After a very optimistic start in January, February served a reminder that the macroeconomic concerns of 2022 are far from behind us.
February was not only hotter-than-expected in terms of weather, but also with economic data releases, which put renewed pressure on share and bond markets. Strong labour reports – coupled with signs of stubborn inflation – were a reality check for investors, suggesting that major central banks may need to tighten interest rates further (and for longer) to rein in inflation.
Higher interest rate expectations saw a continuation of a key theme of 2022, as prices for global bonds and shares moved in the same downward direction in February. However, it wasn’t all doom and gloom: our Plans’ positioning and material allocation to UK shares was a positive, doing a decent job at limiting participation in the negative movements within global share markets.
Elevated interest rates and share valuations in selected regions continue to drive our cautious approach to Plan allocations. As such, we see the prices of bonds as being more attractive to shares, with risks continuing to be unevenly balanced towards the latter.
Markets’ attention remains firmly fixed on policymakers, who were busy once again in February, as the Fed (Federal Reserve), Bank of England (BoE), and European Central Bank (ECB) all imposed rate hikes. Here in the UK, the base rate is now 4% — the highest since 2008.
Interest rates have already substantially increased over the last year, but Central Banks continue to tighten, demonstrating the magnitude of the threat posed by inflation and their commitment to fighting it. Whilst February’s hikes were already priced in, it is the expected actions of Central Banks that will continue to determine the direction of markets.
Despite the aggressive rate hikes implemented in the US over the last year, there are limited signals that its economy is slowing. The employment figures stunned markets last month, as it showed that 517,000 jobs were added in January, beating estimates by over 300,000. Although economists have attributed this strong number to seasonal factors, other data prints – such as a decreasing unemployment rate and jobless claims – highlight the resilience of the labour market.
Increasing consumer confidence in February (as well as retail sales coupled with spending and consumer confidence) also signalled optimism in the US. Whilst a healthy economy is often perceived as a positive, it currently indicates that the Fed may need to keep raising rates for higher and longer to cool inflation, which was 6.4% in February. This would present a headwind to economic growth and, in turn, the prices of shares.
The UK was a bright spot amongst markets and economies last month. Not only was it one of the only regions where shares rose during February, but the latest GDP (Gross Domestic Product) data also displayed that a recession was avoided in Q4 2022. Inflation was also lower than expected — but remains considerably elevated at 10.1%.
Like the US, recent jobs data exemplified the strength of the underlying labour market, as jobs added in the UK surprised to the upside last month (+102,000) and the unemployment rate remained at 3.7%. Manufacturing activity was also higher than expected but remains contractionary. Despite many of the positive signals in February, the BoE still expects a recession, albeit shorter and less severe than previously anticipated.
Recession fears were also allayed in Europe, as economic activity in both services and manufacturing surprised ahead of expectations, signalling that its economy is expanding. The mild winter was no doubt a contributing factor to this, but Europe is not out of the woods just yet.
Although headline inflation slowed on a monthly basis, core measures – which are linked to the labour market – are proving to be stickier than anticipated and expected to drive further European Central Bank rate hikes.
Markets retrenched in February, as interest rates were repriced higher — which also resulted in the dollar appreciating against major currencies. This was a boost for the UK, with the FTSE 100 (+1.35%) reaching a record high in February, as many of its companies derive their profits in dollars.
The smaller FTSE 250 also held firm (+0.03%), as the UK’s positive economic data helped support investor sentiment towards domestic companies. European shares (+1.74%) were the top performers, as the risk of a deep recession declined. Japan also posted a modest gain (+0.87%), as the Bank of Japan (BoJ) continued with its accommodative monetary policy, and a depreciation in the Yen provided a tailwind for its exporting companies.
Despite the positive returns highlighted above, we saw considerable declines in US (-2.61%), Asia-Pac (-6.87%), and Emerging Markets (-6.54%) shares last month. These markets were affected by the anticipation of further tightening from the Fed, and the strengthening dollar presented a headwind for Asia-Pac and Emerging Markets.
Both regions have been supported by China’s easing of Covid-19 restrictions, but investor sentiment towards its reopening somewhat dampened last month, when Emerging Markets underperformed Developed Markets for the first time since October.
In addition to the increase in expected US interest rates, a safe-haven rally also benefitted the US dollar last month, which appreciated by 2.94% against sterling. This also worked against our US dollar exposure in Plans, as a large part of our US share allocation is hedged back into sterling. However, the UK’s GDP surprise helped the pound rise against both the Euro (+0.93%) and Japanese Yen (+2.49%).
Investment type performance breakdown
In our Original Plans, shares (-0.27%), property (-1.76%), infrastructure (-2.40%), and bonds (-1.72%) all ended the month in negative territory. This exemplifies the challenging nature of markets during February, but our Plans benefitted on a relative basis from the higher allocation to UK shares. Our healthy allocation to cash – which is a product of our higher-than-usual caution – as well as underweight exposure to Emerging Markets and Asia-Pac, also added positively to performance.
Ethical shares held up marginally better than Original due to outperformance in the UK, Emerging Markets, and Asia-Pac selections. Ethical Plans performed similarly in February. However, Ethical bonds also dropped by 1.87% against a negative market backdrop. Overall, Ethical and Original Plans performed similarly last month.
Summary with Plan details
Original and Ethical Plans delivered mildly negative returns across all risk levels in February. Investors found themselves in a ‘good news is bad news’ environment, where strong economic data prints have escalated concerns regarding inflation, and the level of interest rates required to combat these pricing pressures. Overall, this had a negative impact on both stocks and bonds, which pared some of their January gains. Share markets proved to be more resilient than bonds, meaning Plans with a higher allocation to higher-risk assets performed better than those with a higher allocation to bonds. We expect further volatility as the market reacts and digests the flow of economic data, which itself has a high uncertainty attached to it. Therefore, we continue to position our Plans with caution.
Our Investment Team continues to actively monitor the financial markets and their impact on your Plan — and are always ready to act in your best interests to events as they unfold. We are continually evaluating new market information and key market drivers to help keep your Investment Plan on track. It’s important to remember that it’s normal for markets to go up and down, with periods of volatility to be expected when you invest.
As always, we continue to look for opportunities to position your investments, with the goal of protecting your money and achieving your long-term objectives.
Please remember the value of your investments can go down as well as up, and you could get back less than invested. Past performance is not a reliable indicator of future results.