“Be fearful when others are greedy, and greedy when others are fearful." , Warren Buffett
Warren Buffet’s quote might sound like a classic suggestion to “buy the dip”, but I would argue that we are nowhere near the level of fear that Mr. Buffet is alluding to in his quote (even though we might be getting closer). The fact that there is a war going on throws a real spanner in the works, making it impossible to know what might happen next. I believe that sentiment in the financial markets accurately reflects these circumstances though, as you can see below.
Equities generally have been drifting lower, and probably will continue to do so given the backdrop / context.
Within equity portfolios, geographic markets closer to the epi-centre of the war are faring the worst so far (meaning European equity markets). The worst performing markets this past week were the FTSE 100 (-6.7%) and the STOXX 600 (-7.0%).
US Treasuries and other developed market government bonds are staging a rally in spite of droves of inflation data from the US and Europe suggesting that inflation is running hot. The 10y UST saw its yield decline a whopping 23bps this week, and the yield curve flattened significantly (2-10y difference is now 24bps, the narrowest since February 2020).
Other safe haven assets – including the US Dollar (+2.0% WoW), the Yen (+0.6%) and gold (+4.7% WoW) – continue to be well bid, as investors bail out of risk assets.
WTI crude oil hit its highest level since the summer of 2008, closing at $115.00/bbl on Friday, 25.6% WoW. Concerns about access to oil and natural gas are much more acute in Europe than in the US, since Europeans are more heavily reliant on oil and gas from Russia.
Corporate credit spreads moved sharply wider last week, with USD-denominated corporate bonds – both investment grade and non-investment grade bonds – widening about 10bps. The real pain though was in the European high yield market, as spreads widened nearly 30bps WoW. (Keep in mind that data is only through Thursday, March 3rd close.)
Cryptocurrencies remain volatile albeit reasonably well bid as other risk assets have faltered more sharply. Is Bitcoin a safe haven asset or a risk asset? It’s hard to say, I could never begin to explain what drives the price of Bitcoin and its brethren.
With this rather unsettling backdrop, what should an investor do? No one is enjoying this downturn, but long-term investors know that it is part of the journey – equities don’t always go up in a straight line month and month. My advice would be to stay at least partially invested in equities, focused on large companies with solid balance sheets that are defensive. This does not suggest that a tilt towards higher cash might make sense if it helps you sleep better at nights. Energy companies (high oil prices) and defence companies (war) have flourished. But these themes can change quickly because of unpredictable geopolitical events and rapid-fire changes in investor sentiment. I remain negative on bonds, both government bonds (e.g. US Treasuries) and corporate bonds, because of inflationary pressures. Even so, I have been wrong the last couple of weeks as inflationary concerns have been swept aside because of the Ukraine-Russia conflict, causing safe haven assets – including US Treasuries – to rally. If you prefer the safety of bank deposits, we are in store for a series of increases in overnight borrowing rates in the US (already occurring in the UK) in the coming months which will lead to higher bank deposit rates. It’s true that relative to returns you might have become accustomed to earning in equities, the return on bank deposits will be very poor but not negative, as they have been with equities so far this year.
Even though the Ukraine-Russia conflict is dominating the news and is at the forefront of investors’ concerns at the moments, let’s visit a couple of events that were noteworthy this past week.
Inflation remains front and centre. The first “flash” read of February inflation in the Eurozone was released on Wednesday, coming in at a record 5.8%. The press release from Eurostat is here. Of course, the largest contributor to record Eurozone inflation was energy prices, which increased 31.7% in February (YoY). Excluding energy and food, flash CPI in February for the common currency zone was 2.9%. With the Ukraine-Russia war waging on the doorstep of the Eurozone, I don’t expect the ECB to make any definitive commitments to address inflation in the coming weeks, and in any event would expect only modest tightening (if any) to begin at the soonest in the second half of the year. The ECB will almost certainly remain accommodative for the foreseeable future.
Things are a bit different in the US and UK. Inflation is significantly higher in the US (than the Eurozone), and the US is further removed and insulated from the ongoing war. The Fed has telegraphed that it will be tightening in the coming months, and aside from the debate over the number of Fed Fund rate rises in 2022 and the size of the first Fed Fund’s rate rise this month (i.e. 25bps vs 50bps), the path ahead seems reasonably clear. Fed chairman Powell gave more clarity on the second point (i.e. 25bps vs 50bps increase) during his biannual testimony before Congress this week, saying that the Fed Funds rate would be increased 25bps at the mid-March meeting. Here is the press release from the Federal Reserve that preceded Mr. Powell’s Q&A sessions this past week: Semiannual Monetary Report to the Congress. The UK, which takes inflation more seriously than most countries, has already raised its overnight bank borrowing rate twice to address inflation. The BoE Monetary Policy Committee will next meet on March 17th, a day following the next Federal Reserve Open Market committee meeting on March 15th-16th.
Other things this week included President Biden’s State of the Union address on Tuesday and the US jobs report for February, released on Friday. The State of the Union address was largely a “rah rah” event, with no news that we didn’t already know. Most interesting perhaps was that Democrats once again displayed deep divisions within their own party, as Dem Rashida Tlaib unusually provided a response to her own party’s President following the State of the Union address. As far as the February jobs report, which you can find here, 678,000 new jobs were added in February and unemployment fell to 3.8%. However, wage growth was stagnant, supporting a view that inflation should begin to moderate in coming months (and supporting the Fed’s likely 25bps increase in the Fed Funds rate in mid-March instead of 50bps).
The Tables
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