What’s gone wrong with the stock market?

It was only a few days ago that we were all getting excited about the FTSE 100 hitting a record high and breaking above 8,000. Now, sellers are out in force. Our City writer explains what's happened.

A robust start to the year for the FTSE 100 index came under strain today as investors worried that higher-for-longer US interest rates will derail the global economic recovery.

Miners and rate-sensitive growth stocks including Ocado (LSE:OCDO) were among big fallers as London’s top flight index lost over 1% in reaction to Wall Street’s worst session in two months.

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The FTSE 100 is still 6% higher over 2023 having surged to a record close above 8,000 on Monday, fuelled by falling wholesale gas prices and signs of economic resilience. But the mood has become more cautious over recent sessions after US labour market and inflation figures raised the prospect of further interest rate rises by the Federal Reserve.

The current Fed funds rate is a range of 4.5%-4.75%, but expectations for July are now up to 5.37% after a 50 basis points rise in futures markets since the start of February.

The implied rate for December is up to 5.19%, suggesting that markets are no longer looking for borrowing costs to begin falling later this year. The rate rise pressure is making it harder for investors to call what type of landing the US economy will experience after the shock of last year’s inflation spike.

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Tuesday’s results from big-box retailers did little for hopes of a soft landing as both Home Depot Inc (NYSE:HD) and Walmart Inc (NYSE:WMT) gave a more negative outlook than markets had been expecting.

Home Depot warned that earnings will contract this year at a mid-single-digit percentage rate, which compared with consensus forecasts for a slight rise, while Walmart also guided toward lower-than-expected profits.

Australia-based Domino's Pizza Enterprises Ltd (ASX:DMP), which is the brand’s largest franchisee with operations across Europe and in Japan, warned this morning that price rises had impacted customer demand since December. Its shares tumbled 24%, while the FTSE 250-listed UK franchise holder Domino's Pizza Group (LSE:DOM) fell 24p to 299p.

The signs of pressure on household spending as borrowing costs rise meant the likes of Currys (LSE:CURY), TUI AG (LSE:TUI) and Marks & Spencer Group (LSE:MKS) also featured on the FTSE 250 fallers board, having performed well in recent weeks. The mid-cap benchmark topped 20,000 at the start of February but has since fallen back to 19,677.

UBS Global Wealth Management said today: “Equities are trading well above the October lows, but also lacking the conviction to move much higher.

“We said 2023 would be a year of inflections for inflation, monetary policy, and growth. We believe this is still the case, but as we have highlighted previously, at the start of the year markets ran too far ahead in pricing in a benign soft-landing outcome.”

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It recommends investors continue with a combination of defensive, value and income opportunities that should outperform in a high-inflation, slowing-growth environment.

But investors will also need to be positioned for when markets begin to anticipate the inflection for inflation, monetary policy and growth.

Determining where we are in the economic cycle will be one of the challenges, particularly given the lag effect of monetary policy means that the significant hikes in interest rates over the last few quarters have yet to fully kick in.

It’s also worth remembering that the economic shock caused by lockdowns early in the pandemic was unprecedented, before a growth spurt as Covid restrictions eased.

UBS said big disruptions such as this make it difficult to seasonally adjust data. “The ripple effect of big shocks can last for years, and it is also possible that the pandemic has permanently altered certain seasonal patterns.“