High Asset

Ameriprise Financial : Investors Search for Safe-Haven Assets as Global Markets Continue

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Investors continue to struggle with discounting fast-moving developments surrounding Russia’s war on Ukraine and the still undetermined impacts that Western sanctions placed on Russia will have on the global economy over time. The Dow Jones Industrials Average closed lower by 1.3% last week, capping its fourth consecutive weekly decline. The S&P 500 Index also finished the week down 1.3%, while the NASDAQ Composite ended lower by 2.8%.

Russia’s invasion of Ukraine dominated headlines and drove sentiment lower all week. As a result, investor sentiment (as measured by the American Association of Individual Investors and Investors Intelligence) remains well below its historical average, particularly in the face of elevated geopolitical tensions, declining growth forecasts, and the expectation the Federal Reserve will likely raise interest rates at its scheduled March 16th meeting.

Notably, hopes for a quick resolution to the Russia/Ukraine war were quickly dashed during the week, as fighting intensified and Russian troops seized control of areas in Ukraine, including its largest nuclear power facility. West Texas Intermediate (WTI) crude surged roughly +26.0% last week on tightening oil supply that the developments in Eastern Europe have exasperated. Due to legal, moral or reputational hazards, market participants are simply avoiding Russian oil at the moment. Most analysts believe energy conservation tactics, increased production out of Saudi Arabia/UAE/U.S., and an Iran nuclear deal are needed to bring more oil supply into the market to help ease the upward price pressures.

With oil prices surging, Energy stocks rose over +9.0% on the week, followed by Utilities (+4.8) and Real Estate (+2.1%). As a result of the risk-off mood among investors, the 10-year U.S. Treasury yield declined by 11 basis points to 1.73%. The dip in yields last week sent Finacial stocks lower by nearly 5.0%, with large money-center banks seeing even steeper declines. The 10-year yield has now retraced some of its gains and is currently back to late-January levels. In our view, the decline in yields since Russia’s invasion of Ukraine is a direct reflection of more investors seeking safety in high-quality government bonds until economic impacts can be more widely understood.

On that point, below are a few considerations to keep in mind as Russia/Ukraine developments continue to unfold:

  • In our view, it remains highly unlikely the conflict in Ukraine will spill outside its borders. However, Russia appears determined to control Ukraine, which may mean the war will worsen before it gets better. Importantly, we do not believe NATO nations will become directly involved in the conflict, which should help de-escalate geopolitical tensions over time. Russia’s response to Western sanctions, however, remains a wildcard.
  • The humanitarian fallout is likely to intensify over the coming days and weeks. 1.5 million Ukrainians have already fled the country. Neighboring European countries, such as Poland, will need increased NATO support and relief funding to help relocate and care for refugees.
  • Global supply chains may need more time to adjust, which could cause increased disruptions for a while. Though Russian energy is not directly targeted in Western sanctions at this time, there has already been a great deal of displacement in the market. Higher commodity prices have begun to reflect the possibility of an energy crisis in Europe, and the potential Western sanctions will soon target Russian oil and natural gas. Notably, the U.S. is now considering a Russian energy embargo. As a result, we expect global growth forecasts for this year to come down. The war in Ukraine has also begun to disrupt the planting season for wheat and corn. Since Russia’s invasion of Ukraine, wheat prices are higher by roughly +25.0%, and corn prices are up +13.0%. And while most of the wheat and corn exported by Russia and Ukraine go to emerging market countries, Americans can expect higher food prices to continue, as commodities are priced in a global market.

At Home, Investors Are Starting to Ask:Will Higher Commodity Prices Lead to a U.S. Recession?

With crude oil prices higher by over +60% this year, the recession question is an important one to consider. In our view, higher commodity prices alone do not cause recessions, but they can be associated with downturns in the economy.

Today, the U.S. economy sits on firm ground, supported by a strong labor market, healthy consumer balance sheets, and growing corporate profits. However, higher energy prices can threaten consumer spending, causing them to retrench in other discretionary areas, particularly among lower-wage earners.

And while visions of the 1970s and 2001 recessions may come to mind, as energy prices were climbing in those periods, those eras were marked by other more influential factors that contributed to the U.S. economy’s downturn.

Notably, there are several other periods in history where commodity prices have climbed aggressively, but a recession did not form over the next 6-12 months. With that said, Bespoke Investment Group recently noted that commodity price growth of 60% or more is consistent with a roughly one-in-three chance of a recession over the next 12 months going back to the late 1960s.

In our view, a critical factor to consider around higher energy prices and the threat of recession comes from Fed policy reactions. If higher energy prices prompt the Fed to tighten monetary policies more aggressively than they otherwise would, the danger of a recession grows. While the Fed currently appears to be on a path to tightening policy/raising interest rates, our view at the moment is that the committee is very sensitive to growth impacts. As such, we believe the Fed is likely to exclude energy-related inflation (due to pandemic/geopolitical conflict) from other inflation pressures impacting the economy when forming its policy decisions. In doing so, we see the risk of the Fed tightening too aggressively and choking off economic growth as a low probability at the moment – even considering the rapid rise in commodity inflation.

A Bright Spot in an Uncertain Environment: The U.S. Labor Market; Investors Seek Ways to be Contrarian

Looking ahead, investors are likely to seek confirmation that the strong labor market (note: the U.S. economy added an unexpectedly robust +678,000 jobs last month as the unemployment rate ticked down to a pandemic low of 3.8%) is translating into other consumer-orientated data. On the economic docket this week, January consumer credit and the JOLTS job openings reports should provide further insight into spending and labor conditions. However, February CPI and preliminary March University of Michigan sentiment reports should be the essential items to watch outside of geopolitical developments. FactSet estimates call for headline CPI to rise to +7.9% year-over-year from +7.5% previously. The month-over-month rate is also expected to increase, which could raise concerns that inflation pressures continue to exert a more significant burden on the consumer, particularly against a backdrop of surging energy and food prices.

Nevertheless, stock prices currently reflect a lot of negativity at the moment. With most broad stock averages already in a correction (down more than 10% from their highs) and many individual stocks in a bear market (down more than 20% from their highs), investors should be looking for opportunities to be contrarian. While downside pressures in the market are likely to persist over the near term, we believe longer-term stock prospects are improving as valuations come down. Patience, the proper perspective, and the ability to avoid reactionary investment decisions during periods of market stress are usually the right ingredients to weather increased market volatility. We believe such ingredients…

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