European equities staged a remarkable rebound last week, while US markets slumped. It seems that there are two themes influencing markets at this stage: a) the hope that the military conflict is probably going to end in the coming days, which is positive for the beaten-down European markets and b) the fact that the central banks appear very willing to continue the tightening of their monetary policies, which hurts primarily the US markets as the FED is about to raise rates. In this environment, China should have behaved as a relatively “safe-haven” given the fact that it does not have an inflation problem and the central bank will actually cut rates. But the performance of its equities markets has deteriorated in the last two weeks, as it is considered an “ally” of Russia and sanctions could come against it too.
In terms of sectors, Energy continued to perform well, but fell from its highs as reports are calling for Putin to be ready to make compromises in order to end this tragedy, which has also been hurting Russia immensely. The interest-rate sensitive sectors in the US, such as Consumer Staples (food, household products etc) and Technology fell by almost 4%, because of the rise in bond yields. However, these should do well when the economy potentially slows down in a few months from now. Investors should perhaps take advantage of these dislocations in the markets and add to positions, especially in these defensive sectors.
The ECB surprised with its hawkishness. In particular, it announced a faster than anticipated end of its bond buying program, which should end in early summer than towards the end of the year. However, they also changed the wording for the timing for the potential first interest rate increase from “shortly after the end of the program” to an undefined period of time. These two put together show a central bank determined to fight inflation before it becomes a permanent anticipation in the consumers’ minds. Lessons from the 70s have been learned, we hope.
The FED will have its own show this week, on Wednesday, when it is expected to raise interest rates by 0.25%. The US is having a much larger inflation issue than the Eurozone at this stage and the FED will chose to go down the path of targeting inflation and engineering an economic slowdown, probably acknowledging that this could have an impact on the markets. Of course, a deep correction in US equity markets is an outcome that the FED will want to avoid. The issue is that many analysts and commentators are making analogies with the 70s, and although there are chaotic differences from that period, one must look back and draw conclusions. Doing this, one sees that to avoid re-living the shock of the 70s, the central banks must prioritize the fight against inflation over the impact on the economy of their tightening the ultraloose monetary policy.
The February US inflation rose further but was in-line with expectations. The CPI index moved to a new high of 7.9%, while the core CPI which excludes food and energy rose to 6.4%.
Commodity prices fell from their highs, as the negotiations between Russia and Ukraine seem to have intensified and are probably entering their final stage. Oil prices fell to around 105$ from the highs of almost 130$, in two days. Gold reached a high of 2075$, but also fell below 2000$ again.
Government bond yields moved significantly higher and to levels seen before the start of the war. The 10-year US yield returned to 2.05%, up from 1.70%, showing that another safe-haven proved to be shortlived.
In corporate news, Amazon announced a 20:1 split for its stock. More companies announced an exodus from Russia, albeit temporary. McDonalds, Starbucks, Coca- Cola, Pepsico were among these.
Charts of the Week
This is the chart of the Euro Stoxx50 index, which has been the most impacted market by the events in Ukraine. It is impressive, but not surprising as we have argued before, that the index has recovered from the steep fall of the first week of the military conflict and is now sitting just 4% below the levels before the invasion. Military conflicts seem to be sparking rallies after-all. History is also on our side. Most recent major shocks to the financial markets ended in March, which proves to be an inflection month. In the financial crisis of 2008/2009, it was March 9th that the markets found their bottom. In the 2001-2003 bear market after the Internet bubble and the September 2001 attacks it was March 12th that marked the bottom. Co-incidentally, it was the start of the US invasion of Iraq at that time that created that bottom. In the worst pandemic in 100 years and the meltdown of equity markets in 2020, it was March 23rd that the bottom was in place.
An interesting analysis of the various scenarios about the war, according to UBS, for the S&P500, which are rather close to our views as well. The best scenario is a quick resolution and de-escalation which will have as an effect a quick rebound and a move eventually close to levels we were back in December. The most probable scenario however is uncertainty to continue for some time, but with no further escalation of the sanctions or the conflict. In this scenario the rebound will be less pronounced, but still a 5%-7% up move from current levels could bring the indices with a small loss for 2022. The bad scenario is a further escalation of the situation with Russia blocking natural gas flows to Europe, oil prices spiking to 150 or 200$ and a recession to follow. In this scenario, we are probably going to move a further 10% down from current levels with a potential to rebound towards year end, but with overall losses for the year of about 10% for the US broad market.
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