Kimmo Koivurinne: Grim second quarter overshadowed by war

As Russia continued its invasion of Ukraine in the second quarter, the uncertainty on the financial markets deepened. The high inflation that followed in the wake of the Covid-19 pandemic continued to rise, pushing the US Federal Reserve to sharply raise its interest rates not once, but twice. Year-on-year inflation in the US in June was a steep 9.1 per cent, the highest rate in over forty years. Inflation also hit record highs in Europe: in June, year-on-year inflation in the Eurozone was 8.6 per cent. The main reason for rising prices is more expensive energy and commodities, which in turn puts upward pressure on the prices of food and consumer goods.

As we know, interest rate hikes have a chilling effect on the stock markets. The Fed’s steep interest rate increases, 50 bps in May and 75 bps in June, came with a strong message: the Fed is capable of tightening monetary policy even further if circumstances so demand. As rates rose, the S&P 500, the cornerstone of the stock market, declined in every month of the second quarter, bringing the negative yield for the quarter close to 20 per cent. The Nasdaq was hit even harder by rising rates and heightened uncertainty: its negative yield over the same period was almost 25 per cent. European shares also declined, although the falls on this side of the Atlantic were a degree milder. The Stoxx indexes and the Helsinki stock exchange ended the quarter almost 10 per cent down.

The European Central Bank (ECB) reacted to inflation in a more measured fashion and only announced a rise in interest rates in July. In Europe, inflation is primarily due to the energy supply problems caused by the war in Ukraine, meaning tightening monetary policy will not solve the problem. Unfortunately, there is no magic wand that can quickly end Germany’s and Italy’s dependence on natural gas. The concerns caused by energy dependence were also reflected in a weaker euro in the first half of the year. The common currency has declined by almost 8 per cent against the dollar since the start of the year.

During the second quarter, Asian stock markets generally declined, with the exception among emerging markets of China. Until the spring of this year, China continued its policy of strict Covid lockdowns, the relaxation of which boosted economic activity. The lifting of restrictions was also reflected in Chinese share prices, and for example the Hang Seng only declined by around half a percentage point during the quarter. In spite of the generally good quarter for Chinese shares, finding anything positive about the financial markets in recent times has generally been hard.

In addition to central banks’ financial policy, the tenser global situation affects market interest rates. The increased interest rate level is poison to fixed-income investments, as bonds’ value decreases as interest rates increase. The risks of tightening monetary policy and global recession in the near future are priced into fixed-income investments.

Diverse investments mitigate losses

In the glum second quarter, Finnish earnings-related pension investors benefited from diversified investments. That diversification softened the impact of the grim start of the year on earnings-related pension assets. As both shares and fixed-income investments were deeply in the red, property investments struggled to nominally stay in the black. Alternative investments, which benefited from increased market volatility, also generated a few percentage points of positive nominal yield. At the same time, it is worth remembering that share investments’ larger swings in value over the short term are a consequence of risk exposure, which means a better expected return over the long term. The old maxim is appropriate here: the earnings-related pensions investor’s quarter is 25 years.