Strategy blog: Market volatility

Strategy team: Kevin Gardiner

The US stock market yesterday had its biggest one-day fall since mid 2020, falling by 4%. Yesterday's close was (just) a new low for the year, leaving the S&P500 index down 18% in 2022.

The immediate cause of the latest sell-off was disappointing news on corporate earnings and margins in the consumer sector, which amplified ongoing concerns about underlying cyclical risk – specifically, the fear that entrenched inflation will add to interest rate and recession risk.

We take this risk seriously: the possibility of higher interest rates than then seemed to be on the cards was one of the reasons for us taking a more cautious "top down" view of global stocks earlier in the year.

That said, we do not see higher interest rates yet precipitating a US recession – if anything, the latest data point still to rising US consumer spending and industrial output through April at least, with business surveys suggesting that May too is seeing ongoing growth.

Consumer confidence is certainly low – it would be surprising if it were not, given higher energy and food costs – but that does not mean spending has to fall.

Inflation pressures are not going to disappear soon, but they will likely fade from today's elevated levels – arguably, in the US they have already started to do so (we will post a short update soon). The "cost of living" is painfully real for poorer families and those in the emerging world, but it is not yet a fully-fledged macroeconomic one.

One of the points supporting overall growth, for example, is that consumer spending power - driven by real net pay and job creation - may not prove quite as fragile as the headline inflation rates suggest it could be.

Without wanting to help talk ourselves into a wage-price spiral, we note that the compositional and growth-related elements of average earnings will have already lifted nominal wage income markedly (to a striking year-on-year rate here in the UK of 10% in March, if bonuses are included). Employment gains will also be supporting total spending power in much of Europe and the US.

The S&P's decline – which is being partially reversed this afternoon – has taken it to the edge of "bear market" territory (a decline of 20%), but this is of significance to headline-writers, not investors. We cannot predict when stability will return, but we still feel that bonds, not stocks, face the greatest valuation challenges from here. Profit margins may be coming under pressure at last – but they are doing so with US return on equity at record levels (a striking 20% in April).

We have been advocating more cash in portfolios than usual in recent months. This seems counter-intuitive at a time when deposit rates are still negligible or even negative, and when inflation has been high, but consumer prices are less volatile than stock or even bond prices. That said, we think further "tactical" or short-term additions to cash are unnecessary. We think stocks – but not yet bonds – can deliver inflation beating long-term returns from here.

Alongside recent stock market declines, "crypto currencies" have also been generating headlines. We continue to avoid such assets, which likely have a negative net worth. We do not think they have contributed significantly to the volatility in securities markets: if anything, cyclical risk may have reminded their owners just how speculative they are.

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Past performance is not a guide to future performance and nothing in this blog constitutes advice. Although the information and data herein are obtained from sources believed to be reliable, no representation or warranty, expressed or implied, is or will be made and, save in the case of fraud, no responsibility or liability is or will be accepted by Rothschild & Co Wealth Management UK Limited as to or in relation to the fairness, accuracy or completeness of this document or the information forming the basis of this document or for any reliance placed on this document by any person whatsoever. In particular, no representation or warranty is given as to the achievement or reasonableness of any future projections, targets, estimates or forecasts contained in this document. Furthermore, all opinions and data used in this document are subject to change without prior notice.

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