Source: Refinitiv DataStream, 31 January 2022. Total Returns in USD.

UK and EM equities were among the leading regional performers. While US equities, having been the strongest performers in 2021, proved the laggards in January – particularly the tech-heavy NASDAQ indices, as the market started to price in a steeper trajectory of interest rate hikes. Japanese equities also underperformed broader global equity markets.

Oil prices hit a seven-year high, with Brent crude rallying more than 17% to finish above $90/barrel on fears that geopolitical risks to supply could limit the ability to meet a strong rebound in demand. The energy sector tracked oil prices higher and was one of the few global sectors to gain ground in the month. Gold was marginally down and the US dollar strengthen against a basket of currencies. In fixed income markets, UK gilts led the declines in government bonds, investment grade and global high yield bonds also lost ground.

As we rolled into earnings season, inflationary pressures continued to loom large for corporates. An analysis of company earnings call transcripts by S&P Capital IQ found that ‘inflation-related’ mentions appeared in 71% of fourth-quarter 2021 earnings calls, and talk of supply chains remained high among textiles, apparel and luxury goods companies in particular. Some of the largest growth in supply-chain mentions came from the healthcare equipment industry, with analysis showing chip shortages affecting new products[1].

With global demand and supply imbalances pushing up input costs for companies (e.g. raw materials, logistics and labour costs), we’ve seen companies including McDonald’s, PepsiCo and Procter & Gamble pass price hikes through to consumers in the US[2]. In the UK, the British Retail Consortium warned of the faster pace of price hikes in 2022 versus last year[3]. Supermarket chain Tesco warned that the worst of the prices rises were ‘yet to come’[4], while multinational consumer goods company Unilever said it would take a country-by-country approach to price hikes in 2022[5]. Although inflation is less pronounced in continental Europe, the cost of food and industrial goods have risen as companies contend with supply-chain issues and rising energy costs. As businesses scramble to meet demand growth, the upward pressure on goods prices is borne out in the recent Consumer and Producer Price Inflation numbers.

Source LHS Chart: Refinitiv DataStream, Bureau of Labor Statistics, Consumer/Producer Price Indices, YoY change, January 2022

Source RHS Chart: Refinitiv DataStream, European Central Bank – Eurozone, Harmonised Consumer Prices, Goods /Services, YoY Change, December 2021.

Companies with pricing power will be best placed to defend margins in 2022, but how are consumers responding? So far, companies are reporting that demand remains strong despite the price hikes[6], but with the unwinding of household savings – as fiscal support rolls off (e.g. furlough schemes and direct stimulus checks) and inflationary pressures hit consumers’ pockets – demand growth could weaken in the face of deteriorating purchasing power.

Source: Refinitiv DataStream, Oxford Economics, February 2022

With inflation prints ticking up, so too are earnings expectations to close the gap between rising prices and real incomes. This is the case across regions but particularly true in the UK where the lifting of the energy price cap in April is due to coincide with a rise in national insurance tax, amid ongoing price inflation.

Despite the Bank of England governor Andrew Bailey looking to temper inflation expectations and urging UK employees not to request a pay rise (to avoid an upward wage/price spiral), as companies continue to pass on costs to consumers – and with the central bank itself forecasting the biggest fall in real incomes in 30 years[7] – households will be looking to close the near-term purchasing power gap.

The combination of fiscal and monetary tightening, an unwinding of remaining supply-chain bottlenecks, and the squeeze on real incomes should slow spending and take some steam out of rising goods prices.

In addition, as developed economies in particular continue to open up on the back of widespread vaccine rollouts, booster jabs and COVID-19 treatments, consumers could begin to redirect disposable income towards ‘services’ that have not seen the same rise in demand under pandemic-related restrictions in the US, the UK and the Eurozone (France being the exception). This would be a welcome relief for service providers, should help to buoy the global economy while normalising demand for goods, and potentially avoid ‘stickier’ inflation over the medium term.

By Kirsty Clark

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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