Fear, Uncertainty and Doubt

Chief Investment Officer's team
18 May 2022
Last week was extremely volatile -again- and overall negative for most markets…

AT A GLANCE

  • Last week was extremely volatile -again- and overall negative for most markets…
  • … With market participants now acknowledging a perfect storm on inflation, policy, and growth
  • The short-term remains totally unpredictable, but we remain reasonably confident for the medium-term

Last week was another negative one for most markets, as participants are finally taking into account the harsh reality of a backdrop combining high inflation, radical monetary tightening and inevitably, risks to economic growth. Cyclical assets lost another -2 to -3% across regions, and defensive assets did not shine, with gold correcting by almost -4%, now negative year-to-date. The fixed income universe was to some extent supported by risk aversion, with the safest segments being close to flat over the week. Crypto assets tumbled, which probably had some contagion effect on US stock markets. Fear, Uncertainty and Doubt dominate.

Let’s start with the bad news. Even after a -20% correction on major risk markets, behavioral indicators are not in full panic territory, and if valuation metrics are reasonable, they are not a “no brainer” bargain. There is an unanswered multi-trillion dollar question: will the Fed be able to effectively fight inflation, without ruining the economic recovery? Adding the war in Ukraine and China’s concerns to the picture, the jury is out and will remain so for months. It means that the short-term is absolutely unpredictable.

There are however reasons to be confident in the medium-term. First, a -mild- recession in the world’s largest economies is possible, but it wouldn’t necessarily be a nightmare for markets. It would calm down inflation for sure and reverse policy responses, and it is arguably at least partially priced-in by some markets. Second, the behavior of interest rates and inflation expectations interestingly suggest that we may approach the perception of “peak hawkishness” from central banks. This is not a catalyst in itself, but it’s better than the opposite. We thus have kept our positioning unchanged. Stay safe.

Cross-asset Update

Psychology has always been a key factor affecting investment decisions. At the January market top sentiment was very bullish in spite of sky-high valuations and of some seasoned investors, like GMO’s founder Jeremy Grantham and hedge fund manager Ray Dalio, having made calls of market bubbles for some time. Who could, after all, have suspected that all that could go wrong would indeed go wrong in the subsequent few months? After a five-month fall, investor mood has finally turned and commentaries of more downside are rife. Indeed, in the good old times at current levels, with equity valuations back at the historical averages and a fall of at least 20% on the major indices, one would have bought the large dip trusting that some form of stimulus measure or the other would have saved the day. And, isn’t it true that such a drop without a recession in sight is a great buying opportunity?

A major bottom is in place not only when there is complete capitulation, for now still absent, but also when all of the bad news is out. As for capitulation, we should maybe expect US equity volatility to reach above 40%, which it did for instance both in early 2018 and in August 2015, even as central banks had investors’ back. But now they don’t, so shouldn’t we be trusting to buy the market only when sentiment sours further, as a safety net is no longer there? As for future bad news still lurking somewhere and waiting to spring to the fore, there is plenty of choice. Inflation is squeezing US consumer confidence, now at recessionary levels, hence neither retail sales nor unemployment should be able to hold at current levels. The Fed’s tightening process still represents a question mark as to the effects of the run-off of the Fed’s balance sheet on markets, considering that the past two episodes of Quantitative Tightening did not end well. China slowdown is developing harsher contours and will affect the global cycle. In summary, we would not sound the all-clear for a major bottom to be in place.

Yet, conditions for a forceful rebound seem to be in place. Market breadth, measuring the degree of investor participation in a market movement, has fallen to levels that in the past saw risk assets react positively. US inflation seems to have peaked, so treasury yields should be capped from here. Although China yesterday reported terrible data, Shanghai is aiming for return to normal life as per official statements by the central authorities. Oversold technical market conditions, US yields and the Chinese outlook should provide the triggers for a rally, still be a bear market one until we get more reassured on the above-mentioned fronts.

Meantime, investors can put money to work but with an eye to downside risks. The potential for gains in equities should for now be more relative than absolute, and investing in high-dividend yielding stocks would be offering some downside protection. On the other hand, peaking bond yields imply that IG bonds are now more appealing and offer some absolute upside potential as well.



