With global markets still reeling from the historic rise in interest rates, this has been called “The Great Unwind” as the world (especially developed markets like the US and Europe) moved from “Free Money” through the fastest rise in interest rates in recent history. This has led to a global fall in asset prices across the board (not only in equities). In USD terms global markets had a horrific year in 2022.
- S&P 500: -19.89%
- NASDAQ: -33.66%
- SA: -4.96%
- CHINA: -18.68%
- UK: -4.82%
- GERMANY: -22.49%
- FRANCE: -12.29%
To unpack this, we have decided to break this market update into several shorter bite-size pieces to keep it sharp.
LET’S TALK ABOUT INTEREST RATES:
The timing of our update today is very intentional as this week the Fed is scheduled to meet and discuss their next potential move on US interest rates. The chart below shows the aforementioned dramatic rise in interest rates from the US Federal Reserve (Fed). You can clearly see that the recent pace and quantum with which rates increased is unprecedented.
Source: Visualcaitalist.com
Even after these extremely rapid rate increases, why do the central banks keep shouting about keeping interest rates high even with the likelihood of a recession? Surely The Fed wants to avoid a recession? This is primarily to put pressure on wage expectations and drive them lower in an attempt to cool the inflationary impact of wage increases. South Africans are used to inflation, but the developed world has experienced a prolonged period of stable low inflation. The combination of QE (Quantitative Easing) and the supply chain issues caused by Covid lockdowns and the war between Russia & Ukraine caused the perfect storm sending inflation to levels not seen since the 70’ and 80’s, this was not an everyday event to be sure! The US can’t sustain such extreme inflation, therefore the Fed’s job is to moderate this using the tools at their disposal, namely US interest rates.
This spike in inflation was initially seen to be mostly a covid hangover but once the Fed realized that it was a much more severe problem the rate cycle was ramped up to an extreme quantum. Below you can see the direct relationship between the Fed rate and market valuations. As an additional point of interest, the grey bars are the recessions which also correlate directly with a rising Fed rate. The Fed must dampen inflation while also avoiding recessions, too much stimulus causes inflation but if there is not enough the economy falls into a recession… their track record is not great.
Source: Macrotrends.net
So, what does this mean for your money? Will the markets recover and if so, when?
Our next update will delve into this in more detail, for now, we can close with this.
The markets are elastic, there are Macro factors that drive movement up and down. When these factors are stretched to an extreme, they pull the market in a direction but as they unwind and then move in the opposite direction the market once again must follow.
Right now we are stretched to higher Fed rates and a lower global market, we do expect this to start shifting in the other direction, in fact, the market has already seen pre-emptive action as some investors are expecting the Fed to “pivot” in the upcoming meeting later this week. While we do not think this will happen, the market activity over the past 2 weeks shows just how quickly markets bounce back, even with speculation alone that they might!
If the Fed move too early, will probably see a resurgent inflation problem, if they move too late and too slowly, the US and the World will go into a deeper recession. We can’t say for sure what the market will do in the short term but if you are a long-term investor, now is not the time to sell.
As always we encourage questions and robust discussion.
Our next update will follow in the coming weeks.
Thanks for taking the time to read this.
If you would like more information on the US Fed Rate cycle, I suggest this article: https://www.reuters.com/markets/rates-bonds/fed-probing-right-rate-level-prospects-rise-soft-landing-2023-01-19/
Regards.
Richard Sharp
MD
Heritage Wealth Partners.