A difficult start to 2022: inflation scare, Ukraine war
The start into 2022 certainly took most market participants by surprise: a rout in equities on the back of rising rates, Russia’s invasion of Ukraine, and an explosion in various commodity prices.
Equally still, it seems the dust has settled quickly with US equity markets recovering most of their losses since the start of the war. So is it all over now?
Some seem to think so: as equity bulls were buying the first trading days of the new quarter despite the macro picture worsening with the first inversion of the US yield curve since 2019, The inversion in 2019 was brief, and no recession followed. In addition to 2-year Treasury note yields rising above the 10-year Treasury, the spread between five- and 30-year yields turned negative. Such an inversion occurred last in 2006, which preceded the years leading to the great financial crisis in 2008.
Yet equity volatility remains relatively low given what many commentators would describe as a worsening macro-outlook: unresolved supply constraints, rampant supply-side inflation, a starting consumer crunch and since last week, a US yield curve inversion.
Rate hikes amid uncertainty, but: late-cycle usually good for equities
Global central banks are continuing with their plans to raise interest rates despite of a worsening macro picture. This will likely add to concerns about a slowdown in economic growth. US real disposable income has already contracted due to the effects of inflation.
In Europe, energy price inflation is just kicking in from Q2, as price hikes for gas and electricity are trailing spot prices by up to six months for consumers in most countries.
Central banks, however, have no choice: the rapid rise in the short end of the yield curve has been dictating their actions, with more market participants expecting a 50bp hike in the Fed’s May meeting and the Fed already telegraphing such a hike.
However, preceding the great financial crisis, equity markets posted double-digit gains after the start of the Fed hiking cycle. Yet, there was a lower weight of inflation-sensitive growth sectors like tech in broad market indices and a higher weight of cyclicals such as energy.
Insofar while the macro outlook has worsened, the late-cycle still offers opportunities.
China, Geopolitical Risk and APAC Equities
While the situation in China remains unstable due to the ongoing property crunch and Covid lockdowns, other Asian economies are doing well.
The weak outlook in China is likely to continue. More and more data points toward China’s economic growth slowing. Even though the central bank has been cutting rates and is on an easing trajectory, significant demand-side risks remain, especially in the property market.
Other Asian countries, however, have displayed remarkable resilience against a potential China contagion.
The Korean Won, a typically very macro sensitive currency, has held relatively steady against the US-Dollar.
Like many other Asian countries that are not formally aligned with the West, India does not yet seem politically inclined to support Russian sanctions in order not to hurt their economy.
On a macro level, a rotation out of developed markets and more growth-sensitive sectors such as tech into late-cycle plays such as encyclicals, energy and mining look to continue.
Similarly, we could see a shift from allocation in the US and Europe into developed Asian markets.
Good outlook for precious metals and commodities
While commodities across the board have seen impressive gains in Q1, it is unlikely that that price performance is set to continue at a similar rate.
In the past, Gold has typically performed well following the first rate hike of a Fed tightening cycle.
Many of the price increases were not driven by supply/demand factors but due to margin calls on speculative short positions when Russia invaded Ukraine and the West retaliated with sanctions.
Oil and energy commodities could quickly come back from their high levels if Iranian sanctions are lifted and Iranian production enters the world markets.
In the commodity complex, precious metals have remained relatively subdued in Q1. Despite of geopolitical headwinds, Gold and Silver are barely up more than 10 per cent year-to-date, while Platinum has remained essentially flat.
It is still unclear what Russian supply will mean to the global precious metal market on the supply side. On the demand side, investment demand from retail is likely to pick up gradually this year with the geopolitical tensions in focus. This could lead to a rally in Gold similar to the cycle pre-2008, where investment and ETF demand drove up prices strongly.