Inflation pressure stablizes. Gleam of light in Europe and China

The convergence of a post pandemic recovery inflation, rising interest rates, the Russia-Ukraine war and a severe pandemic lock-down in China has sent financial markets reeling. However, the deteriorating environment has stabilized in the past week and there is now more room for optimism as recent development has bring about some hope that we will see some recovery from the recent pains. Let's take a look at each of the trigger points and analyze their impact.

1. U.S. inflation & interest rate hike

U.S. inflation eased slightly in April but stayed close to a 40-year high, as strong price pressures in the broader economy continued to make themselves felt. The annual headline rate of inflation fell to 8.3% from 8.5%. In order not to spook the financial markets too much, U.S. Federal Reserve chairman Jeremy Powell maintained that the Fed will continue to raise interest rates at a regular pace of 0.5% per session, giving assurance to investors that a 0.75% is off the table unless inflation pressure continues to rise rapidly. Meanwhile, segments of the U.S. economies most affected by the pandemic such as travel and hotel industries continue its recovery. President Biden also raise the issue of removing the trade tariffs imposed on China during the 2018 trade war as a way to lower inflation and this may lead to a thaw in the U.S. China relationship. Over the next few months, the Fed will attempt to engineer a cooling of the economy that leads to lower prices but doesn't spiral into recession.  

2. Russia-Ukraine war took another unexpected turn

With the withdrawal of Russian troops from Ukrainian capital Kyiv, the Ukrainian army is able to focus their attention on defending against a consolidated and renewed attack by the Russian army in the eastern part of Ukraine, particularly at Ukraine's second largest city, Kharkiv. The attacks came with the Russian trying to make slow and steady progress by carpet bombing their way, but the Ukrainian army was able to hold their ground. An international weapon donation drive saw developed nations contributing heavy weapons to Ukraine and the U.S. government re-enacted a WWII "Land Lease" initiative, which allows the U.S. President to authorize unlimited financial and military support to the Ukrainian army. The heavy sanction on the Russian economy and a now better supplied Ukrainian army started to see a reversal of fortune in the war as the Russian army is loosing more man and equipment than they can replace while a steady stream of new weapons strengthened the Ukrainian army. This allow the Ukrainian army to make a successful counter attack and drove the Russian back to the nearby borders around Kharkiv, securing their most important city after Kyiv. 

With the Russian army weakened, the Russian government could only send empty threats, as once neutral countries Sweden and Finland applied to join NATO without much repercussion from Russia. The tightly state controlled Russian state media also started to talk about the possibility of losing the war, which can be seen as a bid to prepare the population the potential backlash that might occur as the tide turn against the Russian.

With this development, it is very possible that the war may end faster than expected and this will give a huge boost to the stock market. This will also change the geo-politics balance of power in Europe which may see a new development in the relationship between U.S. Europe and Asia.

3. COVID lock down eases in China. China government pledges support for Chinese tech firms

Total lockdown in Shanghai starts to ease as COVID cases started to ease and overall COVID cases in China are also seeing a slow-down in numbers. Essential industries in Shanghai are allowed to re-start again and citizens are now allowed to leave their compound. However, the lockdown has lead to a sharp fall in the economic activities in China. The International Monetary Fund cut its growth forecast for China this year to 4.4%, well below Beijing's target of around 5.5%, on the risks of widespread COVID-19 lockdowns and supply chain disruptions.

This has lead to the China government loosening their monetary policy and provide unemployment support as the Chinese government tries to protect companies and their jobs which are badly impacted by the COVID lockdowns. After 2 years of enacting strict regulations on Chinese tech companies, which have seen the share prices of China tech companies taking a beating, the government recently indicated that they are enacting new policies to support China tech companies, giving a boost to China stocks. 

Portfolio performance and strategy

The portfolio is down -3.54% for cash and -5.34% for CPF-IS investment. Thanks to the heavy weightage in US equities and bonds, the portfolio managed to cushion the shock with the MSCI world index falling more than 8% for the month of April. CPF-IS performed worse than the Cash portfolio is due to the unavailability of a short duration US bond in the selection of fund and we are forced to make use of Asian bonds instead, which didn't have the benefit of the currency appreciation of the USD cushioning the fall in bond prices. USD appreciated 2% against SGD during the month of April.

In my opinion, investors have already priced in many of the negative factors that lead to the current fall in the market and in this type of environment, it just takes a spark of good news to trigger a rally in the market. The bullish case for equities would require the following factors: 

1. Moderating inflation 

2. Improvements in the supply chain

3. Winding down of the Russia Ukraine war

4. Company earnings outlook becomes more positive

Having said that, the sentiment of the Fed potentially mis-managing the inflation problem and push the economy into a hard landing is putting a damper on the markets. However, as the world continues to open up due to the recovery from the COVID pandemic with goods and manpower able to move more freely around, the supply chain issue will gradually ease allowing the Fed to orchestrate a soft landing. In the meantime, we will have to just bear with the pain in the short term.

In any gloom and doom, there are always opportunities to be found. For example, US small caps is still attractive due to the impact of the pandemic on its value and I believe that it will be a strong performer once the overhang is over.

In the mean time, I will be initiating a general rebalance of the portfolio, so watch out for your IFAST alerts for the notification for the switch notice.