May 2022 - If only inflation took a recess…
April was a losing month for markets and the worst month for Nasdaq since 2008. Indeed, technology sector was mostly impacted, while the 10-year treasury yield jumped from 2.5% to 3%.
The same concerns as in previous months called the shots, but in a much more extreme and pessimist way since it is beginning to look like a possible trend. The peaking inflation resulting in increasing rates, the conflict in Ukraine and China’s Covid outbreak, are all the main factors driving the market’s negative momentum.
Things didn’t get better during the last days of the month, after data showed the US GDP contracted in the first quarter, compared with the small increase that was expected. It caused panic selling at first with increasing fears about a potential recession. When one investigates it a bit deeper however, one can see that it has mostly resulted from a trade deficit (more imports than exports), while consumer demand, businesses’ investment growth and housing market stayed resilient during the last quarter.
This week, the Fed’s policy meeting is expected to be a turning point: an aggressive rate hike of 50 bps is expected (and is already priced in) as well as the start of the Fed’s balance sheet reduction, at the largest scale ever, since it reached an incredible record of $9 trillion. Of course, each and every comment of Fed chairman Jerome Powell will be broken down, in order to assess if markets recently overreacted or not, when pricing the bad news. Markets will no doubt adjust accordingly if necessary.
From its side, the ECB meeting did not provide a clear time frame yet regarding its own tightening policy. As of today, the market is pricing an 85-bps rate increase in the Euro interest this year, and the yield of the 10-year German Bund returned to close to 1%, something that has not occurred since 2014.
Still in Europe, the war in Ukraine is continuing, and beside a humanitarian disaster, a huge energy crisis is threatening Eastern European countries. Russia blocked gas flows to Poland and Bulgaria, expecting payment from them in Rubles. Russia already stated that more countries will be cut off from its gas if there is no sanctions’ reversion on its currency. Moreover, Finland and Sweden are considering joining NATO, decisions that could possibly end in World War III, according to Putin. Finally, Russia, together with China, is one of the most important global suppliers of fertilizers. Both countries supply the world with close to one quarter of global fertilizers. Now Russia has stopped providing fertilizers to some countries as a response to the sanctions that have been imposed on it. To put things in perspective, 96% of the US' potassium fertilizer is imported from Russia, meaning the latter has the power to put the Western food industry at a high level of risk. And as time is passing and no positive outcome is taking shape from this conflict, the risk for a huge global food crisis is increasing.
Another major event in Europe in April, was the French Elections, with Macron securing a second term. If it was relatively good news for markets, it also brought attention to the fact that 50% of the French people voted for extremes and so basically half the country said it is not happy with the current regime.
China continues to suffer from its zero Covid policy, a property crisis, the consequences of last year’s crackdown on techs and now, on top of that, the depreciation of its currency. In order to resolve the latter, the People’s Bank of China announced that it will cut the Reserve Requirement Ratio for foreign exchange currencies, from 9% to 8%.
Last month also marked the kickoff for the Q1 earnings season. So far, about half the S&P 500 companies have reported. This quarter again, the surprise rate is above the historic average, but we clearly see lower corporate earnings and how higher costs put pressure on profit margins. Also, the growth forecast for this year is sharply lower than last year. Overall, even if earnings calls have been kind of depressing, inflation apart, it fits the process of normalization we all expected.
In this context, our call would be to stay defensive as long as volatility remains high, and the bearish momentum continues. To do so, we suggest building cash position on each technical rebound, and continue to favor value over growth companies.
As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.
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