Economic Insights for March 2022

The following is our investment analysis for March 2022.  The market, at the moment, is largely shaped by the Russian invasion of Ukraine on the 24^th February, and the consequences of sanctions.  A regional conflict in Europe has an outsized impact on the market. 

At the moment, there is hope that peace talks will put a quick end to the conflict.  The Russian invasion has bogged down, and any hopes of a quick decapitation of the Ukrainian government has long passed.  Even then, this has had a serious impact on risk sentiment.  What is certain is that there will be continued sanctions by the West, and countries aligned with it.  This will make international trade complicated in the next several months, which would dampen hopes of a quick recovery to pre-pandemic levels. 

There are inflationary pressures caused by the spoke in energy costs, a direct result of sanctions.  This adds to concerns of a new variant virus which may lead to international closures.  Governments are also raising consumption taxes to address the costs of the economic shutdown.  These confluence of events have central banks on edge.  There is danger of a second round effect, chief of which is the wage-price spiral, a perpetual cycle where rising wages create rising prices and vice versa.  Ordinarily, central banks would use monetary policy, and fiscal policy to curb this.  This is not as effective when we are dealing with the effects of sanctions.  Russia was the largest energy supplier in the world, and the primary supplier of gas to Western Europe. 

In the meantime, China has been easing its monetary policy in tandem with a shift in Covid strategy from “Covid-zero” to “dynamic zero”.  China has recognised that a total lockdown is not an effective tradeoff.  Hong Kong is an example of the worst effects of this policy.  There is support from state-backed funds to buy China A shares, which are early signals of a sustained recovery. 

Monetary policy normalisation accelerated further, all over the world, in the first two months of 2022 with several key central banks announcing more interest rate hikes over a shorter time period than expected only a few months ago.  This was to address rising inflation.  On the other hand, China is in a different position.  Because of its Covid-zero strategy, there has been months of subpar economic activity.  The result is that consumer inflation is contained.  To address this, monetary and fiscal policies have been eased in order to stabilise investor sentiment and promote growth.  This is not enough, we expect more to be done.  The Chinese economy is still facing challenges.  They include regulatory uncertainty, macro-deleveraging and continued restrictions related to Covid-zero. 

Asset allocation decisions still remain as one of the largest drivers when determining the range of portfolio outcomes amid volatile markets.  The short term geopolitics and earnings revisions of Asian markets have started to look more favourable.  However, in light of the effects of sanctions against Russia, we need to keep a close eye on the market. 

Profit margins and returns on equity have continued to reach record highs for all markets, especially the United States.  The Treasury yield curve is unlikely to invert in the near term.  While inflation is a concern, the possibility of recession continues to recede.  As the year progresses, there should be an upturn in the market in the near term, and equities will start to outperform bonds, and start to gain in value. 

When it comes to equities, if the situation in Ukraine does not escalate, and spread, we should expect above-trend growth among major developed economies to continue, at least the first half of 2022.  This would supports the momentum earnings growth and would be more resilient against expected Federal Reserve hikes to equity valuation.  However, earnings growth is projected to slow down.  That being said, the earnings outlook of Asia excluding Japan companies improved.  They are projected to outperform developing markets.  China is expected to provide more policy support to bolster markets after the recent regulatory crackdown.  This also means a projected recovery of credit growth.  Further good news is the reopening of ASEAN economies amid accommodative monetary policies. 

Investment grade credit spreads have widened significantly over the last two months.  In mitigation, against their own histories, the spread moves remain tame.  We are in a rising rates environment.  As such, the performance of some of these bonds is likely to suffer.  In a sanctions environment, we do not expect material tightening of credit spreads from the current level.  Preference should be given Asian credit over US credit.  We have to consider the credit spread premium Asian credit against US credit, particularly against the backdrop of diverging monetary policy by key central banks in the West versus the People’s Bank of China. 

On Treasuries, we have to consider that the Federal Reserve’s new pivot to fighting inflation expectations means short rates will move upwards quicker than the long-end, causing the yield curve to flatten.  This is overdue, considering the high inflation.  However we do not see any inversion happening in 2022.  Over the medium horizon, we should expect higher rates volatility and weaker price performance.