The return on LD Discretionary, the largest investment fund within The Cost-of-Living Allowance Fund, stood at –6.3% on 25 August 2022. Over a 36-month period, the portfolio has generated a positive return of 7.1 per cent. The return on the employees' holiday allowance fund is also negative. At the start of August 2022, the return stood at –4.9 per cent; however, since the holiday allowance funds were frozen, the return has been –0.5 per cent.
Mixed market reactions throughout the summer
Following a difficult first half of 2022, share prices rose over the summer. In July alone, global shares delivered a positive return of 7.7 per cent, measured in Danish kroner based on the MSCI World Index. Unfortunately, this positive trend did not continue into August, when the stock markets fell again. Danish shares have fallen by -13.8% year-to-date, whilst US shares, measured in Danish kroner based on the S&P 500 index, have fallen by -13.3% over the same period.
Developments in the interest rate markets are one of the factors that have had a particular impact on the equity markets. In July, yields on both US and German government bonds fell. This was because the financial markets reassessed the risk of high inflation as the US Federal Reserve took a firm stance and implemented a series of substantial interest rate rises. However, fears of inflation have crept back into the markets during August, and as a result, long-term bond yields have risen once again. The yield on 10-year US government bonds now stands at 3.1 per cent – at the start of the year it was 1.5 per cent. Over the same period, the yield on 10-year German government bonds has risen from -0.2 per cent to +1.4 per cent.
Higher inflation and the monetary policy balancing act
The main reason why interest rates continue to rise is the assumption that the central banks have not yet brought inflation under control. Both the US Federal Reserve and the European Central Bank are expected to tighten monetary policy further over the next 6–12 months.
Several factors are contributing to the fact that inflation remains high. The war in Ukraine continues to drive up oil and gas prices, which is particularly noticeable in many European countries. For example, the price of natural gas rose by 150 per cent in the first eight months of the year. The labour market, particularly in the US, is strong. A strong labour market has the potential to push up the general price level via a so-called wage-price spiral.
Signs of a slowdown in economic activity
However, leading indicators of economic activity and consumer confidence point to a slowdown in economic activity in Europe and the US. Furthermore, the housing market in many countries is beginning to show signs of weakness in the wake of sharp rises in interest rates. Historically, a downturn in the housing market has had a number of negative knock-on economic effects, particularly on the construction sector, but also on private consumption.
The US dollar continues to strengthen against the euro and the Danish krone. The dollar has risen by 14.3 per cent against the Danish krone since the start of the year.
In the current scenario, where interest rates are rising as a result of high inflation, both share prices and bond prices are being pushed downwards. Significant volatility in the stock markets in recent months indicates that there remains considerable uncertainty as to whether central banks will be able to bring inflation under control and thus avoid a prolonged recession. In LD Pensions, we believe that further tightening of monetary policy in the US and Europe will lead to a slowdown in growth over the next 6–12 months. This will have a negative impact on prices, particularly for equities, which suggests a more cautious allocation to equities and other asset classes that normally benefit from economic growth.
