2022 revisited

In an echo of the challenging market conditions of 2022, shares and bonds have followed each other lower in March in a difficult month for so-called 60/40 balanced portfolios.

For decades, investors have benefited from the divergent performances of the two main asset classes. Holding both in a diversified portfolio - typically 60% in shares and 40% in bonds - has given investors a smoother ride.

But the Middle East conflict this month, which has seen the price of oil soar and inflation expectations rise, has been bad news for both equity and fixed income investors. Diversification has not been the investor’s friend in March, a reminder of the harsh investment backdrop after the Russian invasion of Ukraine four years ago.

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Positive correlations, negative returns

The MSCI All Country World index, a measure of global share prices, has fallen by about 9% month to date. With the US outperforming due to America’s energy independence, that has reflected low double-digit losses for many stock markets - the definition of a market correction.

At the same time, a global measure of bond prices - the Bloomberg Global Aggregate - has fallen by around 3% as investors anticipate rising interest rates to counter higher inflation as the oil price remains stubbornly above $100 a barrel. The cost of crude has risen by more than 50% this month after the effective closure of the Strait of Hormuz, through which roughly a fifth of global oil supplies pass in more normal times.

The US stock market fell by 1.7% on Friday as investors took no reassurance from President Trump’s announcement that he had extended a deadline for Iran to reopen the Strait to avoid punitive strikes on its energy infrastructure. Markets are starting to focus less on what the White House says and more on the growing evidence that the energy crisis will crimp growth and stoke further inflation.

Meanwhile, bond yields are rising to levels at which the income from safe fixed income investments reduces the incentive for investors to take the risk of buying shares. The 10-year US Treasury bond now yields nearly 4.5%, a level above which the returns from shares start to look relatively uncompetitive.

Gold losing its safe haven status

At times of geo-political uncertainty like this, investors can usually rely on gold to offer a port in the storm. Not this time. After a strong three-year rally in the gold price - which had trebled since 2022 - investors have instead used gold as a source of gains to offset losses in other assets.

The price of gold has fallen by 15% since the outbreak of hostilities at the beginning of the month. That has left investors scrabbling around for safe havens. Only commodities and bets on rising inflation have provided any support for under-pressure portfolios.

Holiday lull

As we approach the Easter break, there is little on the economic or corporate front to distract from events in the Gulf. In a shortened trading week, with many markets closed on Good Friday, the only release of any consequence is likely to be Tuesday’s eurozone inflation data.

Analysts expect a rise in the regional inflation rate from February’s 1.9% to 2.7% in March. After Christine Lagarde, European Central Bank president, warned that even a temporary inflation spike could prompt a rate hike, investors have started to price in an upwards shift in the cost of borrowing in Europe.

As in the US and UK, that represents a U-turn from previous expectations of further cuts in interest rates this year. Futures markets are now pointing to a more than 50% probability that the next move in rates will be upwards.

Other releases of interest this week will be purchasing managers index data from China, another early indication of the impact of the Gulf conflict on economic activity.

China is widely viewed as better protected than many other countries due to its more diversified energy sources and sizeable strategic oil reserves plus access to discounted Russian oil.

Also in focus this week will be the US jobs market, with non-farm payroll data due on Friday. A rise in the number of jobs created in March is expected after a fall in February when cold weather hit sectors like construction.

Earnings - light at the end of the tunnel

So, investors head into the holiday period on the back foot. One glimmer of hope is provided by earnings expectations, which remain strong. If anything, they are increasing.

The single digit fall in the stock market comes despite a much heavier decline in the valuation multiple of the US market, down nearly 20% since the start of the conflict. The difference between the two is represented by still strong earnings growth. For the calendar year, growth of 17% is now expected.

All eyes will be on the upcoming results season for the first three months of the year to see whether that level of growth can be sustained in the face of higher energy costs and rising interest rates.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Direct shareholdings should generally form part of a well-diversified portfolio of other investments. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.