Jul 8, 2022
The second quarter (Q2) saw a continuation of war-related uncertainty, market volatility and record-breaking inflation across the globe, with recession fears mounting as central bankers continued on the path of monetary policy tightening.
Developed market equities endured their worst first half of the year for half a century, after the MSCI World Index ended the second quarter down -16.1%, while their emerging market peers (MSCI Emerging Markets Index) limited the damage to -11.3%. Value strategies continued to find support from rising interest rates and higher inflation, while growth (e.g., expensive tech stocks) significantly underperformed, with earnings margins getting squeezed. Regionally, US equities, benchmarked by the blue-chip S&P 500 Index, ended the quarter down 16.1%, sliding into a ‘bear market’ (a fall of 20% or more from most recent all-time peak) and rounding off its worst first half performance since 1970. The decade-long rally in technology stocks came to a screeching halt this year, with the tech-heavy Nasdaq down more than 20% in Q2. Across the Atlantic, the pan-European Stoxx 600 Index closed down 9% for the quarter, as the backdrop of war, soaring inflation and rising interest rates weighed on sentiment. Japanese stocks also ended with losses, with the Topix Index down 13.8% over Q2, while Chinese stocks (CSI 300 Index, +1.4%) caught a strong bid in June on the back of easing COVID restrictions and promising manufacturing and non-manufacturing data to end the quarter.
Rather than offer refuge amid equity market weakness, government bonds and credit suffered the same fate as their equity counterparts as investors moved to price in significantly tighter monetary policy on the back of persistently high inflation. US Treasuries lost 4.1% over the quarter, while European sovereign bonds posted their weakest quarter in decades. The Bloomberg Barclays Global Aggregate Bond Index ended the quarter down -8.9%.
All returns are quoted in US dollars.
The US economy, while less sensitive to the war in the Ukraine, contracted by an annualised 1.6% quarter on quarter (q/q) in Q1, marginally worse than the second estimate of 1.5% previously reported. This was the first contraction recorded since the onset of COVID in 2020, coming off the back of record-high inflation, record-breaking trade deficits, protracted supply-chain woes and labour shortages. Core growth, however, remained robust, buttressed by a strong consumer (despite soaring prices) and a healthy dose of fixed investment spending. The manufacturing purchasing managers’ index (PMI) slipped further in June to 52.4 (from 59.2 in April and 57 in May), well below consensus expectations of 56 and marking the slowest expansion in factory activity in nearly two years. Consumer prices surprised to a four-decade high 8.6% (y/y) in May on the back of soaring energy costs and food inflation breaching 10% for the first time in 40 years. The core personal consumption expenditures price (PCE) index (the US Federal Reserve’s (Fed) preferred measure of inflation) rose by 4.9% in April from a year ago, down from 5.2% in the previous month. Following the record-high inflation print in the preceding week, the Fed raised the Federal funds target range by 75 basis points (bps) – to 1.5%-1.75% – instead of the expected 50bps that was initially priced in markets. Fed Chair Jerome Powell noted in an interview at the European Central Bank (ECB) Forum held in Sintra, Portugal, that the US economy remains in “pretty strong shape” and well-positioned to withstand the Fed’s hiking cycle.
The eurozone economy grew at an annualised rate 0.6% q/q in Q1, upwardly revised from the initial estimate of 0.3%. Momentum remained weaker over the reporting period, as elevated commodity prices and supply-chain constraints (exacerbated by the war) weighed on industrial production. Manufacturing activity gauges tracked lower over Q2, with the June PMI coming in at 52 points, a 22-month low. The services sector also showed slowing momentum as the cost of living ratcheted up and pent-up demand began to ease. In the labour market, the unemployment rate remained steady at the record low 6.8% in April, unchanged from the previous month and in line with consensus expectations. While the growth outlook for the area continues to deteriorate, inflation continues to shatter records, with the June inflation print in France the highest since the introduction of the euro. For the area as a whole, expectations are for 6.8% inflation for the year, well beyond the ECB’s 2% target, with energy prices accounting for the bulk of the upward pressure. Price pressures have become more broad-based, impressing a sense of urgency upon the ECB to raise borrowing costs at a faster pace. Amid surging bond yields and the rising risk of debt crises in the area, at an emergency meeting in June the ECB announced plans to create a new tool to support highly indebted member states, given the uneven transmission of monetary policy normalisation.
The British economy shrank 0.3% m/m in April, below consensus expectations of 0.1%. The weakness was broad-based, with all of the major sectors posting consecutive monthly declines. The manufacturing PMI fell to its lowest level in 23 months, coming in at 53.4 in June, from 54.6 in May, and below consensus expectations of 53.7. In labour markets, unemployment climbed to 3.8% in the three months to April, recording the first increase in the jobless rate since the fourth quarter of 2020. Inflation woes intensified as the May print came in at 9.1%, in line with consensus, and the highest reading since 1982. Meanwhile, core inflation appears to be easing, lending a modicum of support to the ‘transitory’ narrative as some of the COVID-19 induced pressure on prices rolls over. The Bank of England (BoE) Monetary Policy Committee (MPC) delivered a 25bps hike by a majority vote when it convened at its 16 June gathering, taking the Bank rate to 1.25% - the highest the rate has been in more than a decade.
