Over the past month the FTSE 100 has fallen approximately 700 points, or 8.8%. This has come as investors comprehend an environment of rising interest rates and potentially higher global inflation, following a sustained period of loose monetary policy.
The Monetary Policy Committee of the Bank of England met on 7 February 2018 and voted to keep interest rates at 0.5, however also suggested that rates may rise more quickly than previously anticipated. Interest rates can have an impact on nearly all asset prices. All other things being equal, a quicker than anticipated rise in interest rates means that bond yields rise, causing bond prices to fall and that in turn causes equity prices to fall.
This is broadly what has been observed in the US market recently. Wage growth inflation has been higher than expected. Interest rates are one of the tools used to control inflation; therefore a higher than expected inflation figure may lead to the US Federal Reserve raising interest rates faster. This fear of rate hikes sparked a bond sell-off, which caused US equity markets to fall. The effect was exacerbated by an outflow from investors of low volatility strategies, causing a raft of forced selling. The US market tends to lead the way for equity markets across the globe and the fall in US stocks was a precursor for the UK market falling back.
In the short term, rising inflation and interest rates remain a headwind for UK equities, however historically companies have been able to pass rising costs on to consumers and grow earnings faster than inflation over the long term. Our opinion remains that equities remain the best asset class to outperform inflation over the long term. In the short term markets may be more volatile, as evident this year so far, but for investors taking a long term view short term volatility eventually becomes insignificant.