Markets look to shake off inflation-linked wobble
As we write the bond and stock markets have stabilised after a period when fears over mounting inflation and an increase in interest rates saw fixed income yields spike and equities fall over.
Having reached a record high market close in mid-February the MSCI World index of developed markets then fell nearly 4% by 4 March. The slump has been more pronounced in the US technology-heavy Nasdaq Composite index which fell nearly 10% between mid-February and 8 March, before rebounding 3.7% on 9 March.
Some stocks like Tesla suffered badly – the electric vehicle manufacturer and bitcoin investor had slumped 31% from its recent record high before rebounding nearly 20% on 9 March. The popular ARK Innovation ETF, tracking a basket of Silicon Valley stocks, also sold off heavily.
The reason behind the downward moves in February and early March is that investors have been less willing to stomach the sky-high valuations technology firms have attained in an environment where interest rates are expected to rise.
Corrections can be a healthy thing, particularly if a market has become overheated – the question now is whether the recent rebound in many tech stocks can be sustained.
This would have significant implications for equity markets across the board given the dominance of technology in many geographic regions.
OIL PRICE SURGE
The FTSE 100’s focus on the old world economy, with a heavy weighting to banks, mining stocks and oil companies, and its underperformance of other global markets heading into the latest correction, has insulated it from the worst of the recent volatility.
Oil prices surged in the wake of OPEC’s decision not to boost supply on 4 March, extending the gains from the low point in April 2020 at the height of the pandemic – with attacks on Saudi Arabian oil facilities briefly driving Brent crude above $70 per barrel. The black stuff remains up more than 300% last April’s lows with demand expected to benefit from a reopening of the global economy.
Several of the big investment banks have increased their forecasts for oil – for example, Goldman Sachs now expects $80 per barrel in the third quarter – and further price hikes could add to inflationary pressures and potentially crimp the Covid recovery.
Rising oil prices are effectively a tax on growth as they increase the costs of transportation, manufacturing and heating.
Elsewhere in the commodity markets, the price of nickel – seen as a key metal in the electric vehicle revolution and recently trading at six-year highs – tanked almost 15% to $16,100 per tonne over two days in early March after a surprise increase in supply.
Chinese metal giant Tsingshan upended the market by starting production on a battery-grade form of nickel from low-grade ore, which could see it flood the market.
Stocks in China have taken a hit as the top advisory body to the country’s government says it is still ‘30 years away’ from being a manufacturing nation of ‘great power’.
Despite being responsible for a third of the world’s manufacturing output, former industry and technology minister Miao Wei, a member of the Chinese People’s Political Consultative Conference, warned on 7 March that China is still heavily reliant on the US for high performance products like semiconductors, adding China’s ‘basic capabilities are weak’ with the country running the risk of ‘being hit in the throat’.
It clearly resonated with investors with the Shanghai Composite stock market index reacting with a 2.3% fall following the comments and the Hang Seng in Hong Kong falling 1.9%, compared to a 0.4% drop for Japan’s Nikkei 225. Concerns are mounting that Chinese stocks are overvalued and due for a correction.
That comes as emerging market assets more broadly have suffered their first wave of outflows since October with fears over a rise in the cost of borrowing. Higher yields in developed markets dent the allure of emerging market assets, which typically have higher returns to compensate for higher risk.
Could inflation be a short-term issue?
Bond investors have been spooked by data which increasingly points to supply chain bottlenecks and longer lead times, increasing risks of higher inflation.
For example, the US ISM purchasing managers’ index survey for February reported that prices paid were the highest since 2008 with aluminium, copper and chemicals leading the increase.
The big question for bond investors now is the sustainability of current supply shortages and whether the impending $1.9 trillion US stimulus programme will add to a trend of rising prices.
John Dizard at the Financial Times argues the supply chain problems are a classic case of the whiplash effect caused by retail inventories being run down at the beginning of the pandemic.
Covid-19 shutdowns and restarts disoriented supply managers who then ended up overstocking supplies to catch up with initial shortages. This had a concertina effect all down the supply chain.
If the February ISM non-manufacturing inventory sentiment reading is a good indicator, then upward pressure on prices may ease. The survey showed that 19% of respondents reported inventories were too high, up from 10% in December.