21-02-2022
George Lucas, Raiz Group CEO
Fear is being stoked in financial markets by two factors right now: the prospect of aggressive policy tightening from major central banks; and the risk of a war between Russia and Ukraine.
Unfortunately, neither the crisis in Ukraine nor aggressive tightening from central banks has a direct parallel in recent memory, and there remains a lot of uncertainty around both.
Adding to the complex picture is that neither issue will likely be resolved by March, and so the usual seasonal reduction in liquidity in March may result in the market sell-off intensifying during March.
S&P 500 correction continues
Just focusing on US markets, as we do in these situations, the S&P 500 is down almost 9 per cent for the year, after hitting a record high in January, while the Nasdaq has shed 13.4 per cent.
This is now the largest correction in the US since the panic in March 2020 and approaches the scale of the late 2018 sell-off, which was also driven by concerns about the pace of monetary tightening.
On drivers: it is difficult to disentangle exactly how much of the sell-off is due to fears around the Russia-Ukraine situation, and how much is due to more hawkish rhetoric from the US Federal Reserve, and other major central banks.
The impact of Ukraine crisis is clearly in commodity markets, for instance looking at the price of oil and energy. Brent oil is now trading around US$93 — thus stoking the fears of inflation — and would probably go higher if an invasion were to proceed.
More inflation is exactly what hawkish central bankers fear, pushing up expectations of future rate rises and the faster removal of quantitative easing. This, in my view, is probably the dominant contributor in relation to the current S&P 500 correction.
Global stocks outside US still robust
Outside the US, so far equities in the rest of the world have, in aggregate, held up; although this relative performance might shift if the situation in Ukraine escalates. That’s because the rest of the world, especially Europe, is more directly exposed to the economic effects of a Ukraine conflict.
As investors, the problem we face is that policymakers are likely to remain focused on inflation, which would probably rise further if a conflict broke out. So, the interplay of these two uncertainties — central bank hawkishness and the Ukraine conflict – is potentially a toxic relationship ahead.
Fortunately, Australian, Indonesian and Malaysian stock markets — and their economies — have a high exposure to commodity prices and a low exposure to tech so this part of the world may be insulated somewhat to potential upheavals on the horizon.
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