Stocks fall as concerns over rising rates add to market uncertainty
On a month-to-month basis, headline inflation was 0.8%, with underlying prices rising 0.5%. The release comes ahead of next week’s FOMC policy meeting, when the Fed is expected to announce the first rate hike since 2018.
The US data was accompanied by reports that the European Central Bank will end its bond-buying program sooner than expected, paving the way for rate hikes. The Governing Council described the Russian invasion of Ukraine as a “turning point for Europe” and added that it would “take all necessary measures…to pursue price stability and safeguard financial stability” .
Talks between the Russian and Ukrainian foreign ministers on Thursday did not lead to a ceasefire. This is despite optimism earlier this week about the potential for diplomatic progress after Russia signaled the limits of its territorial claims and Ukraine indicated it was open to discussing neutrality.
How do we interpret this?
The latest news undermines hopes that central banks will significantly slow the pace of tightening in response to the economic damage caused by the conflict in Ukraine.
U.S. inflation data, which reflects a period before the last commodity price spike, will make it harder for the Fed to moderate the path of rate hikes, with the market now expecting about six hikes this year . The relatively hawkish rhetoric from the ECB is also consistent with a rate hike before the end of 2022.
Overall, central banks now have less flexibility to cushion equity market shocks, as they have managed to do in recent years.
Our baseline scenario for the war in Ukraine remains a ceasefire and a reduction in hostile rhetoric between Russia and NATO by the summer, although that outcome still seems distant. We continue to see considerable uncertainty over a range of conflict-related factors, including Russian President Vladimir Putin’s intentions, the extent of future sanctions, military results and the policies of non-NATO states. The war also adds to a lack of clarity on commodity prices, global growth, inflation and central bank policy.
Our view remains that simply selling risky assets is not the best response to the war in Ukraine. But in this environment of heightened uncertainty, we advise investors to reduce excess equity exposure above long-term strategic benchmark allocations and increase hedging. Specifically, we advise investors to:
1. Manage inflation and rising interest rate risks. We will receive further indications next week on how the Fed will react to the Ukraine conflict, whether it is focusing on higher prices as a new inflation threat or as a demand risk. But while war-related uncertainty means the pace of interest rate increases may change, the longer-term need for higher rates is clear. So, after years of low rates and low inflation, investors need to prepare their portfolios for a new normal. Exiting the markets in favor of cash would be counterproductive in an environment of rising inflation and negative real yields. Instead, we favor investments that should outperform in this environment. Investors can consider, for example, US senior loans, which offer an attractive yield and a floating rate structure that offers some protection against Fed rate hikes. In equity markets, financial stocks generally benefit from rising yields and value stocks tend to outperform growth sectors. Click here to find out more.
2. Build portfolio hedges. In addition to bringing equity holdings back to neutral, we see other ways to make portfolios more defensive in the current environment. Given the war in Ukraine, we believe broad commodities remain an effective portfolio hedge. Energy stocks, still a favored sector, should also benefit from a further rise in commodity prices. We also see the global healthcare sector, the use of dynamic asset allocation strategies and structured solutions as potential ways to reduce portfolio volatility. In the short term, we also believe the US dollar can act as an effective portfolio hedge. Click here to find out more.
3. Position for the energy transition. The recent ban on Russian oil imports by the United States, as well as the EU’s goal to reduce dependence on Russian natural gas imports, indicate increased attention to safety and energy independence. We see this trend accelerating due to the conflict in Ukraine. The desire for energy independence goes hand in hand with the longer-term goal of reducing carbon emissions. We believe this is likely to drive investment in green technologies, clean air and carbon reduction solutions. Click here to read more.
Main contributors– Mark Haefele, Vincent Heaney, Jon Gordon, Patricia Lui
The content is a product of the Chief Investment Office (CIO).
Original Report – Stocks fall as concerns over rising rates add to market uncertainty, March 11, 2022.