June 2022 – US steering towards recession?

For global markets, the biggest news of June was the 75 basis point interest rate hike in the US, the largest increase since 1994, raising concerns that a recession might be on the way. It’s worth remembering that the cumulative 1994 interest rate hikes did not lead to an immediate recession – that only arrived in 2000. But more rate hikes in 2022 and 2023 are to be expected. Following the Fed’s so-called ‘dot plot’, most members of the Federal Open Market Committee now expect US interest rates to peak next year in the 3.5-4% range. That would be the highest since 2008 but looking at long-term data, the expected peak is actually not that high. And considering current inflation levels, rates in the US are still negative. Already, though, US housing is showing signs of stress: the housing inventory has increased sharply in recent weeks and housing starts fell sharply in May.

During June the yield on the 10-year Treasury bill spiked to the highest level since 2011, and two-year rates are at their highest since the Global Financial Crisis. This – and the downturn in the global stock markets – was spurred on by the consensus that rocketing inflation will lead to an even more aggressive monetary response from the Fed than previously expected, which will weigh heavily on US economic growth.

In both the EU and US, consumer inflation is now above 8%, with the US figure at 8.6% year-on-year. The University of Michigan’s measure of expected inflation five to ten years from now stood at 3.1% at the end of June’s release. The biggest driver of US inflation at the moment are energy prices, up nearly 35% from a year ago. Will the Fed be able to rein in inflation? The size of the current rate hikes will certainly help to increase the cost of borrowing, which should stymie aggregate demand in the US. Also, average hourly earnings are up 5.2% year-on-year, which is significantly lower than consumer inflation, effectively leading to a drop in real income among Americans, also dampening demand. On the supply side, once the Russia-Ukraine-related pressure on commodity prices eases, one of the key drivers of surging inflation would be under control. (With the recent move of Russia to restrict natural gas pipelines to Italy and Germany, the end of the price surge is not yet in sight, and European gas prices were up 60% in the last week of June.) Also affecting supply is the recent strict lockdowns in China. With these easing now, the supply chain could see some efficiency restored, taking at least some of the pressure off prices.

Speaking of China, it’s worth remembering the positive role this economy has played in the past in staving off a global recession, specifically in 2016. Six years later, it’s no longer in such a strong position. China’s most recent economic data is mixed. On the one hand, retail sales continue to weaken from a year earlier. On the other hand, industrial production grew slightly in May. Our globe’s other Asian economic giant, Japan, has been battling with growth for decades, and now its currency is losing power too. The yen fell to a 24-year low during June as Japan’s easy monetary policy is increasingly at odds with developed peers’ tightening. The slide in the yen is putting pressure on neighbouring Asian economies, affecting their export competitiveness.

Locally, our first-quarter GDP data was released early in June. The SA economy expanded by 1.9% in the first quarter of 2022 and the size of our economy is now at pre-pandemic levels, with real GDP slightly higher than before the pandemic. SA’s year-on-year consumer inflation accelerated to 6.5%, the highest level since January 2017. Towards the end of June, Health Minister Joe Phaahla repealed the country’s last remaining pandemic-related restrictions. These include the wearing of masks, curbs on gatherings and border checks for Covid-19.

June marks the worst half-year start in 50 years

The S&P 500, a gauge of companies listed on three US exchanges, lost 20% up to the end of June after starting the year at an all-time high. It’s the worst half-year start for the index since 1970. For the sixth consecutive month, global equity markets had a negative rand return. The MSCI World index (developed market global equity) lost 4% in rand terms for the month, bringing the year-to-date downturn to 18.4%. The FTSE/JSE All Share Index (ALSI) ended down 8% for the month, resulting in a -8.3% year-to-date return. The local listed property index (SAPY) lost 10.3% during June. SA bonds (ALBI) lost 3% during the month (-12.7% YTD) and cash (STeFI) returned 0.40%. The rand weakened 5.13% against the US dollar and 2.59% against the euro during June.

Performance measured over the past 12 months looks less grim

Over the past 12 months, most major market indices delivered positive returns and dollar strength/rand weakness helped South Africans investing abroad, as the rand weakened 14.7% against the US dollar. Looking towards international markets, the MSCI World Index returned -1.7% in rand terms over the past 12 months. The loss was more than 14% when measured in dollar. Those who invested in emerging markets, though, would have been significantly worse off over the past year, with losses of 14.3% in rand terms and more than 27% in dollar terms. Locally, SA equity and listed property gave 4.7% and 0.2% respectively. The ALBI returned 1.25% for the year, and cash gave 4.18%.

World stocks remain the outperformer over 5 years

Over the long term, specifically measured over a five-year time horizon, world stocks offered SA investors the highest rewards. Global stocks as measured by the MSCI World Index returned 12.6% p.a. on average over the five years to 30 June in rand terms. In comparison, the ALSI returned 8.7% per year. SA bonds gave 7.8% per year and cash 5.93%. Listed SA property (the SAPY) is underperforming other asset classes over the long term at -7.3% per year, on average.

Table 1: Total returns to 30 June 2022

Source: Morningstar | Total returns annualised to 30 June 2022