Overall, investors may rather forget the first half of 2022, however, with share prices reverting to more realistic levels, some sectors may present enticing opportunities to investors. 

The start of 2022 came with some measure of optimism: inflation may have been high, but economic growth was robust and the worst of the pandemic appeared to be over. Russia’s attack on Ukraine threw this benign scenario into disarray, with implications for agricultural and energy prices, global inflation and economic growth.

First and foremost, the Ukrainian conflict is a humanitarian crisis, which threatens to undermine Ukraine’s right to self-governance and puts its citizens in significant peril. However, it also has major geopolitical and economic consequences. Companies can no longer operate as freely across the globe and must navigate greater restrictions on how they do business. It creates a further wedge between the US and China, who are on opposite sides of the conflict.

It also has significant implications for economic growth across the world. While neither Russia nor Ukraine are major economies, each has considerable raw material wealth, including a large share of global energy exports, as well as exports of a range of metals, food staples and agricultural inputs.

KPMG outlined the problem in its April economic outlook: “Russia is the world’s largest exporter of natural gas, second largest exporter of oil and the third largest of coal. It is also a large exporter of titanium, uranium, aluminium, copper, nickel, and palladium. Ukraine is a significant source of global neon exports and produces components that are part of highly integrated automotive manufacturing supply chains, among others.”

It pointed out that higher prices for energy and metals, coupled with delays in supply, will hit industrial production, particularly in Europe. The EU relies on Russia for about a quarter of its energy needs and sources several of its manufacturing components from Ukraine. The conflict puts pressure on already-strained global supply chains, while pushing up inflation across the globe. This has a knock-on effect for interest rates and consumer spending. It is destabilising the world just as it was getting back to normal.

Inflation and interest rates

The first half of 2022 has been characterised by accelerated inflation. While this has generated some negative headlines, particularly around its effect on the cost of living, after several years of extremely low inflation it will have some positive effects too, namely in reducing debt levels.

Central banks have revised their forecasts faster and higher. At the time of writing, the US annual inflation rate sat at 8.6%, the highest since December 1981. This was largely driven by energy prices, which rose 34.6% in May, but food costs also surged 10.1%. In the UK, the Bank of England is now predicting that inflation will peak at over 10% over the coming months.

Central banks are treading a precarious path between letting inflation continue to rise and pushing their economies into recession. Now, they are erring on the side of inflationary caution. In May, the Federal Reserve announced it would raise the benchmark US interest rate by 0.5 percentage points to a target rate range of between 0.75% and 1%. This follows a 0.25% rise in March.

Markets continue to expect further rate rises. The Economist Intelligence Unit is predicting seven rate rises in total over 2022, with interest rates reaching almost 3% in early 2023. Central banks around the world are following suit. The Bank of England raised rates to 1% in May, while the European Central Bank has signalled it is likely to raise its benchmark deposit rate above zero in the second half of the year.

The one exception has been some emerging market countries. Brazil has raised its interest rates to more than 12% and is further through the monetary policy cycle than other countries. China is now loosening credit availability as it tries to encourage economic growth.

Economic growth

Russia’s invasion of Ukraine is likely to have a profound, sustained impact on global economic health, according to experts. In its most recent Global Economic Outlook, the IMF said: “The economic damage from the conflict will contribute to a significant slowdown in global growth in 2022 and add to inflation. Fuel and food prices have increased rapidly, hitting vulnerable populations in low-income countries hardest.”

It predicts global growth will slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January. The IMF has also revised its inflation predictions higher: 5.7% in advanced economies and 8.7% in emerging market and developing economies.

Stagflation, where high inflation combines with low growth, is now a real possibility for many countries across the globe. The only bright spot has been employment. The UK now has more job vacancies than employed people for the first time since records began. The US is seeing similarly strong employment data. This may prevent an even worse economic scenario.

Markets

It has been a tough few months in markets, with plenty of volatility. As of June 2022, the MSCI World was down 12.8% for the year to date, while the MSCI Emerging Markets index was down 11.7%. However, some areas have been more difficult than others.

The biggest casualty of the recent market environment has been technology. Some of the major global technology companies have seen a significant hit to their earnings, which has hurt share prices. Netflix, for example, has seen its shares drop more than 75% from its highs after losing 200,000 subscribers in its first quarter. Even Amazon has seen growth slow, as ecommerce has not taken off as expected post-pandemic.

The sector has also been hit by higher interest rates and inflation, which have diminished the value of the companies’ long-term cash flows. This has caused investors to reassess the sector’s sky-high valuations. At the same time, retail investors have started to lose interest.

Where technology has tumbled, other areas have emerged. Energy stocks – both traditional and, to a lesser extent, renewables – have soared as oil, gas and electricity prices have risen. Equally, it has been a better time for ‘value’-focused areas, particularly dividend stocks. At a time of higher inflation, dividends today are more valuable than cash flows in the future.

Commodity-focused markets, such as Latin America have performed well over the six-month period. Traditionally inflation-proof areas, such as infrastructure and commercial property, have also been a safe shelter for investors. The weak spot, apart from technology, has been the smaller companies sector, which had performed very well during the pandemic but has now given up most of those gains.

Overall, it has been six months that most investors would rather forget. Nevertheless, it has brought share prices down to more realistic levels and there is a sense that inflation may be peaking.

It is crucial that the conflict in Ukraine is ended, for the civilians affected and for the global economic effects it is having. When this happens, the economy will adjust in a new capital system, and we hope the second half of the year may bring a steadier ship.