Global markets

A very exciting few days.

US

The Fed has now moved away from the zero lower bound, hiking by 25bps, as explicitly signalled by Powell a fortnight ago.

The graph below tells us most of what we need to know. The level of rates is highly risky asset friendly, and hence supportive to an ongoing allocation in line with one’s SAA.

The co-movement between macro market variables is consistent with monetary and fiscal tightening, which equates to higher rates, a stronger dollar, widening credit spreads, and weaker risky assets – this configuration (interpretation) describes the past quarter, particularly well.

The reason for “risk on” today was a function of a slightly “dovish” tightening, at the margin. The bull case can be made that rising nominal rates are really just being matched by higher break-evens, and even higher actual inflation, such that real rates are still low, in both ex-post and ex-ante. That’s very friendly to secular growth stocks, and equities in general.

The flattening of the yield curve (see the term spreads graph, bottom left) suggests that inversion is possible. Flat is fine, negative is problematic, and can be taken to imply that the bond market thinks a mistake is being made, that the Fed will overtighten, and cause a recession.

Clearly this overtighten narrative is somewhat at odds with the risk on interpretation also outlined above.

Now the Fed hasn’t happened in isolation.

Ukraine/Russia

A) each day, there is commentary from both Ukraine and Russia about what peaceful negotiations might entail. None of it guarantees anything, but each day of wording along those lines is taken as a better day than one in which Putin sabre-rattles about nuclear war. That’s risk on, or at least less awful, in the mind of the market.

B) That observation, and the seeming evidence of global buyers for Russian oil and gas assets, suggests that the 10% of global supply isn’t actually out of market. We can see either this supply flow aspect, or this risk premia unwind, operating through the 40% fall in TTF natural gas pricing, and a similar fall in the price of oil.

Both commodities are essential to operating one’s economy, and at $135bbl a European-led energy induced global recession was very likely.

That risk is now declining from certain to merely quite possible, and hence the bid for European equities. Pleasingly, we bought some more a week or so ago.

China

The other major news item is the state policy directive to support embattled equity markets. Whist detail is somewhat scant, pledges to support property, support dual listed stocks, moderate or stop “common prosperity” intervention into tech or state champions and co-operate with the US regarding audits appears to be a “line in the sand” moment for deeply depressed valuations.

Given a 20% fall in China centric markets (and much more so for the HSI, and China-tech themed markets) the valuation argument was only compelling if accompanied by a political consideration. It bears restating, as we imitate the words used by other China watchers – the politics IS the fundamentals.

They don’t separate.

Now, China is a very small exposure across our balanced funds, and none of the long run fundamental challenges to the economy (the declining growth rate, the ill-balanced nature of growth favouring investment over consumption, the necessity for households to have a larger share in GDP, likely at the expense of the governments share) are resolved.

However, things are “less worse” and narrowing our underweight to the region (more specifically, to the Emerging market region) makes sense, to us, with a very modest deployment of capital.

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