Market Update March 7, 2022

Photo by Conny Schneider on Unsplash

Economic data for the week included a robust employment situation report, as well as other labor metrics, and improved manufacturing and construction activity.

Global financial market sentiment continued to be driven by the Russia-Ukraine conflict, with U.S. and especially foreign stocks losing ground and staying in correction territory. Bonds were mixed, with higher-quality safe haven debt faring positively. Commodities experienced sharp gains, led by crude oil and grains—exports most affected by Russian and Ukrainian supplies.

U.S. stocks fell back again last week, with Russian advances into Ukraine dominating global news, and sanctions leveled from all sides, creating uncertainty about the near-term economic environment. Most notably, the role of Russia as a significant gas and oil producer has raised concerns over further near-term inflation as backup sources of energy are being rerouted globally. By the end of the week, a Russian bombing of a Ukrainian nuclear facility and subsequent fire raised concerns on several levels (one of which being that Chernobyl, site of the 1986 disaster, is also in Ukraine). By sector, high oil prices caused energy to spike by 9%, followed by positive returns in defensive utilities and health care. Real also ended positively as interest rates fell. Financials, technology, and communications all ended down around -3% or more for the week.

Fed Chair Powell’s testimony before the House Financial Services Committee noted the Fed will ‘proceed carefully’ in raising rates (implying a March move of 0.25% as opposed to the more extreme 0.50%), which gave the market a short-lived rally. The run-off of the Fed’s balance sheet was also discussed, which provided some reassurance that a plan was being considered. This tempered language was a reflection of higher inflation, driven by energy prices, but also uncertain effects from the Russia-Ukraine situation (and sanctions) on global economic activity. An important risk, in addition to inflation, is the fact that an intensifying war, perhaps greater participation by neighboring European countries, and sanctions/sanction reactions could depress growth enough to dip the globe into a recession. This doesn’t seem to be the base case, but is now at a higher probability than a few weeks ago.

On the brighter side, measures of investor risk appetite and sentiment have fallen to lows, in keeping with worries about inflation and geopolitical concerns; however, such low points have tended to be bullish for risk assets from a forward-looking standpoint over the next six to twelve months. Any sign of an improvement in conditions or negotiated peace treaty could be especially bullish.

Foreign stocks were led downward by sharp declines in Europe, with the geographic proximity of the Ukraine war as well as an expected negative impact from higher natural gas and crude oil prices outweighing most other factors. Japan fared slightly better, but still lagged the U.S. by a few percentage points. In emerging markets, sentiment was negative but skewed toward Eastern Europe. China and India also saw losses as commodity importers, while net exporter Brazil fared positively. Russian equities fell over -30% Monday morning alone (nearly -70% for the week) as the brunt of sanctions and a possible recession caused investor sentiment to sour immediately. Index providers MSCI and FTSE Russell, among others, decided to remove Russia from equity and fixed income indexes, due to the lack of investability. Interestingly, and contrary to what might be expected, emerging market equities have outperformed U.S. and developed foreign stocks on a year-to-date basis.

U.S. bonds experienced a positive week, as general risk-off sentiment pushed flows toward fixed income, lowering interest rates. Treasures outperformed investment-grade and high yield corporates, as credit spreads widened. In foreign bond markets, developed markets were little changed, while emerging markets lost significant ground due to geopolitical concerns, a stronger dollar, and index composition.

Russia raised interest rates from 9.5% to 20.0% in an effort to stabilize their ruble, which had been hammered the prior weekend (-30%) after sanctions were announced. The fact that over $600 billon of Russian central bank assets held in the West have been frozen make foreign currency transactions to defend the ruble less possible. Unfortunately, higher interest rates in emerging markets can tighten conditions sharply as well, which brings enhanced recession risk. It appears the Russian economy is already in a freefall, perhaps along the lines of 2008; unfortunately, citizens are bearing the brunt.

Is a Russian default a risk (as they did in 1998)? The environment remains hazy, but many institutional investors appears far less leveraged to Russia than they did in the 1990s, when emerging markets were the new and exciting growth story. Much of the current complication is operational and legal. By Thursday, it appeared Russia made the ruble equivalent of $100 mil. in local coupon payments; however, a central bank ban on funds leaving the country left foreign investors in the cold for the time being.

Commodity indexes were up dramatically last week (based on composition, 15-20%) led by a rapid spike in the price of crude oil (26%, from $92 to just under $116/barrel) and wheat (34%), as well as to a lesser extent, agriculture, natural gas, and industrial metals. Dislocations between U.S. and European-priced natural gas have reached extremes (as in $5 vs. $30 per mil/btu, etc.), as transportation problems for gas or liquid gas limit potential closing of prices through arbitrage. Broadening sanctions against Russia have already affected the prices of certain heavily-exported materials including oil and gas, but also aluminum and copper (among other metals), and wheat. After falling in a trading range for some time, gold has also seen stronger sentiment in keeping with the war-driven safe haven trade. Mid-week, the U.S. and several allies agreed to release 60 mil. barrels of oil from strategic reserves, in order to buffer lost Russian export production. (Crude touched $130 over the past weekend with discussion of a full U.S. ban of Russian energy.) With sanctions in place, as well as bad weather in Ukraine already, wheat supply is expected to be sharply down this year, which has caused the price of that and several related grain commodities to spike.

Period ending 3/4/20221 Week (%)YTD (%)DJIA-1.23-7.15S&P 500-1.24-8.94NASDAQ0.50-13.36Russell 2000-1.92-10.74MSCI-EAFE-6.51-12.66MSCI-EM-2.29-6.95Bloomberg U.S. Aggregate0.95-3.09

U.S. Treasury Yields3 Mo.2 Yr.5 Yr.10 Yr.30 Yr.12/31/20210.060.731.261.521.902/25/20220.331.551.861.972.293/4/20220.341.501.651.742.16

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.