Alastair Winter on Global Markets in Mid-March 2022

Alastair Winter

(Hay una versión en español de este artículo aquí.)

We’re pleased to introduce Alastair Winter of London as our new guest blogger. Alastair does not manage client portfolios. While it is true that Alastair’s views often differ from those of Genevieve Signoret, Genevieve’s discussions with Alastair greatly enrich her own views. In cases where material differences between Alastair’s views and Genevieve’s arise, she’ll clarify her views by responding to Alastair in the comment section of his blog entry or in her own follow-up post.

Outlook: Even before Russia invaded Ukraine, it was going to be very difficult to make significant financial gains in the next two years without taking greater risks than has been necessary in the ‘everything markets’ that have mostly prevailed over the last decade. Some investors will surely try all the same and, through doubling up on derivatives, generate greater levels of volatility. There remains, however, no alternative to equities for mainstream investors seeking capital growth. Cash generation has become more important again for equities and, as higher interest rates start to bite, even more so for bonds and real estate.

Regime change: While Covid had a dramatic immediate economic impact, investor sentiment only fundamentally changed from mid-2021, by which time valuations of both equities and bonds were at last widely considered to be unsustainable. A combination of supply and demand shocks sparked by Covid had unleashed a surge in inflation, which investors feared that the Fed and other central banks would mis-manage to the extent of crashing the global economy. Major wobbles in September and November, originating in the US Treasury market but with spillovers elsewhere, set the scene for a nervous start to 2022. Accordingly, although intensified by the Russian invasion, the regime change in market sentiment was already underway well before the tanks rolled in and, indeed, investors (along with many others) had proved reluctant to accept the warnings from the US and UK Intelligence Services.

Geopolitical developments: Despite the stream of terrible reports from Ukraine and the endgame’s being far from clear, global investors are already showing form in looking beyond the news headlines. The Ukraine economy is already wrecked, and the Russian economy is now suffering major permanent damage. However, the economic impact on the rest of the world is expected to be much less severe, even if energy and agricultural prices are currently soaring. Looking longer-term, however, some war-related political developments will have a significant economic impact that will in turn feed through to global markets:

• New impetus in the European Union (EU) on policy convergence, especially fiscal harmonisation.
• A resurgence in NATO led by the US and henceforth a more financially committed EU.
• Diminishing Russian influence around the globe due to financial constraints as well as ‘pariah’ status.
• Three major trading blocs (the US, China, and the EU) will become increasingly self-sufficient in supply chains and protective of jobs.

Macroeconomics: The war in Ukraine should be seen as both a catalyst for new developments and an accelerator for those already underway:

• Stagflation: After rebounding from the immediate impact of Covid, most advanced economies together with China are at various stages of slowing down. Inflation is already inflicting real hardship on the less well off, further squeezing Consumption. Even before the war, energy prices were compounding the effect of Covid-related Supply and Demand shocks, pushing up inflation higher and for longer. The US has made the early running, but the UK will more than catch up, with the consumer price index likely to peak around 9% in Q4 and average 5.5-6% in 2023 as global and domestic deflationary pressures feed through. In the EU the peak is also likely in Q4, albeit lower at 7.5%, averaging 4.0-4.5% in 2023.
• Fiscal stimuli around the globe to Covid have varied but all have involved further public borrowing. More is on the way to help alleviate social hardship, boost defence spending and fund investment in climate change, infrastructure, technological innovation, and skills training. This should prove enough to avoid, at worst, a prolonged recession in advanced economies, especially those with a more productive and skilled workforce.
• Deglobalisation was already underway before Covid disrupted supply chains, but the 3 major blocs will continue to trade with each other when it suits them. Elsewhere, trade blocs in SE Asia and Africa look to be making progress but Mercosur appears to be breaking up. The UK and Japan will have to be content with bilateral trade agreements.
• Central banks have for some time wanted to return interest rates to more ‘normal’ levels and despite the prospect of a deflationary impact from rising energy prices, there are increasingly hawkish signals emanating from the Fed, Bank of England (BoE) and now the European Central Bank (ECB). Monetary tightening has started but official rates over the next 2 years are unlikely to exceed 2% in the US and UK and 1% in the euro area and Sweden. Greater focus will be on systemic rather than market stability with no Fed “put”.

Equities: Many fund managers and traders are facing for the first time in their careers and all at once stagflation, rising interest rates and sweeping sanctions on a major energy supplier that could well combine to cause a global recession and hit corporate earnings. This comes on top a massive rotation within and from US markets that started in mid-2021. The scope for panic and error is considerable.

• US: The best way to view the rotation is from expensive to less expensive rather than uniformly from growth to value or from cyclicals to defensives. This has not hit all the FANGs, but it seems tech companies will henceforth have to up their game in respect of innovation and growth. The Nasdaq Composite is likely to continue to underperform both the S & P 500 and the Russell 2000 but all of them will struggle to pull back their losses by year end.
• UK: Share prices have been flat overall since the post-referendum dip in 2016 with the FTSE 250 outperforming the FTSE 100 until last year. The latter has pulled ahead in 2022 thanks to its weighting in energy and mining, together with 70% of revenues’ being generated overseas. Both indices could well recover from their current levels and the FTSE 100 end the year ahead, but the economic outlook is poor, especially if the Government persists with its plan to raise taxes and rein in public spending while the loss of trade with the EU deepens and the US remains aloof on any deal.
• Europe: After a very strong 2021, European stocks have been hit hard by the surprisingly united and robust political response to the invasion. Fears over energy shortages will limit a likely rally this year but Germany’s 180-degree turnaround on public spending bodes well.
• Emerging Markets: China continues to weigh on the various indices but together with India, Indonesia, Brazil, and Mexico still offers significant long-term growth in middle-class consumption.

Bonds: If one takes a 40-year view, the bull market is not yet over but yields probably bottomed out last year. The war in Ukraine will add to the Covid-related glut of new sovereign issues and central banks are venturing into the unknown by stopping net new asset purchases. However, there seems to be no shortage of investors, and this suggests a ceiling in the next 12-18 months for 10-year gilt yields at 2.5%, 3% for USTs. 1% for bunds. Such low rates will tempt more investors into both High Yielders and Emerging Market sovereign bonds, notably of China but also of some ASEAN and E. European countries. Real yields net of inflation could yet become more important to investors if inflation remained elevated far into 2023, thereby pushing the curve much higher but only thereby adding to other deflationary pressures.

Commodities: Wild movements in futures are the most immediate result of the war but the biggest problem will come from the physical supply of cereals rather than from diverse sources of oil and gas. Longer-term, higher prices for metals and rare earths will result from supply chains forcibly reconfigured by sanctions.

Currencies: The war has confirmed the USD’s safe-haven status with EUR continuing to suffer as the main countertrade. Interest rate expectations are also a factor, hitherto supporting GBP. Of the majors, the BoE and the Bank of Canada are already hiking, the Fed is about to start, and the ECB and Reserve Bank of Australia will join them by year end but not Bank of Japan or the People’s Bank of China.