Consumers under pressure

Most regional equity markets continued to lose ground in March, but strong returns from US equities pulled global equity performance into positive territory by month end. The MSCI AC World Index ended March up 2.2% (total returns in US dollar terms), clawing back some of last month’s losses. Amid rising uncertainty, investors rotated into quality and perceived safety as markets grappled with US rate hikes, resurgent COVID infections and lockdowns in China, and the enduring war in Ukraine. Growth outperformed Value and large caps pulled ahead of their small-cap counterparts.

The US was the only major region to post positive returns in the month. Emerging Markets, Japan (TOPIX) and UK mid-caps (FTSE 250 Index) were among the weakest performers, alongside Chinese A shares. At a sector level, energy, utilities and healthcare outperformed, while banks and consumer staples lagged the wider market.

In commodities, Brent crude was up around 7% (39% year-to-date through the end of March), and closed the month above $107/barrel. Oil exporters continued to benefit from the commodities tailwind.

The wider Refinitiv CRB Commodities Index finished up around 10% in March and 27% in the first quarter. Gold has also been a beneficiary during the market uncertainty, up 1.5% and 6% over the month and quarter respectively. The US dollar maintained its strength against a basket of currencies in March. In fixed income markets, government bonds sold off as yields ticked up and the Fed initiated its rate-hiking cycle (raising rates for the first time since 2018). Global investment grade and high yield bonds also sold off.

In 2021, central banks grappled with sustained price rises amid growing demand and lingering supply-chain bottlenecks. Monetary policy remained loose, with inflationary pressures initially perceived as ‘transitory’, and the global economic outlook was constructive.

By the start of the new year, there was widespread recognition that inflation was more persistent than initially thought, particularly in the US, and that the Fed was in catch-up mode. The difficultly for central banks in following lagging, and often conflicting, data is that it is an increasingly flawed barometer of current economic health and an imperfect guide to the direction of travel.

For those who were tied to the ‘transitory’ narrative as 2021 drew to a close, there were some compelling reasons to believe that inflationary pressures would ease – supply chain bottlenecks were beginning to unwind, the oil price was falling, COVID-related stimulus was being wound down and demand patterns were expected to normalise as economies emerged from the most stringent COVID-related lockdowns.

Since the beginning of 2022, signs of ‘stickier’ inflation have begun to emerge, and the inflationary pressures have been exacerbated by supply-side constraints and commodity price hikes due to the war in Ukraine and subsequent sanctions on Russia.

Sitting alongside this uptick in inflation, is the potential for demand destruction and a deteriorating outlook for global growth. Looking at the OECD’s Composite Leading Indicator (CLI) series, denoted in the LHS chart on the slide below – monthly data points have been signalling a slowdown since the second half of 2021. In line with the deteriorating OECD CLI monthly data points, OECD-wide Consumer Confidence has also been on a downwards trajectory since mid-2021 (RHS Chart on the slide below), with the latest reading the weakest since May 2020.

The degree of the erosion of consumer confidence has surprised some commentators, given the relative strength of labour markets, but the withdrawal of pandemic support measures combined with rising consumer prices likely contributed to deteriorating confidence even prior to the invasion of Ukraine. The additional upward pressure on energy prices and ongoing uncertainty stemming from the war in Ukraine has exacerbated concerns. At the time of writing, the oil price was sitting at around $100/barrel versus $60/barrel a year ago – and this rising cost is feeding through to prices at the pump. These demand deflationary factors could see confidence, and subsequently demand, ebb even more as we move through 2022. 

In a recent note released by Fabiana Fedeli, CIO Equities and Multi Asset, she pointed to anecdotal evidence of demand erosion in the US, with weekly gasoline demand on a downward trend as prices have spiked year to date.

While we are seeing anecdotal evidence of demand erosion, we are yet to see significant signs of demand destruction. However, even before the war in Ukraine created additional supply-side pressures, and despite economies closing 2021 on a decent footing, global GDP growth forecasts for the year were being trimmed back. In January, the IMF cut its 2022 global growth forecast from 4.9% to 4.4%, largely reflecting reduced economic forecasts for the US and China. Officials cited rising energy prices and supply disruptions resulting in higher and more broad-based inflation, the impact of reduced stimulus and withdrawal of accommodative monetary policy in the US, and slower-than-expected recovery of private consumption, along with pandemic-related disruptions, in China^[1].

In March, the OECD estimated that global economic growth could be more than a percentage point lower this year than was forecast before the Ukraine war, with inflation at least 2.5% higher in aggregate^[2]. Fitch ratings also revised down its global growth forecasts by 0.7 percentage points to 3.5%, as Russia’s invasion of Ukraine intensifies global inflationary pressures and threatens global energy supplies^[3].

Few areas of the market have been immune to recent volatility and the global outlook is looking increasingly uncertain. In this environment, investors need to stay selective, look for companies with robust balance sheets and strong pricing power, and maintain well-diversified exposures.

[1] Source: IMF, January 2022, available at https://www.imf.org/en/Publications/WEO/Issues/2022/01/25/world-economic-outlook-update-january-2022

[2] Source: OECD, March 2022, available at https://www.oecd.org/economic-outlook/

[3] Source: Fitch Ratings, March 2022 available at https://www.fitchratings.com/research/sovereigns/world-growth-forecasts-cut-as-inflation-intensifies-due-to-war-21-03-2022#:~:text=Fitch%20has%20cut%20its%20world,rate%20hikes%20than%20previously%20anticipated.