The rise in volatility and macro uncertainty have led to a significant de-rating in the equity market. The S&P 500 index had seven weeks of negative returns (ending on May 20), an uncommon event that last occurred 21 years ago in March 2001.

By the end of the third week of May the SPX was flirting with bear market territory as the year-to-date performance exceeded the -20% threshold, before recovering slightly.

Yet, despite a slew of negative macroeconomic prints during the week ending May 27, the equity market recovered strongly, with the S&P 500 recording one of the sharpest rallies on record. The 6.6% total return for the week was the 19th strongest return since 1950.

The economic backdrop has changed meaningfully since the start of the year. The market expectation back then was for economic growth to moderate to above-trend (above trend implies growth exceeding 2%) growth for major economies. This followed the abnormal growth reported in 2021, which was primarily driven by the re-opening of economies after the pandemic.

The positive outlook for 2022 was factoring in an improvement in the supply side constraints which would ease inflation concerns. However, inflation remained elevated for longer than initially expected as pent-up savings have supported consumer demand while the supply side was under pressure from the Ukraine invasion in March and China’s zero-case policy (which led to several city lockdowns in the country in April).

It meant that we had gone full circle from the reflation trade for much of 2021, to stagflation concerns late in 2021/early 2022 to recession fears today.

We looked at the biggest market moves in 2022 and tried to understand the main drivers of performance. We found four periods where equity market moves were significant for global equities: (1) 12/01 to 27/01 – MSCI World Index (MXWO) fell by 12.0% in just 15 days; (2) 09/02 – 10/03 – MXWO fell 17.1%; (3) 14/03 to 29/03 – S&P 500 rallied 11.0%; and (4) 30/03 to 20/05 – S&P 500 fell by 15.9%. This should provide a good overview of the changes in investor sentiment throughout the year.

The economic backdrop has changed meaningfully since the start of the year.- Robert Ducker

Period 1: The sell-off in global equities during Period 1 was driven by the expectation that monetary policy will be tighter than initially expected and weakening global growth expectations. The primary concern here was the mix between growth (lower) and inflation (higher). The interest rate expectations in the US for 2022 moved from zero hikes expected in the summer of 2021, to around seven by January, which led investors to start to price-in the potential for stagflation.

Period 2: The second phase captures the rising Russia/ Ukraine tensions which eventually led to the invasion of Ukraine. Global growth expectations had started to pick-up in February but peaked on 09/02, when news-flow around the Russia/Ukraine deteriorated. During this period the main driver of performance for equi­ty markets was the revision lower of global growth expectations, mainly due to the impact on the supply-side from the war and on energy prices. Crucially, during this period monetary policy expectations remained largely unchanged.

Period 3: The relief rally that followed was a mix of improving growth expectations and expectations that the tightening cycle would be interrupted by the war. Historically, investors priced-in a much worse outcome for equities before/during a war, which generally led to a sharp drawdown followed by a strong rally. This was the case during the Ukraine invasion. 

The expectation at this point was that the war will end quickly and the impact on global economic growth would be limited. Curiously, global growth expectations moved to the highest for the year (and highest since November 2021) despite the ongoing war in Ukraine, which suggests that optimism was too high.

Period 4:  The expectation that the Ukraine invasion would be short has not mate­ria­l­ised, with the war continuing to date. Inflation prints have remained elevated, higher than it has been for decades. Rising prices (inflation) implies that demand is greater than supply, and therefore the rationale for hiking rates is to put a cap on demand.

However, trying to control inflation could have severe implications for economic growth. Weakening demand without going into a recession is a tricky balance to strike and investors are well aware of this. The narrative during April and May has shifted away from stagflation to the potential for a recession.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.

Robert Ducker is a senior equity analyst at Curmi and Partners Ltd.

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