Financial markets see-sawed in March as they sold off on news of conflict escalation and rallied on news of peace talks as the Ukraine Russian war drags on. Meanwhile, the COVID-19 outbreak continues in Shanghai and an initial 1 week locked down has now extended to more than a month, with no end in sight. The prolonged lock down causes China equity markets to sell off as concerns that the Chinese economy will face serious head winds as one of the most important Chinese city is left floundering. The twin scares of a prolonged war and a pandemic lock down has kept the stock market from rallying, even with American corporations showing strength, thanks to the COVID-19 recovery in US.
On the fixed income front, bonds continue to loose ground as fears of more supply crunch due to disruption in the European and Chinese economies may add to the inflationary pressure around the world, causing concerns for more interest rates rise. On the flip side, oil prices came down as fears of a slow down in demand for oil, due to the pandemic lock down in China. The US government contributed to the price moderation of oil by aggressively releasing oil from their strategic oil reserves.
Another concern is the inversion of the US 2-10 year yield curve – an infamous indicator of recession. However, the 2-10 year yield curve is just one of many recession indicators and more signals from other indicators need to be present before we hit the sell button. Typically, equities do well in an rising interest rate environment as real estate prices will increase, along with pricing power of the corporations which will take the chance to raise prices of their goods and services.
A large part of market volatility is driven by uncertainty in markets which fuels volatility – investors dislike uncertainty. Evidently, the Hang Seng China Enterprises index experienced its largest one-day fall of 11% during March on concerns of ADR delisting, divestment out of China and Covid lockdowns.
The volatility is expected to persist in the coming months as the Ukranian war is expected to drag out and it is very possible that the Chinese authority may loose control of the virulant Omicron variant leading to a general spread through out China, along with sporadical lock downs in vast swatches of the China's population centers. Increased volatility and uncertainty in markets have thrown up attractive risk/reward opportunities such as in US Small-caps, and China ‘A’ equities. The key to how long the Chinese stock market will remain depressed will depend on how the Chinese authorities will react, continue with a Zero COVID strategy and impose economically crippling lock downs in tier 1 cities, or start to transit to a live with COVID strategy.
Meanwhile, it make sense to focus more on the US markets due to much lower geo-political risk and attractive buys in technology and small caps which has been hit hard by fears of rising interest rates.
Portfolio Strategy
The market is currently in a kinda of zombie mode, with crisis popping up here and there, with no quick fix in sight. Previously, when the market risks a recession, governments will drop the interest rates and that will support the economy. However, in a stagflation scenario - A scenario where high inflation is causing damage to the economy, the government will be careful in rising interest rates too fast as this will hurt a lot of companies and house owners who have taken out a loan to fund their businesses or home purchases. The last time such a similar scenario occurs in the early 1980s, as a result of the Iranian revolution leading to a sharp spike in oil prices, causing a global recession. One of the key contribution to the recession is a sharp spike on interest rates by the US Federal Bank to 10% within a short span of time. With that lesson in mind, the current Federal Reserve is more careful with raising the interest rate, opting for a slow moderate rise, rather than a quick sharp rise, to avoid creating further shocks to the markets, even though they have been criticized for being behind the curve for rising interest rate.
The best thing for investors to do in such a scenario is to wait out the storm and let the supply chain sort out the in-balance themselves as global economies continue to recover from the COVID-19 recession.
There are certainly opportunities to invest, but I feel this is too early to try to jump in as it takes time for all the recent crisis to resolve themselves. It is also hard to tell if we are in the worst of things yet, as it certainly feel so, but we can also count the number of possiblities that things may turn for to become far worse. It may be prudent to observe for another month, before jumping in to take advantage of the opportunities that have come about.
The portfolio has regained some grounds with cash gaining 1.25% and CPF-IS gaining 0.85% for the month of March. However, I expect the gains to be temporary as the market will continue it wild swings as global events continue to unfold.
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