Susannah Streeter, chief investment strategist at Wealth Club, examines the sharp deterioration in market sentiment as renewed conflict in the Middle East and rising oil prices reignite fears over inflation and higher interest rates.
Susannah Streeter, Chief Investment Strategist, Wealth Club
”The spectre of high interest rates has seen investors finally take fright, and the slide is being exacerbated by renewed Middle East conflict. While markets had been surprisingly stoic through the Iran war and a painful energy crunch, sentiment is now more fragile. Iran has fired missiles at Israel, sparking fresh worries about the inflationary impact of the war. Brent crude has risen sharply, up 4%, trading above $97 a barrel as supplies in the region stay stranded. The prospect of borrowing costs staying higher for longer, if the prices stay elevated, has shattered the optimism which had pushed indices to record highs.
There had been hopes that the US economy might stay in Goldilocks territory – not too hot and not too cold – but inflation concerns have reared up again, and the bears are back on the prowl.
Friday’s US jobs report sparked a firestorm of selling, with big tech bearing the brunt of the wobble in confidence. Indices in Asia have been hit by the contagion of pessimism, with semiconductor stocks falling sharply. South Korea’s Kospi plunged more than 8%, triggering a market-wide circuit breaker. The slide looks set to continue, with Wall Street bracing for another sell-off and European indices also caught up in the downbeat sentiment. The FTSE 100 is also set to trade lower, as wary sentiment spreads and investors in the internationally focused index fret about the prospects for global growth.
Markets are now pricing in a growing likelihood of a rate hike from the Fed this year, and potentially another next year. The Bank of England also looks on track to raise rates at least twice, given the repercussions of the Middle East crisis.
Higher interest rates reduce the value of future earnings and, given how heady tech valuations have become, it’s not surprising that investors are reassessing allocations and opting for companies with more reliable income streams and dividends.
There had already been undercurrents of worry about the surge in tech stock prices and fears that today’s insatiable demand for the apparatus needed to support AI products and services would eventually wane.
Fears of higher interest rates come just as tech giants, which have some of the deepest cash pockets, are seeking fresh funding to help finance eye-watering capital expenditure plans. The demand is voracious right now, but there is concern that assets being invested in today, at a time when the technology is so expensive, could become obsolete further down the road. So, tech is starting to fall out of fashion, while companies operating in the ‘real economy’ may be more sought after – those selling consumer staples, providing healthcare, or keeping the lights on through utility services.
Bonds may provide more reliable returns, but they too are suffering as interest rate expectations have been sharply adjusted, particularly in the US. Treasuries have sold off and gilts have continued to come under pressure, illustrated by the rise in yields, especially for longer-duration bonds. Investors don’t want to be locked into lower rates for an extended period when they can secure higher returns from new issuances.
This is a treacherous tide which risks lifting other governments into more perilous waters, with UK gilt yields also rising as competition for returns intensifies across markets. With government borrowing costs climbing, public finances are set to become that bit more precarious. Another worry which, for now, is percolating in the background.”
