The Present and Future: Russia, Recession and Rates

As the Russia Ukrainian war grinds to a stalemate, the rest of the world has to wrestle with the problems brought about by the war. The global economy only started to recover from the COVID recession, when the Russia Ukrainian war drove a new shock to the fragile recovery. Three months into the war, we are starting to see the effects of the combined effects of the war and post pandemic supply shortage. This will cause many countries will fall back into a recession... and the stock market is already reflecting this reality. 

The Present Situation

The US S&P 500 has lost 21% since it's Jan record high and is now in a bear market. As the stock market is often a forward indicator of the economy, a bear market usually points to a looming recession as its inflation hits a high of 8.6%, it's highest since 1981. The US federal reserve raised interest rates by 0.75% instead of the previously communicated 0.5% in order to combat the inflationary pressure. The inflation was caused by a combination of rising commodity prices, rising shipping prices and rising wages due a tight labor market due to the COVID recovery. The US economy is still strong with the consumer sitting on $3.4 trillion of deposits, which will allow the US economy to keep this recession a short one, with careful management of the interest rates. The inflation is expected to abate in the coming months. Shipping freight rates have already started to moderated and started to fall while commodity prices are starting to moderate as commodity producers are starting to ramp up their supplies to meeting the increasing demand. The rising interest rates will keep a lid on the spiraling wage cost as companies have to rein back their hiring and expansion in order to set aside more cash to finance their interest payments.

US will probably weather this double dip recession well.

For Europe, it is more concerning as they are right in the middle of the storms from supply chains, from energy crisis, and just the proximity to the Russia Ukrainian war. They will take a much bigger hit from this perfect storm of market shocks and will probably take a longer time to recover.

The macro economic situation in China is in a totally different situation due to the COVID lockdown. Demand has been badly impacted due to the uncertainty and periodic lock down in two of the most economically important cities. China had to lower it's interest rates to help support troubled enterprises that are hurting from the shutdown, unlike the rest of the world which has been increasing rates. However, food prices in China are starting to creep up, and this has the potential to create both a potential supply shock from worldwide food shortage and falling consumer demand due to COVID lockdown. In the short term, thanks to the loose monetary policy in China, the stock market will be well supported as compared to the rest of the world, but the long term economic situation may be worse off as compare to the rest of the world if a China is hit by both a supply and demand shock.

The Future

The current US economic data are a mixed bag of contradictions. You have data pointing to a recession, then at the same time historically low unemployment, biggest wage increase in a decade, higher consumer spending, and supply chains starting to unclog. US GDP was negative last quarter, pointing towards a recession. But the upcoming GDP in the next quarter is already looking like it might see an increase and give much better numbers. It would be a bit of a contradiction to have growing GDP when you're supposed to have a recession.

And it's not just in the US. Things are a little bit all over the place as everything is correcting and readjusting from the COVID crisis and Russia-Ukraine war. 

With a mixed bag of economic data and consumer demand remaining stable, the global economy could tip in any direction in a blink of an eye. It was only two years ago that oil price was at $0 and last year around this time, around $60. It could just take OPEC to increase oil output by a large margin to begin a domino effect to tip things in the right direction and they have since agreed to increase output in July. 

The financial markets will come soaring back quickly once the supply shock sort itself out in time, and high prices is always the greatest motivation for entrepreneurs to innovate in order to produce more goods and services in order to make a profit in today's soaring prices. 

Hence taking a too defensive stance, will result in a lost opportunity when the stock market comes soaring back. During the COVID bear market, it took 5 months for the market to recover fully from the bottom and just 2 weeks from the bottom to recover half of the losses.

One of the sector that will have lots of value is in the technological sector. The market rout has pushed the price of some of these tech stock to pre-pandemic price level. For example, Netflix is at $350 pre-pandemic and it is trading around $170 in today's price. As compared to pre-pandemic, Netflix definitely has much more subscriber now and having such a lower price than pre-pandemic, makes the current price attractive by comparison. 

The Portfolio Strategy

We are due for a portfolio rebalancing as equities have fallen in value which has resulted the fixed income component increased in size and needs to be trimmed. However, I decided to hold off on increasing the equities components as the June inflation data has a high possibility to move the market in a negative way. 

With the announcement out of the way, we can now rebalance the portfolio as valuation has fallen to a good level, which will benefit returns in the long run.

For the month of May, the cash portfolio lost 3.11% and the CPF-IS lost 5.55%.  The CPF US focused fund has a large component in Technology shares which caused the larger drop as compared to the cash portfolio. Consider it as a payback for the outstanding run during the 2020 COVID recession when technology stock performed outstandingly. I still have strong recommendations for technological stocks due to the increased demand in technological products post pandemic and the current pull back makes it an attractive proposition to buy in.