Seeing risk assets get flung from one side of the ring to the other reminds me of watching wrestling matches on TV as a kid, states Jay Pelosky of TPW Advisory.
There was lots of noise and action, and ultimately a winner and a loser with major role reversals along the way—sounds a lot like today’s markets. To stick with the wrestling analogy a moment longer, writing this Monthly in real time has been like wrestling a greased pig.
Investors are mis-ordering the Fed, Russia, and Covid in terms of importance. Omicron’s ebb and the resulting global synchronized reopening/expansion is the most important factor, yet it is receiving the least attention.
After a long march up the Fed rate hike mountain, first two or three, then five, no seven, we summited on JPM’s nine rate hikes in a row. When the Fed roleplay took a breather, the Russia-Ukraine twosome took over, pummeling risk assets as armed conflict unfolds between two sovereign states much as US intel said it would. Net result: Nasdaq down close to 20% and off five days in a row, the S&P in official correction territory, first since Covid, non-US equity outperformance gets hit as Europe sells off and China looks to catch a safe haven bid while gold and USTs chop around.
Amidst a very tough start to 2022, there have been ways to limit portfolio damage while staying invested if that is one’s choice (as it is ours). Non-US is down much less than the S&P 500 (SPX), equal weighted S&P is down much less than Nasdaq. Value has widely outperformed Growth and being allergic to DM sovereign debt has been a way to stay healthy. Commodities have been on a tear and the whole complex has been the place to be. On many levels it has indeed been a “Golden Age’ for asset allocation. The question now is does this playbook stay intact should the Russia-Ukraine conflict extend for weeks if not months. No one really knows—I certainly don’t and so we must be humble and open minded; arguably President Putin’s decision to invade seems irrational which suggests the option set could be quite wide, cyberattacks on Europe and the US, energy blockades by both sides, etc. Could the conflict widen to include other states?
What happens if Russia succeeds in a matter of days in toppling the Ukrainian Govt and installing a puppet regime? Russia’s invasion has served to clarify the key issues: namely the economy and the Fed. As LPL has pointed out geopolitical issues tend to derail markets only when a recession is near; no recession and the S&P averages up 11% one year later. Thursday’s record setting US equity market reversal: the biggest losers ytd up 7% while the biggest winners were flat jives with the bond market action—an aggressive Fed is off the table, as is 50bp hike in March, and even the seven rate hikes priced in are now down to six. Russia’s invasion may have given an assist to both the tactical and strategic outlooks, and thus to global risk assets on both a NT (sell off over) and LT (bull market intact) basis.
Climate
Russia’s decision to invade Ukraine will force an EU wide decision to reduce its energy dependence on Russia. Germany is most exposed—low hanging fruit includes reversing nuclear plant shut downs. Enhancing energy security while going green gives EU chance for a two-for-one win.
Economics
Understanding and appreciating the distinction between slowing y/y growth, likely in all DM economies this year and slow growth, unlikely in any DM over 2022-2023 time frame, is key to getting the economic outlook right.
Nominal growth across the US, EU, and Japan will be higher than pre Covid levels; be careful to distinguish between signal and noise insofar as EU energy price spikes and growth-inflation estimates are concerned.
The inflation bogeyman will shrink as we move into Spring — ebbing Omicron, clearing supply chains, growing production of semiconductor chips, autos etc. should all help. Media narratives of a Fed that has lost control are not supported by three, five, and ten-year inflation forwards.
Politics
While still very early days the winners and losers from Russia’s invasion can start to be toted up. Pres. Biden is a clear winner—his poll #s are like an ARKK stock, bottoming. Former Pres. Trump is a loser—his comments regarding Putin and Ukraine should disqualify him from the 2024 race in fact if not in deed. Ukraine’s President Zelensky is a winner—his speech as the invasion began should be watched by all—it is a profile in modern day courage. President Putin is a loser—his decision seems irrational and is likely to leave both him and Russia ostracized.
From our Tri Polar World POV, the EU is a major winner as Russia drives deeper cohesion and integration across the security and energy fronts much as Covid did across joint fiscal spending. NATO has found a new lease on life while Russia, a petro state, has just kicked its top customer right where it hurts.
Policy
NATO/US boots on the ground are very unlikely—further sanctions should Putin not reverse himself are quite likely, perhaps to include Russia’s ejection from the SWIFT system.
The Fed has the option of bringing inflation down to 2% by breaking the stock market; its second option is to bring inflation to 3%, declare victory and unleash a multi year period of above trend growth not only in the US but globally. It will choose the latter.
The ECB is highly unlikely to tighten policy in 2022; Europe’s Stability and Growth Pact’s updating will now almost certainly include more spending to bolster defense and energy security. The PBOC continues to provide liquidity to support China’s 2022 glide path.
Markets
Where to begin? The ytd selloff would seem more rotational than systemic as non-US outperformed the US while Value outperformed Growth, Bonds weakened, and Commodities roared. The invasion of the Ukraine led to a final flush and an epic record setting reversal underpinned by an inverted Volatility Index (VIX) curve and extensive backwardation across the Commodity complex.
The equity bear case—another 15% drop resulting from a Fed that tightens until something (stocks) break—has likely been taken off the table—not only by invasion but the reality that the Fed has not started a tightening cycle with all three major US indices under their 200 dmav in 40+ years.
Our tactical outlook: LTE inflation in the months ahead coupled with BTE growth leaves us fully invested in our GMA and TPW 20 Model Portfolios. OW equity; within equity OW Cyclical/Value in the US and non US vs US. UW FI, especially DM sovereign debt; 2% ten-year UST and .20% ten-year BUNDs are not attractive. OW Commodities across the complex; hold thru any profit taking. Continue to expect a weak USD.
Two big opportunities: the non US equity space and the ARK Inovations (ARKK) type disruptive tech/thematic space. If we are right on our strategic outlook, the current period will be seen as a great entry point—of course only in hindsight by the majority…don’t be in the majority!
