Market volatility is on the increase and there are fears of persistent bear market conditions as global equities continue to perform poorly. Although there are numerous reasons for investor anxiety, three key macroeconomic issues appear to be driving current market sentiment, according to Investment Strategist Izak Odendaal at Old Mutual Multi-Managers.

These issues are: the impact of the war in Ukraine; the continued effect of the Covid-19 pandemic; and – most concerning of all – rising inflation.

Geopolitical risk often makes investors jittery, and with Russia’s invasion of Ukraine heading for the six-month mark, it’s unsurprising that markets are feeling the effect of what will clearly be a protracted and destabilising war.

‘Russia’s invasion of Ukraine has caused energy-supply disruptions, which has led to a massive increase in commodity prices, particularly energy prices,’ Odendaal points out. ‘Ironically, given our preoccupation with a just transition in the face of the climate crisis, it’s the fossil-fuel prices that have increased most – but food prices have also increased rapidly, since Ukraine and Russia are both big producers of foodstuffs. Unfortunately, this has a massive impact on the cost of food around the world, to the detriment of poorer people.’

Odendaal says consumers are taking financial strain as their real income is reduced, along with their purchasing power – and this will have a negative effect on economic growth. Paradoxically, South African producers are benefiting, with coal exports increasing, but inefficiencies at Transnet mean the country is unable to increase export volumes.

‘Although the oil price has increased a lot, in real terms, it’s not near extreme historical standards yet,’ he explains. ‘By itself, the oil price is not going to drive a global recession – other factors would need to come into play.’

Pandemic woes and the rise of inflation

Although much of the world has done away with pandemic restrictions, China has dealt with a renewed surge in cases of Covid-19 with enforced lockdowns. The country’s ‘Zero Covid’ policy has had an impact on the economy, which has had a spillover effect on the rest of the world.

‘China is the world’s biggest producer of manufactured goods, and we have seen some major supply-chain issues over the past couple of months,’ Odendaal says. ‘This feeds into inflationary pressure.’

Perhaps the biggest market risk, however, is rising inflation and how central banks respond to it.

‘Inflation rates in the US and Europe have shot up after hovering around 2% for a decade,’ Odendaal points out. ‘In the States it is currently around 9%.’ Incomes are not increasing at 9%, which means real wages are falling ‘at a record pace’. This is a potential headwind for spending, and since consumer spending contributes around 70% to GDP in the US, the country could enter a recession.

‘This prospect has caused central banks to shift their approach and focus quite sharply on inflation. Up until quite recently, they were focused on growth, as they did in 2020 when the pandemic started and there was massive stimulus to prop up economies – but they are now prepared to sacrifice growth to contain inflation.’

Although current inflation may be temporary as the result of oil-price spikes, pandemic disruptions, supply-chain issues and other distortions, he believes we will only feel the effect further down the line. ‘The problem is that inflation is a lagging indicator, so we will only see the impact of the Federal Reserve’s decisions in about a year’s time. They may try to cool demand, but this means that people will have less money to spend, and that means workers could lose their jobs.’

Rising inflation could lead to recession

As predicted in March, Odendaal still expects the US Federal Reserve to raise interest rates. He expects it to be increased to around 3.5% by the end of this year – a rapid increase from close to 0% at the beginning of 2022.

‘They want to achieve a “soft landing” – that is, reduce inflation without causing a recession – but it’s going to be difficult to achieve that,’ Odendaal predicts. ‘There is a risk that increasing interest rates will actually cause a recession. If inflation is entrenched, however, only a recession will bring it down.’

All this has caused market jitters and market sell-offs. ‘Pain in financial markets has come from companies that depend on low interest rates for their valuations, like technology companies that have done well over the past couple of years,’ he explains.

What should investors do?

‘We need to prepare for continued volatility until there is more certainty about how these crucial macro issues play out. Although history has shown that geopolitics can cause volatility, it’s ultimately the big shifts resulting from changing monetary policy that we should really keep an eye on,’ Odendaal explains.

A lot of the ‘bad news’ has already been priced into markets, which means asset managers are unlikely to sell; if anything, they could increase exposure to equities as they identify value in the market.

‘Speculative investments like crypto assets or unprofitable tech companies have fared worst. Solid companies are holding up a lot better as they’re able to absorb cost increases,’ Odendaal explains. ‘The bottom line is, investors should ensure that their portfolios are appropriately diversified, especially as market conditions are likely to remain volatile for quite some time.’

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