China’s economy lost a lot of ground in the early part of the second quarter on the back of the economically restrictive lockdown measures employed to contain COVID-19 outbreaks. May saw a recovery in momentum, as retail sales, exports, industrial production and fixed investment performed ahead of expectations. The latest data points to a potential bottoming of the economic fallout as authorities begin to roll back lockdown restrictions, but caution is warranted as the impact on activity and supply chains may be felt for some time to come. At the same time, the ‘zero-COVID’ policy remains in place, thus, the risk of restrictions being reintroduced remains. In a speech in late May, the People’s Bank of China (PBoC) Governor Yi Gang promised that policy will in aggregate terms remain “accommodative to support economic recovery.” President Xi Jingping also reaffirmed commitments to meet the country’s “social and economic development targets for 2022 and minimise the impact of COVID-19” in a keynote address at the virtual BRICS Business Forum on 23 June.
The removal of all lockdown restrictions helped growth return to pre-pandemic levels, as the economy expanded 1.9% q/q in the first quarter of 2022, compared to an upwardly revised 1.4% in the previous period, and well ahead of expectations of 1.2%. Recent data, however, shows production in mining and manufacturing trending weaker on the back of weather conditions, while the deteriorating supply of electricity is also compounding the weakness. May also saw a decline in trade, which served as additional proof of the consequences of exogenous shocks from around the world (i.e., China, Ukraine, supply-chain problems, rising inflation and interest rates). Domestically, Eskom’s worst rolling power blackouts on record and logistical disruptions at ports only added to the headwinds.
Headline inflation printed at 6.5% y/y in May (0.7% m/m), from 5.9% in March and April, breaking through the upper limit of the South African Reserve Bank’s 3%–6% target band. The main driver of the higher increase was food inflation, even though many other components are also beginning to ramp up. Core inflation (which excludes volatile items in the basket such as food, fuel and energy) quickened to 4.1% in May, its highest reading since August 2019. In a Bloomberg TV interview at the Sintra Forum, SARB Governor Lesetja Kganyago said a 50bps rate hike in July was “not off the table” despite the bank’s baseline scenario of 0.25% hikes at each of the next three meetings.
The Bloomberg Commodities Index ended the quarter down 5.7% after a bruising final month of the quarter. Energy stocks, however, helped limit the downside over the period. Brent crude oil and West Texas Intermediate (WTI) extended their strong run, as the ongoing war in Ukraine continued to drive up energy prices. Industrial metals (i.e., copper, aluminium, zinc) struggled over the period as recession fears intensified, while gold held up relatively better than silver, platinum and palladium, given its safe-haven allure.
Figure 1: Hard/Resources - Q2 2022 % change (US$)
Source: Bloomberg as at 30.06.22.
South African bonds and equities suffered a similar fate to their global peers. The FTSE/JSE All Share Index declined in all three months of the quarter, with the biggest losses coming in June, to end the quarter down a hefty 11.7%, while the Capped SWIX Index limited the losses at -10.7%. At a super-sector level, resources (-20.7%) took the biggest hit, followed by financials (-15.3%), while industrials only fell 3.0%, thanks in large part to the Naspers-Prosus rally. Rising fears over the economic outlook, combined with higher US rates, weighed on emerging market debt. The yield on the South African 10-year note rose past 11% for the first time since April 2020 (yields rise as prices fall). In the end, bonds outperformed equities over the quarter, with the JSE All Bond Index capping losses at -3.7%. Cash, as measured by the STeFI Composite Index, returned 1.2% over the same period. In currencies, the rand plunged to its weakest level since October 2020 against the greenback, and also lost ground against the euro and pound sterling.
At the sector level, it was a tough period for basic materials: diversified and precious metals miners fell out of favour as industrial metals, such as iron ore, edged lower on the back of Chinese demand uncertainty; precious metals miners (gold and platinum-group metals) also came under pressure, while petrochemicals firm Sasol bucked the trend as energy commodities outperformed. Rising interest rates proved insufficient to prop up banks and the financials sector ended deep in negative territory. It was a tough quarter for consumer-facing sectors as the cost of living crisis, rising interest rates and energy outages demoralised the South African consumer. On a more positive note, the technology sector was the biggest gainer over the period as the market reacted positively to news surrounding the index bellwether stable, Naspers and Prosus. The group announced plans to sell parts of its stake in Chinese tech giant, Tencent, in a share buy-back programme designed to unlock value in the underlying assets. The regulatory crackdown in China has pummelled Tencent performance, which has been a major drag on earnings for Naspers and Prosus.
Selection of FTSE/JSE All Share Index stock performance
|Name||Index weight||Q2 2022 % return (ZAR)|
|British American Tobacco||2.6||13.6|
Source: Bloomberg as at 30.06.22.