Marching Markets into Uncharted Territory

By Geoffrey Muns

As US stocks and oil prices leaped as investors held breaths for updates from Ukraine and parsed testimony on the Fed’s plans to raise interest rates. The SPX rose 1.9% on 2nd March, a day after the benchmark index fell 1.6%. The Dow gained 596 points or 1.8%, and the technology-focused Nasdaq Composite Index added 1.6%. The advances were broad-based, with most of the SPX’s 11 sectors rising 1% or more.

Despite the continuing war in Ukraine and spiraling oil prices, investors were focused on interest rates. Fed Chair JP appeared before the House Committee on Financial Services saying he would propose a quarter percentage point rate increase at the central bank’s meeting in two weeks. That alleviated concerns on Wall Street that the central bank would raise rates by half a percentage point.

Yields on benchmark 10-year Treasury notes rose to 1.862%, from 1.708% on 1st March. Yields and bond prices move in opposite directions. Stocks have been volatile, to say the least of late as investors tracked escalations in the war waged by Russia in Ukraine as well as domestic news about the economy and inflation.

Investors are reacting to fast-moving developments on the war news, Western sanctions on Moscow, and major companies cutting ties with Russia. By boosting energy prices, the conflict has added to uncertainty regarding the likely path of US interest rates this year.

2nd March gains marked the SPX’s sixth move of more than 1% in either direction in the past seven sessions and the whipsaw moves reflect a skittish and fragile market.

There haven’t been any big moves like this in two years in the context of the early pandemic days.

Since the Russian invasion, major US indices have been relatively resilient, with both the SPX and Nasdaq up about 1.9%. However, soaring oil prices threaten to unleash more volatility across markets and equities are still in an overall downswing dating back to last year. Oil driving other assets or rising interest rates haven’t been seen in years or decades and very few investors have lived through a rising rates environment. Rising oil prices pose a migraine for central banks already dealing with the fastest inflation rates in decades.

Energy markets rallied with crude prices surging well over $110 a barrel for the first time since 2014 as refiners refused to buy Russian oil taking a bite out of global energy supplies. US crude traded as high as $112.10 and more recently was up 7% to $110.60. The knock-on effects across markets are hugely reliant on how high oil prices get and if prices start to head to $120, we’re going to see plenty of economic consequences globally of these sanctions.

Energy companies stand to benefit from higher energy prices, even as they work to disentangle themselves from Russia. Exxon said this week it would halt operations at a multibillion-dollar oil and gas project in Russia and would make no further investments in the country. BP said Sunday it would exit its nearly 20% stake in Russian government-controlled oil producer Rosneft.

Financials were the second-best sector on the day, up about 2.6% and erasing about half of their losses from earlier in the week. Berkshire Hathaway was up 2.2%, JPMorgan gained 2.1%, Bank of America was up 1.6% and Wells Fargo rose 3.9%.

Among other corporate names, shares of Nordstrom jumped 38% after the retailer projected stronger than expected earnings this year. Hewlett Packard Enterprise raised its earnings forecast for the year, lifting shares 10%. Prices leaped in other pockets of the energy market tied to Russia. European natural gas prices jumped 37%. There has so far been minimal disruption to the pipeline system in Ukraine, through which about a third of Russian gas exports to Europe flow, according to analysts.

OPEC and its Russia-led allies agreed to raise their collective production by another 400,000 barrels a day in April in line with what was agreed to last year. This came after the US and other major oil-consuming nations said they would release 60 million barrels of oil from their emergency stockpiles. IEA said it wanted to send a unified and strong message to global oil markets that there will be no shortfall in supplies as a result of Russia’s invasion of Ukraine.

In the cryptocurrency market, bitcoin traded at around $43,662 according to CoinDesk down 0.3%. Russia’s invasion of Ukraine has driven demand for cryptocurrencies in both countries, helping drive up the price of bitcoin. Russia’s incursion into Ukraine is sad and it undoubtedly marks a historic moment in geopolitical balance with undetermined total effects on global security, humanitarian needs, political alliances, and economies.

Last week’s invasion touched off a de-risking episode in global financial markets, with stocks selling off and commodity prices surging in reaction to the news. Though markets rebounded on Friday, volatility will likely remain elevated, and both the political and economic situations are in flux. At the same time, US bond markets are pricing the potential for stagflation, a scenario of higher inflation and lower economic growth. And the Fed which recently has grown more hawkish in its plans to raise interest rates and unwind its balance sheet will have to weigh the trade-off between inflation and growth amid escalated global tensions. No one knows if the conflict in Ukraine will create lasting or just momentary effects on the market. But I don’t believe now is the time for impatient buyers to enter what might look like an oversold market. In fact the below three additional challenges that could be with us for a while and may not be fully appreciated by investors:

• Complexity and Uncertainty of the Fed’s policy tightening path-Near term inflation expectations have risen recently as energy prices could remain higher given Russia’s role as a major producer. Meanwhile, the overall US economic outlook appears downbeat with nominal yield curves at their flattest since the early days of the pandemic. Though some market participants assume the Fed will not tighten as aggressively because of the Ukraine conflict and I expect the Fed to stay the course though it will likely prioritize supporting growth over fighting inflation. All this suggests that Fed policy execution has become only more complex.

• Weakening of demand for goods consumption- I expect an eventual shift in consumer spending from goods to services which should fuel a recovery in sectors such as travel, leisure, live entertainment, and dining. But gains for services businesses may come at the expense of durable producers which may face falling demand. Many companies that catered to the stay-at-home trends of the past couple of years benefited from an extraordinary pull forward in demand. Investors will need to consider the likely give back for such companies, including secular growers.
• The pressure of Inflation on corporate profit margins-Most companies have asserted that they are sheltered from inflationary drags by strong pricing power. But this pricing power is likely unsustainable and if it is somehow maintained would only contribute to further inflation. I see mounting pressure on earnings forecasts with negative first-quarter guidance rolling in from many companies and tech firms feature prominently among those muting expectations.

Given all these factors I advise investors against jumping back into the market, even though recent declines have made valuations look more attractive. Investors should watch earnings revision trends and bond market dynamics to gain conviction around a buyable bottom. Consider recalibrating expectations and sticking with quality names with strong cash flow and earnings achievability that aren’t fully priced. Sectors including financials, energy, materials, consumer services, and healthcare look ripe for stock picking ideas, while the U.S. small-cap category and emerging markets appear to have strong longer-term valuation support.

Closer to home, Abu Dhabi’s FTSE ADX index was the second-best performing market in the GCC during February with over 7 percent gain to close at 9,319.4 points. The exchange’s market cap rose 8.9 percent to reach 1.7 trillion dirhams mainly due to the listing of Abu Dhabi Ports on the exchange. The Financials index recorded an increase of 10.2 percent, the largest monthly gain among the indices. The total volume of shares traded rose to fell to 4.5 billion shares compared to 4.2 billion shares in the previous month. The total value rose slightly to reach 28 billion dirhams. DFM General Index was the third-best performing market in February. The benchmark closed at 3,354.64 points, up 4.7 percent. Gains in six out of nine sectoral indices including large-cap sectors such as Banks, Telecom, and Real Estate supported. The Banking Sector index rose 8.2 percent. The total volume of shares traded fell over 23 percent to reach 2.6 billion shares in February. Total value also fell over 11 percent to reach 5.8 billion dirhams.

Geoffrey Muns is an Independent Financial Advisor and Planner certified from the UK, US, and UAE based out of Dubai for the past 20 years. He also works in the PE/VC space and is a seasoned investment banker having worked with international banks and investment firms in the region. You may contact him at 1mgicapital@gmail.com