Fixed Income Update

The latest bout of bond price movements and macro data releases could mean that we are at the cusp of two types of risk. While markets get more convinced about the peaking the US Treasury yields, thus reducing the interest rate risks, the recent fears of slowdown and recession could indicate that we may be moving on to a credit risk scenario. We had mentioned earlier in our publications that increasing rates could make certain sections of the high yield market vulnerable to refinancing risks leading to an increase in defaults. The record bond issuances in 2020 and 2021 and the resultant decrease in short-term liability insulate the high yield issuers to a large extent for 2022 and the first half of 2023. If the Fed is successful in moderating demand, this could hit the toplines of the issuers leading to a double whammy for the lowly rated B and CCC issuers. While high yield spreads in the developed world have widened YTD significantly, this is not the time to go overweight in the segment. We want to give the clarion call to "Go Up in Quality" within fixed income portfolios for the first time since Q2 2020. The recent sell-off comes as a blessing for investors willing to take a plunge. Tons of short-duration BB-rated bonds are available at attractive yields. This is our preferred segment within High Yield. Doing proper due diligence on cash flow versus EBITDA, working capital conversion cycle, and other leverage and coverage indicators will save investors a lot of heartache in the future.

With treasury yields sliding last week, some segments such as the US Treasuries, Euro-denominated Investment Grade corps, EM Sovereign and GCC Debt posted positive returns ranging from +0.4% to +0.8%. On the other hand, emerging Market Corporate and US High Yield had negative weekly returns due to widening spreads as investors get cautious about credit risk. Asia High Yield was the worst-performing segment yet again due to Sunac missing its grace period for payments. Since March, we had turned very cautious in this segment mainly due to two factors. The first one is the non-declaration of audited FY 2021 results by 40% of the players and decreasing quarterly home sales despite the banks' efforts to loosen lending policy. We believe it will be a long road to recovery for the segment unless we see some bi- bang reforms from the govt and monetary authorities in China.

GCC bond returns, especially in the investment-grade space, were positive due to the movement in the yields. The spreads did increase slightly. However, high yield continued to trade weakly, indicating the risk-off nature of the market. Egypt and Turkey continued to trade weak due to worsening macro backdrops. Egypt bonds' fate remains closely tied to the IMF deal, while Turkey needs to stabilize its currency while gaining the upper hand on inflation which is a challenging task for a central bank that is reluctant to increase rates.


Equity Update

The Fed hiked by 50 bps in May with 2 more on the way, and India and the UK are also in synch on monetary policy. The ECB should follow suit later in the year. Inflation at 40-year highs and economic growth slowing with talks of a recession a year down, has led to global equities falling for a 6th straight week. Last week’s 2% fall has YTD equity performance at -16%, with Developed Market equities just slightly better than Emerging Markets. The selloff widened as the outperformers so far, the GCC and Indian equities fell over 5% last week, the latter as inflation over the target range led to an unscheduled rate hike. The unappealing growth-inflation policy mix, probably set to continue till year end, is keeping volatility high across all regions. Europe’s economy is worse affected as the war in Ukraine is at a stalemate, while Asia economies are exposed to the ongoing COVID-19 lockdowns in China. Defensive sectors are in favour globally with consumer staples and healthcare outperforming last week. Do equity prices now more or less reflect the worsening macro-outlook and the hawkish Fed? Valuations are lower for most regions and sectors than historical averages.

Markets may see a rally from oversold levels as Q1 corporate earnings have been stellar and margins have held up, reflecting the ability to pass rising costs onto customers. In the US we still see a buoyant jobs market and strong consumer even as concern over inflation and rising mortgage rates builds. However, we remain cognizant of the very high inflation numbers and guidance from corporates around supply chains constraining production, hence expect rallies to be short lived and equities range bound near term. Food and fuel inflation are key but housing rents, 30 – 40% of the core and headline baskets, are rising faster than at any time since 2006 in the US. European car manufacturers have spoken of essential components shortage from Ukraine. Stellantis CEO said its target to sell only EV’s in Europe by the end of this decade depends on fixing supply-chain problems and if the EU ensures access to enough clean energy, batteries, raw materials and charging infrastructure.

Saudi Aramco, the world’s largest oil producer, has overtaken Apple as the world’s most valuable company. It showed stellar Q1 results, with net income of $39.5bn, an 82% rise on a year ago and in line with oil price gains. Plenty of cash for capex. The UAE and KSA markets gave up some of their gains last week, but are still very much positive for the year with both the Dubai and Abu Dhabi indexes over +10%YTD. Dubai’s residential market sales in April are up 36% y/y propped by off-plan and ready-unit sales reflected in the real estate sector rally.

JP Morgan upgraded the China tech sector as they feel ’significant uncertainties facing the sector should begin to abate on the back of recent regulatory announcements,” The Nasdaq Golden Dragon Index whilst it recovered last week is still down 30% YTD, close to the Nasdaq’s 25% YTD drop. Growth sectors continue to sell off on the higher Treasury 10-year yield. Twitter shares fell as Elon Musk looks into fake/spam accounts which he estimates at 20%, much higher than the 5% earlier disclosed and this could affect his $44bn takeover bid.



