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Capital Market Impact

Market resilience reemerges in the face of geopolitical uncertainty

February 28, 2022
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Thoughts

  • Equity markets defied expectations last week, with the S&P 500® Index managing a tremendous reversal, jumping 6% after touching the lowest level since May on Thursday morning to finish the week with a modest gain. The tone of markets appears to have shifted, with the tendency to sell the rallies experienced for much of the year shifting back to a buy-the-dip approach. Following a sharp selloff driven by deep uncertainty, markets are attempting a stabilization, consistent with the behavior of markets in similar periods of geopolitical stress. With one trading day left in February, the S&P 500 is tracking towards a loss of 4% for the month, marking the first consecutive monthly losses since September and October of 2020. This would mark only the second time in 50 years (1978 and 2009) when stocks and bonds were both down in January and February, per Bespoke Research.
  • Investor sentiment continues to collapse, with the Investor’s Intelligence survey showing bulls falling to 32.2%, the lowest since March 2020, and just above bears at 31.0%. This echoes last week’s AAII Sentiment Survey that showed only 23% bulls versus 54% bears. Institutional investors are increasingly seeking downside protection, with the put/call ratio at the highest level in 22 months, while short interest has doubled since the start of the year. Despite the weak confidence, equity funds and ETFs continue to attract flows, as fixed-income and money market funds are shedding assets at the fastest pace in seven years.
  • Markets were turbulent in February, reacting to a flurry of uncertainty around the Omicron variant, rising inflation, and bubbling geopolitical tensions between Russia and Ukraine. But markets tend to price in worse-case scenarios, and with the market rally late last week, we expect a more positive outlook in March. With upcoming Fed decisions around a rate hike, the rollback of pandemic restrictions, increased knowledge of the situation and risks between Russia and Ukraine, a “March to certainty” should calm the markets.

News

  • The invasion of Ukraine by Russia continues, with the U.S., E.U., and others making the decision to cut several Russian banks from the SWIFT messaging system, blocking the ability to connect with the global banking system and conduct trade. The Russian ruble plunged nearly 30% against the dollar to a record low, forcing the central bank to hike rates. Markets were unsettled by word that Russian President Putin put his country’s nuclear deterrence forces on high alert, with crude prices at an eight-year high. Ukrainian and Russian delegations are holding talks Monday on the Ukrainian-Belarusian border, though Ukrainian President Zelensky has expressed skepticism about the potential for the talks to produce any meaningful breakthroughs.
  • Inflation pressure remains intense, with the core PCE deflator (inflation metric preferred by the Fed) at the highest level since April 1983 at 5.2%, with the headline number at 6.1% versus 5.8% in December. Consumer spending remains healthy, rising 2.1% versus the 1.6% estimate, while income was flat, better than the expectation for a drop of 0.3%. Income fell 2.1% from a year ago, as government transfer payments slow. When adjusted for inflation, real disposable personal income fell 10% from a year ago. Durable goods are quite healthy, rising 1.6% in January versus an estimate of 0.8%. High-frequency data points reflect the 90% decline in COVID cases, with Google mobility data showing time outside the home down 6% from pre-pandemic highs, up from -15% in early January.
  • The conflict in Ukraine, the choppy economic data, and the historic level of inflation create a difficult path for the Federal Reserve to navigate. Fed Governor Waller echoed recent comments from St. Louis Fed President Bullard that we need a 1% hike by mid-year, and potentially 0.50% in March. The Fed Futures curve has seen a sharp decline in expectations for 0.50% at the meeting on March 16, down to 10% following the surge to over 90% following the reading on CPI. Long-term interest rates have come off their recent highs on a flight-to-quality, resulting in a flattening of the yield curve. The volatility in the bond market is a clear indication of the uncertainty and emotion of investors.

What to Watch

  • Markets could continue to be volatile next week on Russia news and positioning around month-end. Economic data include ISM manufacturing on Tuesday, the Fed’s Beige Book on Wednesday, durable goods and ISM non-manufacturing on Thursday, and the payroll report on Friday. Fed Chair Powell delivers his semiannual policy testimony to Congress this week.
  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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