The risks for stock markets in full "transition" towards a more volatile context
2022 has started with high volatility. The health, macroeconomic and geopolitical situation has favored this beginning of the year. To the expansion of Ómicron, with a large number of infections around the world, and high inflation rates, the crisis in Ukraine has been added. Investors are looking closely at the behavior of the market in the face of these events, which can change the paradigm experienced up to now.
"We believe that our new economic realities are in transition and will change permanently. The new environment will be marked by greater volatility in economic data. The great moderation is coming to an end," they maintain from Credit Suisse, whose experts believe that it is likely that cycles of boom and bust return.
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US inflation shoots up to 7% and returns to record highs since 1982They also state that inflation rates will remain higher than pre-pandemic levels, putting government finances under strain and limiting fiscal flexibility. "All of this should lead to volatile markets from time to time, but given strong economic growth, equity markets in particular should continue to have upside potential, albeit not at the same levels as the last two years," they argue. That is why the latest market sales must be interpreted in this context, as they are driven by the factors of the great transition. This market environment, according to these experts, is nothing more than confirmation of this thesis they hold.
That is why they are now neutral on equities, although they are prepared "to take either side of this market as data becomes available". Of course, they warn that "the next few weeks will be critical for the rest of this year of the great transition." This change of strategy took place in December, due to the sudden movements of the market, since they anticipated the beginning of the year that we have experienced.
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"Following our adjustments at the end of December, we have maintained the allocation to equities in strategic pesos and are underweight in fixed income, mainly due to our opinion that the profitability prospects of public debt are difficult", they argue.
THE FED TURN
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How does the market value a more aggressive Fed against inflation?Among the risks that are contributing to this behavior, in addition to the coronavirus pandemic, monetary policy and the geopolitical situation stand out.
Regarding the first, the high inflation and the rigidity of the labor market have caused the Federal Reserve (Fed) to turn its policy towards a tougher tone. In fact, in the last Open Market Committee (FOMC, for its acronym in English), officials confirmed that they will raise interest rates once the asset purchase program ends in early March, something that was well received in a market principle. However, the tone of Jerome Powell, president of the organization, in the press conference after the conclave has been what did not sit well with equities. "There is a lot of room to raise rates without affecting the labor market," he said, while announcing that the Fed will begin to reduce its balance sheet faster than on previous occasions because financial conditions are very different.
While all of the Fed's policy is focused on containing inflation, investors have taken refuge in bonds, so their yields have risen as equities have fallen.
"Another consequence of this negative market impact has been the rotation of growth segments in equity markets, including computer stocks, which have fallen particularly sharply," Credit Suisse notes in its report. These securities are more sensitive to movements in interest rates and tend to benefit from periods of loose monetary policy and ample liquidity, an environment that is precisely "we are leaving behind".
THE CONSEQUENCES OF UKRAINE ON THE MARKETS
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Russia warns: there are "little reasons for optimism" after the US rejectionOn the other hand, the conflict with Ukraine may have a significant derivative in the stock markets. The growing tension on the border, with the accumulation of Russian troops while Washington mobilizes 8,500 troops to counter a possible attack, leaves three possible scenarios for equities: the diplomatic solution, which de-escalates military force; the invasion of eastern Ukraine by Russia and the complete occupation of the country.
"In this phase of geopolitical tensions, we believe that investors should not rule out the risk of a new military escalation, even if a peaceful compromise is eventually reached. Minor attacks, stealth operations with special forces or in cyberspace, as well as a A further build-up of military forces on both sides of the Ukrainian border would unsettle financial markets," they argue.
If the escalation goes further, these analysts estimate that there will be a significant sale of Russian and Ukrainian assets, so they have a cautious opinion on this, including the Russian ruble. At a European level, it is also likely that this increase in tension will be transferred to the markets in a negative way. Among all the sectors, the most critical is energy because the possible rationing of it "would further worsen the inflation outlook and negatively affect growth, as world economies struggle to get out of the Omicron wave" .
However, Japan and the United States will not be vulnerable to developments in Eastern Europe. "The path of inflation and monetary policy, in addition to the outlook for growth and profits, will be the key factors in determining the direction of the markets."