Outlook - April 2022
Markets and tensions SUMMARY OF THE MONTH
Markets rose as tensions eased, but a host of problems continue to exist below the surface. Bond and equity markets have different views on the future, with stocks rising during the month. While fixed income fell as higher inflation and aggressive monetary policy expectations became a certainty.
Caution and patience are required. A few weeks of positive price action does not imply a change in trend.
The April CPI numbers will show the first true reflection of how much incremental inflation is being caused by the Russia-Ukraine war. In addition, the upcoming PMI numbers will certainly be driven by what happened in March.
CORNER MACRO
Volatility continued in all markets as investors began to absorb the implications of the invasion. Moreover, as the prospect of a protracted conflict grew, so did uncertainty about its resolution. Hundreds of companies, along with dozens of countries, denounced the invasion and effectively cut the Russian people off from traditional markets. With thousands dead and millions displaced, we are just seeing what the consequences could be.
However, there is a divergence in the way asset classes have reacted to the new information. For now, equities have risen substantially, reducing the overall YTD drawdown to mid-single digits. This happened despite rising inflation expectations, rising rates, and continued conflict. One possibility is that this is a bear market bounce or simply a strong technical reaction in a market that was largely oversold. Something similar has happened many times in the past, including from 2000 to 2002, where it took place several times during the 2-year period, but the overall trend remained negative.
On the other hand, while equity markets rallied, fixed income markets are saying that we are in for a lot more pain. In particular, 10-year yields have risen sharply and are above 2.3%, up aggressively in a short period. In addition, the yield curve is flattening and, in some cases, heading toward an inversion. One predictor of recession that many use is the inversion of the 2-10 year curve and it has now taken place.
Whenever equity markets and bond markets diverge, it is up to investors to watch. One of the most important elements in the discussion, and the crux of the problem, is how much more inflation the geopolitical situation will cause. As the price of oil soars past $120 per barrel and the price of agricultural commodities, such as wheat and fertilizer, follows. We may find ourselves in an even harsher inflationary environment than we expected.
The reality is that, especially in the energy markets, there is not enough slack, as of now, to wean the world and especially Europe off Russian oil and gas. The United States announced that it would provide Europe with substantial additional quantities of liquefied natural gas. But U.S. refineries are operating at capacity and the move is largely symbolic, as it is simply a rerouting of existing shipments.
