There’s no free lunch, the bill is coming

Saleh Jamodien, Research and Investment Analyst at Glacier by Sanlam, examines the past three quarters of 2022, and the current state of markets.

By the end of the third quarter of 2022, equity and bond markets were down for the year, with major headwinds throughout the year being widespread across developed and emerging markets. Geopolitical tension, inflation at unsustainably high levels, rising interest rates to combat inflation and concerns about a global recession looming, dominated headlines. With nowhere to hide as both equity and bond markets sold off, investors fear that there is more pain on the horizon. In order to contextualise the current state of the market and how we got here, we need to understand the catalyst and series of events as a whole. Sometimes we need to go back in order to move forward. A lot of what we are experiencing now is an aftermath of events of the past.

Annus horribilis
2020 was a year synonymous with the COVID-19 pandemic, lockdowns and loss of life. It was not only a public health crisis but a pandemic that was felt across the global economy. As infectious diseases spread more rapidly in open economies, governments stepped in by implementing lockdown measures to curb the spread whilst long-term solutions, such as vaccinations, were in development. The impact of this, however, caused a halt in productivity, leading to business closures and rising unemployment. Furthermore, a slowdown in the transportation and manufacturing industries led to supply chain disruptions around the globe. In an effort to cushion these effects, global central banks adopted a dovish stance on monetary policy, slashing interest rates to encourage spending and stimulate economic growth – a decision which would later contribute to inflationary pressures. With that came inflated asset prices and irrational exuberance in equity markets.

Inflation 101 – too much money chasing too few goods
Against this backdrop, fiscal stimulus in the form of encouraged spending, stimulus checks and very easy monetary policies followed, to cushion the hardship and loss of jobs. This started to stimulate demand (specifically for goods), while, from a supply perspective, things began to grind to a halt. Higher prices in the form of inflation were always going to occur, but it was underestimated how significant that would be. Add to that the geopolitical tensions, under-investment in energy, and we are where we are today.

Fast-forward to 2022, a post-pandemic world, where communities are vaccinated, economies have opened up, tourism is on the rise and a hybrid, work-from-home-and-office is now the norm. These highlights have been eclipsed by the inflationary pressures and the Russia-Ukraine war. Economics 101 taught us that lowering the inflation rate makes it more attractive for businesses and consumers to spend on goods and services. This higher demand and increased spending results in higher prices. Additionally, headwinds have been encountered in China through their zero-COVID policies which demand quarantine and continuous testing. This has impacted the number of truck drivers on the road distributing goods to Chinese ports for export, which has stalled global supply chains. The narrative of inflation being ‘transitory’ began to change as central banks gradually became more hawkish.

The war over there
The Russia-Ukraine war has further exacerbated the inflation situation, given its impact on energy and commodity prices, with Russia and Ukraine being major energy and soft commodity producers. Europe is highly vulnerable to the war through the country’s reliance on Russian energy imports. The region has been experiencing a problem with its energy supply which began last year when power grid issues in Texas reduced cargoes of liquefied gas to Europe. Furthermore, a colder-than-average winter, and the country increasing its energy consumption by 25%, led to a surge in energy prices. Energy, in the form of fuel and electricity, is used to produce goods and services, and therefore is an input cost. Consequently, the rise in energy prices directly leads to a rise in the cost of these goods and services. Rising food prices have also been a contributor to the inflation print, as Russia and Ukraine are global suppliers of agricultural staples and fertilisers.

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