Monetary tightening, no recession: Market Commentary April 2022

MARKET CONTEXT: Monetary tightening, no recession

Global Macro:  

• Slower economic growth: Uncertainty regarding a potential ceasefire in Ukraine, the accelerated pace of interest rate hikes (except for China), high energy prices, and Covid-related supply chain disruptions in China are the main headwinds to global economic growth.
• Inflation is close to 8% in Western economies, which has induced most central banks to tighten their monetary policy.
• Central banks’ reaction: The US Federal Reserve announced a series of rapid interest rate hikes to bring down inflation. The US Fed funds rate may reach 3% this year (currently 0.33%). The European Central Bank (ECB) may raise its deposit rate from -0.50% to zero this year, which would add some support to the EURUSD.
• China’s monetary decoupling: In contrast with central banks in Western countries, the People’s Bank of China (PBoC) may lower interest rates to boost consumption and economic growth, as well as support weakened real estate and financial firms.
• The US economy remains strong with sustained US job growth and nonfarm payrolls expanding by 431,000 in March.
• Global corporate earnings growth is expected to reach 8% this year, which should help avoid a global recession.  

Financial Markets:  

We expect central banks’ tightening monetary policy, the war in Ukraine, and China’s Covid restrictions, to keep volatility high in the months to come.

• Equity: The recent stock market rise partly reflected expectations of a ceasefire in Ukraine. Chinese companies have been more active in their capital management through share buybacks and higher dividend payouts, providing a key catalyst for a sustainable rise in the cheaply valued Chinese equity market.
• Fixed Income: The US yield curve has inverted on recession worries with the 2-year US Treasury yield rising above the 10-year yield. Such an inversion has occurred prior to each of the last ten US recessions.
• Currencies: The IMF announced that the sanctions on Russia will accelerate de-dollarization as the US dollar's share of global FX reserves has dropped from 72% to an all-time low of 58% in favor of the euro and renminbi.

Equity: In March, the S&P 500 and Nikkei 225 gained 3.8% and 3.6%, respectively, while the HSCEI fell 6.2% and the Euro Stoxx 50 edged down 0.6%. Fixed Income: The 10-year US yield jumped 49bps to 2.33%, which contributed to the continued sell-off in Emerging Market government bonds (-0.9% in USD; -1.2% in local currencies) and High-yield corporate bonds (-1.2% in USD; -1.7% in EUR). Currencies: With respect to USD: EUR -1.3%, AUD +3.1%; CNY -0.5%; safe-haven JPY -5.9%, CHF -0.7%. Commodities: Gold went up 1.7% while oil prices rose 5.2% amid growing supply fears triggered by the war in Ukraine.

Risks: 

• Russia-Ukraine war: A worsening of the war would affect Europe the most, while the US and Asia could suffer an economic slowdown amid surging commodity prices.
• President Biden’s loss of power: The US president’s mental and physical health is a cause for concern. A disruption of the US presidency could generate impactful instability domestically and globally.
• Omicron variant: New waves of infections caused by the Omicron variant could weigh on the economic growth outlook.
• Sustained inflation: Lasting inflation would induce central banks to tighten their monetary policy faster than expected, leading to higher interest rates and a compression of equity stock valuations.
• Commodity price surge: Commodity mining and supply chain disruptions as well as the lack of new investment in energy sectors, like oil over the past five years, are causing supply to lag demand, leading to rising prices and contributing to higher inflation.
• US tech bubble & corporate tax hike: Tech stocks are under pressure, given rising long-term yields, the highest valuations since the dot-com era, and high market concentration, while we expect the Biden administration to challenge tech companies’ light taxation and push through anti-trust legislation in the US.
• US-China tensions: US-China trade frictions remain strong, with increasing tension around Taiwan and the South China Sea. In addition, the US is increasing pressure on Chinese companies listed on US stock exchanges by implementing stricter rules targeting Chinese firms, effectively leading to the delisting of Chinese stocks from US exchanges in favor of Hong Kong and Shanghai. We expect this to result in increased volatility in the coming months.

Opportunities:

• Floating-rate safe cash deposits: Cash can be placed in safe-haven cash deposits and earn US Fed funds rate +0.80% (close to 1.2% currently) net annualized in USD or 3% net annualized in RMB.
• Chinese equities: The Chinese stock market has strongly underperformed Western equities in 2021 and 2022 amid US-China tensions and increased Chinese regulation on tech firms, with Chinese tech stocks plunging 60%. However, we think the downside risk from here is moderate as the Chinese government and PBoC pledged to support the economy in order to reach China’s 5.5% growth target in 2022.
• Financials: We believe the financial sector will continue to benefit from higher yields, but also from stronger growth via a reduction in nonperforming loans and the positive impact from lower loan provisions on earnings revisions. Hong Kong, and Japan will pay above-market dividend yields.  We think stocks of well-capitalized quality banks in the US, Europe, Hong Kong, and Japan will go back to paying above-market dividend yields.
• Oil & Gas: The energy sector is a major beneficiary of the global recovery, while long-term anticipated oil demand remains robust. Moreover, we are seeing increasing interest from investors towards major energy players that are implementing green energy programs to transition from fossil fuels to clean, sustainable energy production, thus making them major decarbonization contributors.
• Nuclear energy: We believe the nuclear sector will be instrumental in the world's decarbonization efforts. To achieve fossil fuel reduction targets, the nuclear power industry’s safety standards need to be brought to the next level, for instance by using new technology to recycle uranium. New “green” nuclear energy is the number one priority of President Macron in France, while being high on the agenda in the US and China, which will build 150 nuclear power plants in the next 15 years.