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Investing

Markets are still volatile. What could go right?

De-escalation, an energy equilibrium, and a different policy response could bring calm to markets.


 

Our Top Market Takeaways for March 11, 2022.

Market update

Aftershocks

Global markets are still dealing with the fallout of Russia’s invasion of Ukraine. Here is an abridged list of what happened this week.

  • Russia and Ukraine continued to communicate on a resolution. If you squint, you can start to make out some framework for a potential end to the violence. 
  • European equities actually went into Friday with gains on the week, even though the only day with a positive return was Wednesday, when the Stoxx 600 Index rallied over 4.5% and the German DAX was up almost 8%.
  • Crude oil prices spiked to almost ~$130 per barrel on Sunday night and early Monday morning, but lost 20% over the course of the week and ended up a little below where they started.
  • The Broad Commodity Index had both its largest daily rally since 2008 and its largest daily decline since 2008.
  • The European Central Bank seems to be sticking with its plan to remove policy support despite the downside risks from the invasion, but it does seem to be leaving its options open.
  • In the United States, inflation came in at a scorching 7.9% year-over-year pace, but the core measure decelerated from January’s reading. At the very least, the inflation picture (excluding food and energy) didn’t get any worse.
  • 10-year U.S. Treasury yields started the week at 1.70% and ended at 1.98%, their largest move higher over four days since March 2020.
  • Amazon announced a 20-1 stock split and a buyback authorization. Shares ended trading on Thursday about 11% above their Tuesday lows.
  • Chinese internet stocks lost ~9.5% on Thursday to hit new five-year lows, and are now down a staggering 75% from their February 2021 peak.

Markets are kind of a mess. Volatility seems likely to continue for the next few weeks, at least. That said, volatility can create opportunities, especially for long-term investors.

 

Spotlight

What could go right?

Equity markets have been under pressure all year, and some bulls are starting to lose the faith. Sentiment indicators, such as the AAII Bull/Bear Survey, market implied volatility metrics such as the VIX Index, and market health statistics such as the number of stocks trading at 52-week lows, are all near their 90th percentiles relative to history. Macro indicators such as the yield curve continue to flash warning signs. Translation: Markets aren’t healthy, and investors are nervous.

When things seem bleak, it can help to think about what could go right. Market timing is a dangerous habit, and is antithetical to goals-based, long-term investing. However, when all the focus is on the risks (war, energy price shocks, commodity shortages, stagflation, recession, etc.), it lowers the threshold for what constitutes better, or even less bad, news that markets tend to appreciate.

We see at least three things that can go right.

  1. Progress in peace talks. Markets rallied in fits and starts when headlines alluding to a potential framework for compromise between Russia and Ukraine hit the wires, but they haven’t been able to hold. It seems like investors want to see substantial progress in talks that could lead to a new stasis (even if imperfect) before fully embracing a relief rally.
  2. Energy markets reaching a new equilibrium. Crude oil prices may be 20% below the highs reached earlier this week, but the calls for $200 per barrel crude are ubiquitous. Many investors believe surging energy prices will act as enough of a tax on consumers to destroy demand. Our view is that the U.S. economy can withstand higher crude prices, but equities aren’t waiting around to find out. The only day the S&P 500 gained this week was Wednesday, when crude prices lost 12%. Energy is the main transmission channel between the invasion, the economy and the stock market. As long as crude prices are volatile, we should expect volatile stock markets.
  3. The policy response. So far, the focus has been on what type of sanctions U.S. and EU officials are placing on the Russian economy. It is worth watching now to see what type of policies could shield domestic economies from the fallout. Gas tax repeals are on the table to help with the consumer burden in both Europe and the United States. The International Energy Agency has already released 60 million barrels from member states’ strategic reserves, which will add 1 million barrels to global supply per day for two months. The White House also seems to be lobbying Saudi Arabia, Venezuela, Iran and domestic drillers to increase production to help replace the 2–4 million barrels per day of Russian supply that are effectively blacklisted. A huge boon could be a coordinated output increase from OPEC, but we aren’t holding our breath for that at the moment. All of these shifts are likely to take time, and will have varying degrees of efficacy, but at the least they signal that policymakers are aware of the potential damage that Russia’s punishments could cause to domestic economies.

Investment takeaways

The more things change

Sometimes it feels as if everything has changed since we released our year ahead outlook in December. The Federal Reserve and European Central Bank seem out of patience and set to embark on a rate hiking cycle. Commodity supply shocks are causing soaring prices and are likely to pinch consumers going forward. The specter of all-out war is horrifying the world and paralyzing investors.

However, there are some key tenets of our outlook that hold.

  • A resilient consumer. Spending data we track suggests that consumption is healthy, even in more discretionary areas such as boats and motorcycles that could be most at risk due to higher gas prices. Pandemic-impacted services such as hotels still have room to catch up. Importantly, it seems as if consumers are largely funding spending through wage gains. Wall Street may be underestimating their ability to continue driving the economy.
  • Balance in equity portfolios. The sectors of the economy that were out of favor during the last cycle are holding up admirably this year. Regional banks in the United States, for example, are down just 1% this year, while the Nasdaq is down almost 17%. Commodity exporters such as Brazil are top performers. We continue to suggest that investors have adequate exposure to assets that perform well in abundant growth, higher inflation environments (such as financials, industrials and parts of energy).
  • Opportunities in core fixed income. As 10-year U.S. Treasury yields continue to rise above 2%, we still think we will get an opportunity to add back to core fixed income, the most efficient ballast for portfolios, from underweight levels.

For more on how we are navigating portfolios through this uncertain global environment, please reach out to your J.P. Morgan team.

 

All market and economic data as of March 2022 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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All market and economic data as of March 2022 and sourced from Bloomberg and FactSet unless otherwise stated.

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