2021-22 economic and market commentary
Daniel Selioutine - 29 Jul 2022
Daniel Selioutine, Head of Investments, provides economic and market commentary on the 2021-22 financial year.
Summary
Financial Year 2021-22 (FY22) was a year of two halves, beginning with optimism after more than 15 months of intermittent lockdowns and ending in concerns about inflation and pessimism about the future path of interest rates. The initial positivity was reflected in strong demand for goods and services and generally robust economic data which recovered close to pre-pandemic levels on some measures. Vaccination administration rates remained on-track in Australia allowing businesses to re-open and restart trade. Equity markets finished the calendar year close to all-time highs, with investors brushing aside the emergence and spread of a highly infectious new variant of COVID-19.
Sentiment deteriorated in the second half of FY22, beginning on 24 February 2022 with Russia's military activity in Ukraine. Several western countries responded with unprecedented sanctions on Russian exports. The humanitarian crisis engulfing eastern Europe fed already heightened inflation and shortages of essential goods (oil and gas, input commodities and food) in other parts of the world.
Market performance
Equity markets began the financial year delivering very strong returns on the backdrop of companies reporting higher than expected earnings. While some investors cautioned of an overheating economy and emerging signs of inflation, equity markets showed little signs of fragility. The US Federal Reserve dismissed inflation as 'transitory' and continued to stimulate the economy by growing their balance sheet through asset purchases.
The Russia-Ukraine crisis served as an untimely reminder to some investors that financial markets carry downside risk. Equity market sentiment became bearish in February, as investors took note of record high inflation prints and supply chain disruptions which weighed on revenues and profits.
As at 30 June 2022, many major equity market indices posted losses for FY22 after a period of exceptionally strong returns. The S&P 500 declined approximately -20.0% (USD) over the final six months of the financial year. The index ended the financial year negative, wiping all gains from the first half of FY22. The pandemic favourite sectors (Consumer Discretionary, Communication Services and Information Technology) were the largest detractors to performance, with most sectors excluding Energy generating negative returns. The S&P 500 Energy sector delivered over +30% (USD) in the latter half of the financial year, boosted by rising commodity prices exacerbated by the conflict in Europe.
Share markets in Europe and Australia experienced more modest losses. The Stoxx Europe 600 Index fell -7.2% (EUR) over the financial year, while the ASX 300 declined -6.8% (AUD) over the same period. The UK share market defied the trend, with the FTSE 100 ending the year +5.8% (GBP) higher.
Real asset investments in diversified Property and Infrastructure portfolios delivered strong returns in excess of +10%, providing investors with stable income and capital growth. Property and Infrastructure assets performed well due to strong consumer spending spurred by a general recovery in the economy during much of the financial year.
Investments in Cash and Fixed Income generated negative returns over the financial year as central banks began tightening monetary policy to curb inflation. Fixed Income investments offered little protection against falling risk assets, with the Barclays Global Aggregate Index (Hedged to AUD) declining -9.3%.
Economic update
The global economy demonstrated a speedy recovery in the first three quarters of the financial year, before signs of economic distress and slow-down emerged later in the year. Economists remain vigilant and uncertainty is rife as low unemployment and labour market statistics paint a positive picture of the economy, while rising inflation and falling economic activity (i.e. the purchasing manager' s index) suggest a different picture. In many regions, consumer confidence has decreased materially.
The US headline inflation rate, as measured by the Consumer Prices Index (CPI) increased by +8.5% year-on-year to May 2022, the highest level since 1981. In Australia, the CPI increased +5.1% year-on-year to March and the Euro Area recorded a record-high increase of +8.1% to May. Central banks have cited a number of global factors accounting for much of the increase in inflation. In particular, events in Russia-Ukraine and China' s zero COVID-19 policy have drastically shocked supply chains. Demand for housing has been another large contributor to rising inflation, with the number housing transactions and related economic activity reaching record highs during the financial year.
The US Federal Reserve and other major central banks have expressed a strong desire to control inflation, signally future interest rate hikes to eventually reduce inflation closer to target (approximately 2% for most developed economies). As at May 2022, the Federal Reserve increased the target funds rate to 1.5%-1.75% (up from 0.25-0.5% throughout 2020 and 2021). Similarly in Australia, the Reserve Bank of Australia increased the official cash rate to 1.35% (up from 0.10% during the pandemic.
Looking ahead, financial markets will eagerly be monitoring the effectiveness of central bank efforts to combat inflation, and the degree to which their policy response will lead to a slowing of the global economy.