Low growth and high inflation: a toxic cocktail for anxious markets

Low growth, high inflation, central bank tightening, a strong dollar, and the risk of recession is proving a toxic cocktail for world stockmarkets – and for emerging markets in particular.

“Growth is slowing fast, inflation is stubbornly high, and central banks are on the warpath,” say Ajay Rajadhyaksha and Amrut Nashikkar of Barclays. As the world economy enters the second half of the year, “the macro outlook is gloomy”.

Following two years of “chaos” in the pandemic, 2022 was always going to be “a bumpy ride, but nobody expected this – the most turbulent first half global markets have ever seen”, says Marc Jones on Reuters.

During the first six months of the year world stocks saw $13trn wiped off their value, while ten-year US Treasury bonds – a traditional safe-haven – suffered “their worst first half since 1788” after dropping more than 13%. That is better than some other debt: “Italy’s bonds have haemorrhaged 25%” amid fears of a new eurozone crisis.

Volatility has returned, with the Japanese yen plunging 15.5% and commodities serving up their strongest rally since World War I.

Bruised and anxious

“Financial markets enter the second half of 2022 bruised and anxious,” says the latest strategy outlook from investment manager Gramercy. Soaring inflation comes at a time “when many countries’ resilience has already been heavily taxed” by Covid-19.

The current cocktail of “lower growth, higher inflation, tighter financial conditions, a stronger dollar, and recession risk” is especially toxic for the developing world, where currency turmoil and “debt restructuring” could be in the pipeline. Emerging-market debt is down nearly 20% so far this year.

US stocks suffered their worst first half since 1970: the S&P 500 benchmark tumbled 20.6%. The tech-heavy Nasdaq Composite fell 29.5% for its “worst first half of a year on record since its inception in 1971”, says Evie Liu in Barron’s. The fall has beaten even “the 25% drop in the first half of 2002 at the height of the dotcom bubble burst”.

A sell-off that started in tech has since spread to other sectors: ten out of 11 US sectors are down this year. The exception? Energy stocks, up 28% due to soaring oil prices.

London’s heavy weighting towards energy and commodities has helped the FTSE 100 avoid the worst. It finished the first half down 4.5%, better than almost every other global market. But with the more domestic FTSE 250 losing more than 20%, the first half was still a mixed bag overall for UK investors.

Is the inflation panic over?

“Inflation almost seems passé. The worry of the moment is now economic growth,” says John Authers on Bloomberg. Central bankers have made it clear that tackling inflation is now their “overriding priority”. They appear willing “to force a recession to get rid of inflation”.

The outperformance of value stocks compared with growth stocks – a key theme earlier this year – has halted in recent weeks, says Robert Armstrong in the Financial Times “This is consistent with recession fear”. Cheap stocks are in the “cyclical, highly leveraged… highly competitive industries” that suffer most in a recession. Halfway through 2022, battered investors are “increasingly defensively positioned”, but have yet to succumb to outright panic.

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