March 2022 – Fall and rebound and extreme uncertainty over inflation

After touching February lows on the day of the invasion, markets started to recover on the 14th of March. SFRR closed the month at -0.16% (-16.26% YTD), SFPG at +1.09% (-19.71% YTD) and SFQS ended the month at +2.68% (-11.95% YTD).

March highlights:

  • Growth stocks rebound strongly from minimums.
  • Inflation continues to rise although some sectors are already showing signs of containment.
  • Good US employment and growth data.
  • The inversion of the US yield curve is worrying, but does not yet warrant recession.
  • We favour equity exposure to companies with high quality, sustainable growth and strong balance sheets.
  • Better USA than Europe.
  • Neutral in Asia, good opportunity price-wise but high risk if the environment and regulation do not improve.
  • Commodities and energy trending but possibly overvalued.
  • Better USD than Euro in the long term. We hedge short term so as to not be so exposed in case of ceasefire in Ukraine.
  • We reduced risk in the first half of March and have been gradually increasing it in the second half of the month.

A significant rebound took place in the stock market, especially in the Growth style, due to the large oversold conditions that had been weighing on prices. The two catalysts that plunged markets to lows were the Fed’s meetings on 15th and 16th of March, when it rose interest rates by a quarter point and also confirmed its intention to reduce its balance sheet, and Beijing’s announcements pointing to an easing of regulatory pressure on the country’s companies and, in particular, its intention to facilitate the communication of information on those listed in the US to its regulator.

This month the principle that markets fall with uncertainty and rise with certainty, even when the news is bad, is once again proven true. In February when the invasion was a certain fact markets started to rebound, and in March markets rallied when the FED confirmed that it would rise interest rates and reduce its balance sheet. Both are bad news for the market, but many sectors were already oversold when the news were confirmed.

The two factors that continue to put markets and the Fed itself under great pressure are inflation and the war between Russia and Ukraine, which also directly aggravates growth and inflation. Both factors are highly unpredictable as the market scenario can rapidly change. The possibility of a ceasefire is always present, and this would lead to a sharp drop in energy and commodity prices, and a rise in the Euro and stock markets. Prolonging the war has the opposite effect, and limits market recovery. We are now avoiding entering in sectors and assets that are overvalued due to the current situation. We did not take advantage of their rise and prefer to stay on the side-lines when correction comes.

In our core macro scenario, we now expect to see the wished for inflation peak, delayed by the prolongation of hostilities in Ukraine, in the second quarter. Some improvement in inflation data would support markets and reverse the bearish trend of the beginning of the year. The Fed minutes announce a balance sheet reduction of USD 95 billion per month, 60 billion in US Treasuries and 35 billion in agency mortgage-backed securities. Interest rate futures anticipate it will be at 2.5% by the end of the year. Both measures are digestible by the market and should not jeopardise the positive growth of the US economy, which continues to deliver good employment data.

The markets have been heavily impacted by the US 10-year bond yield, which has soared by more than 110 basis points so far this year, equivalent to a fall of around -9% on a portfolio of 7-10 year bonds. In the first days of April, the yield on the 2-year bond has also risen and at a faster rate, reaching 2.5%. The yield of 2-year bonds is now higher than the 10-year yield, inverting the yield curve and foreshadowing the feared recession. However, we believe it is too early to predict such an outcome. The Fed has not yet started to sell bonds, which will increase the yield in the middle of the curve. In April, the curve will be positive again and it is foreseeable that the whole curve will be pushed towards higher rates, trying to avoid it’s actually inverting. Even so, we will closely monitor this as an extended inversion of the curve –in itself– will have adverse effects on the economy.

In the funds we started the month with less risk and reduced it further until the middle of the month. We waited for the market to break out of its bearish channel before increasing exposure and reducing hedges. It is difficult to predict what the market will do in the short term because of the uncertain conditions that are putting it under pressure, but we are bullish between now and the end of the year. In an environment of inflation, whether high or moderate, cash also has a cost and money seeks profitable assets. The most reasonable risk-return trade-off continues to be in equities and we maintain exposure in portfolios and funds. Bonds are still in free fall with less prospect of recovery and commodities are already trading in overvalued territory in the medium term.