The Navigator provides insight into stock market events with an outlook.
April 8, 2022
“Turning Point.” The conflict between the West and Russia is part of the developments of recent years: The supply of important raw materials is becoming more expensive and scarcer, and together with pandemic-induced capacity bottlenecks, this is further driving up inflation. The consumption-driven economy in the West is coming under pressure, as are the profit margins of businesses. Consequently, stock market valuations would have to correct: Inflation is causing interest rates to rise, and furthermore, the imposed sanctions could call into question the status of the US dollar as the world’s reserve currency. The structure of the global economy continues to falter.
Market review
At the beginning of the year, the focus was on the deployment of Russian troops in the border region with Ukraine. In addition, expected interest rate hikes throughout the year were anticipated – up to 10 increases were expected. The markets reacted cautiously during the first quarter. Until the invasion of Ukraine by Russian troops, there was a collapse in prices. However, these managed to recover somewhat soon after. Technically, however, the downtrend or a correction is still intact by the end of the quarter. The overarching uptrend continues.
The American markets suffered the least, while the European and also the Chinese markets corrected more sharply. Gold was able to succeed, albeit less than some had hoped or expected. Nevertheless, gold demonstrated its quality in uncertain times. Compared to yields, a ‘spread’ emerged where, historically, interest rates would have to fall or gold would lose value.
Among the sectors, the energy sector primarily benefited. However, the relative strength in this sector was already evident last year.
Regarding interest rates, the curve flattened with the expected increases throughout the year. The seven-year yield on US government bonds recently even surpassed the ten-year yield – an inversion that historically does not bode well.
Much indicates an impending recession. Furthermore, interest rates remain close to their lows. Especially longer-term interest rates rose relatively little, which suggests that markets anticipate rate hikes initially, but then expect rate cuts again.
On the currency side, the US dollar stood out, gaining strength. The Yen virtually collapsed, after having already undergone a trend reversal towards weakness a year ago.
Bitcoin did not react strongly to the events, but was able to continue its consolidation phase with a tendency towards strength. On the blockchain, it was observed that addresses with long holding periods tended to buy again, which is historically a positive sign.
In focus
With the Russian invasion of Ukraine, the structure of the markets began to falter. But like a pre-quake, the tension built up over years was first released. Further troubles are likely to follow – especially economically and at political and societal levels. Of course, it remains to be hoped that the military situation does not escalate. Where some were surprised by the attack on a sovereign state, we wake up to a world of reality where states assert their interests, if necessary, by military means. The sanctions imposed by the West as a result of the invasion divide the world into good and evil – a Team USA against the rest. Just over 30 countries, accounting for cumulatively just under 50% of global economic output, have imposed sanctions against Russia.
The rest are more or less holding back. Russia is moving closer to China and distancing itself from Europe and the Western world, where we actually have so much in common. The sanctions are having far-reaching effects, and other, including emerging, states like India, for example, will closely observe the situation. New alliances could emerge. Consideration will also be given to how reserves should be invested, as the financial world (including the SWIFT system) is being used as a weapon, with assets frozen. Since the 2014 sanctions, Russia has already expanded its gold reserves relative to the US dollar and has now effectively pegged its currency to gold with the announcement that 1 gram of gold can be exchanged for 5000 rubles at the central bank. Furthermore, Russia demands payment for oil and natural gas in rubles, or, for friendly states, also in gold. Shortly before the end of the quarter, the Saudis announced that they would also sell oil for Chinese Yuan in the future – and no longer exclusively in US dollars, as has been the case since 1974.
The sanctions hurt Russia, but also cause at least headaches on the other side. Countries that have imposed sanctions cannot or do not want to enforce them with full consistency: Japan continues its cooperation in the Sakhalin 2 project, Europeans find it difficult to forgo Russian gas supplies, and the USA continues to import Russian uranium for the operation of its nuclear power plants.
Outlook
Central banks are under pressure and are raising interest rates due to inflation figures. This is despite the fact that we have less inflation due to dynamic demand, with a booming economy. Rather, we have a situation with record-high debt that needs to be refinanced – the long end of the yield curve consequently sees little inflationary potential. The effectiveness of the central bank is at least somewhat called into question. The danger is rather that central banks, with their measures to combat deflation, inadvertently fueled the current inflation, and now a recession looms due to the very measures taken to combat inflation. Moreover, markets are dependent on cheap money. It will be crucial how much monetary policy will change. We assume that a cautious approach will be taken and that interest rates should remain below the inflation level. Thus, the situation is reminiscent of the 1940s after the war, when debts were ‘inflated away’. Bankruptcies are to be avoided, as every debt represents an asset for the counterparty. A contraction of the money supply must be avoided. The yield curve confirms the probability of a recession with the inversion in longer maturities, where interest rates would have to be lowered again. For the investor, the question probably arises whether they want to go through a possible ‘valley of tears’ and, by holding quality stocks, at least be able to collect dividends. There are few alternatives, and in a diversified portfolio, they should largely already be included.
In such an environment, within equity allocation, we see the possibility that yesterday’s losers will be tomorrow’s winners. With the raising of short-term interest rates, ‘financial engineering’, where, for example, companies bought back their own shares via debt financing, is likely to recede into the background. Unexciting stocks with healthy cash flow could become more popular again in the medium term.
Furthermore, with the worsening economic situation, government interventions are also to be expected. The COVID-19 situation has already shown us what is possible: governments have guaranteed loans, which is a form of money printing via fiscal policy. If prices rise across the board, pressure on politicians increases. Around 70% of Americans, for example, live paycheck to paycheck. The US administration has already reacted and is releasing part of the strategic oil reserves to counteract the development somewhat. Members of the European Parliament speak of further state interventions, President Macron has launched ‘France Relance’. In an environment fraught with many uncertainties, a conservative investment approach seems to be the choice of the hour to mitigate damage and also remain invested.
“Before you act, free yourself from doubt.” Alexander Dostoyevsky
EDURAN AG
Thomas Dubach