Written by:
Emirates NBD Bank PJSC (“Emirates NBD”) is licensed and regulated by the UAE Central Bank and this website aims at providing Internet users with information concerning Emirates NBD Private Banking, its products and activities. Persons having access to information made available by Emirates NBD on this website accept the following rules:

Reliance:
Emirates NBD uses reasonable efforts to obtain information from sources which it believes to be reliable, however Emirates NBD makes no representation that the information or opinions contained in publications on this website are accurate, reliable or complete. Published information may include data/information from stock exchanges and other sources from around the world and Emirates NBD does not guarantee the sequence, accuracy, completeness, or timeliness of information contained on this website provided thereto by unaffiliated third parties. Anyone proposing to rely on or use the information contained on this website should independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professionals or experts. Further, references to any financial instrument or investment product are not intended to imply that an actual trading market exists for such instrument or product. Emirates NBD is not acting in the capacity of a fiduciary or financial advisor. Any publications on this website are provided for informational purposes only and are not intended for trading purposes. Data/information provided herein is intended to serve for illustrative purposes and is not designed to initiate or conclude any transaction. The information available on this website is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. This website and anything contained herein, is provided "as is" and "as available," and that Emirates NBD makes no warranty of any kind, express or implied, as to this website, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Modifications:
The provision of certain data/information on this website is subject to the terms and conditions of other agreements to which Emirates NBD is a party. Emirates NBD reserves the right to make changes and additions to the information provided at any time without prior notice. The information may be modified or removed without prior notice. No buy or sell orders submitted via the internet or email will be accepted. In addition, the data/information contained on this website is prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors relevant to the determination of whether a particular investment activity is advisable.

Liability:
Information contained on this website is believed by Emirates NBD to be accurate and true, in all material respects. Emirates NBD accepts no responsibility whatsoever for any loss or damage caused by any act or omission taken as a result of the information contained on this website. Further Emirates NBD accepts no liability for the information and opinions published on the website and is under no obligation to remove outdated information from its website or to mark it clearly as such. The information given on this website may not be distributed or forwarded in whole or in part. Accordingly, anything to the contrary herein set forth notwithstanding, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from the information available on this website including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. or (c) under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of the information on this website, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business. Emirates NBD expressly accepts no liability for losses or damages of any kind arising from using or accessing this website or links to third-party websites or from viewing information on any of its web pages. Furthermore, Emirates NBD accepts no liability for any unauthorized manipulation of users IT systems. Emirates NBD expressly draws user’s attention to the risk of viruses and the threat of hacker attacks

Third Party Website:
Users may be aware that Emirates NBD has no control whatsoever over third-party websites linked to or from this website and therefore accepts no liability for the content of such websites being correct, complete and legally valid for the products and services offered on such websites. Emirates NBD’s express written permission must always be sought before including a link to this website on a third-party website.

Solicitation:
None of the information on this website in any way constitutes a solicitation, offer, opinion, or recommendation by Emirates NBD to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment.

Forward Looking:
The information contained on this website does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication on the website are about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Undue reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.

Risk: In addition, before entering into any transaction, the risks should be fully understood and a determination made as to whether a transaction is appropriate given the person’s investment objectives, financial and operational resources, experiences and other relevant circumstances. The obligations relating to a particular transaction (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk should be known as well as any regulatory requirements and restrictions applicable thereto. Data included on this website may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records.

Investment in financial instruments involves risks and returns may vary. Before making such an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment.

Intellectual property:
The information on this website has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and all present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties and you acknowledge that you have no ownership rights in and to any of such items. Except as specifically permitted in writing, the information provided in this website shall not be copied or make any use of any information on this website or any portion of the intellectual property rights connected with this website, or the names of any individual participant in, or contributor to, the content of this website, or any variations or derivatives thereof, for any purpose. Further you shall not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you or, except as otherwise provided with Emirates NBD’s prior written consent,

Confidentiality:
The information on this website solely for non-commercial use and benefit and the use of this information is not intended for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. Information contained in this website shall not be used, transferred, distributed, reproduced, published, displayed, modified, create derivative works from any data contained on this website or disposed of in any manner that could compete with the business interests of Emirates NBD. Any part of this website may not be offered for sale or distribute it over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet without the prior written consent of Emirates NBD. The information contained on this website may not be used to construct a database of any kind. The data on this website shall not be used in any way to improve the quality of any data sold or contributed by you to any third party.

Recipient Acknowledgements
In accessing this website, you acknowledge and agree that there are risks associated with investment activities. Moreover, you agree that your use of this publication is at your sole risk and acknowledge that the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described on this website and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with you.

Emirates NBD Bank (P.J.S.C.) is licensed by the Securities & Commodities Authority and subject to regulation, supervision and control of the Authority.
Head Office : Baniyas Road, Deira, PO Box 777, Dubai, UAE