Navigating in low visibility

Chief Investment Officer's team
12 April 2022
Share
The FOMC minutes confirmed an accelerated tightening, sending shockwaves across markets

AT A GLANCE

  • The FOMC minutes confirmed an accelerated tightening, sending shockwaves across markets
  • The war in Ukraine and a resilient covid in China also add to uncertainty
  • We will review our 2022 central scenario, but also note that valuations have improved

Volatility remains the name of the game this year, and last week was no exception. The minutes of the March FOMC meeting confirmed support for at least one 50-basis-points hike and for a possibly imminent start of the balance-sheet runoff. This took a toll on markets, starting with long duration assets such as government bonds and growth stocks. The levels of interest rates are impressive compared to their recent history, with the US 10-year Treasury yielding 2.77% as we write. Uncertainty is also exacerbated by the war in Ukraine and a still large Omicron drag in China. Gold was the only positive asset class last week, and the situation is similar on a year-to-date timeline.

We will hold our monthly tactical asset allocation committee this week. We will change our central scenario for the year, around the accelerated tightening from Western central banks and the amplifying effects of the war on a backdrop combining slowing growth with rising inflation. At this stage we keep on thinking that global growth is dented rather than derailed, but uncertainty should remain extreme. The good news is that so far the global expansion is resilient, and that valuations have improved in many asset classes.

This week is all about inflation. March numbers were just released in China, and they slightly exceeded expectations for both consumer and factory prices – the former however remains very contained there with only +1.5% year-on-year. The picture should be very different in the US, where the March CPI, released Tuesday, is expected to exceed +8% over 12 months. The earnings season will also kick off with US financials. Most Western markets will be closed on Friday for Easter weekend, and the ECB will meet on Thursday. Stay safe.

Cross-asset Update

From above-trend growth to recession concerns is a big leap, yet we have got here as it was also a big leap from all-out stimulus and temporary inflation to a steep tightening cycle and not-so-temporary price pressures. While the probability of the economy contracting this year has increased, it not in the United States that one should look to for such an occurrence, but rather Europe, due to war spill-overs. While in China, if the authorities insist on zero-covid policies and mismanage stimulus, the soft patch could turn into something harsher. Two quarters of back-to-back negative growth should not be a big deal, in a year where headwinds are plentiful to say the least. Historically, the six months before the mid-term elections have been the weakest in the four-year presidential cycle showing up in US equity returns since records are available, and this time negative seasonality comes alongside steep tightening, inflation at multi-decade highs and a war. But given negative real rates and a strong labor market, the US economy should only go through a slowdown phase. Q2 could be the worst quarter, if projections of services recovery from the covid crisis are correct.

In the euro area life is not that easy, though. In its worst-case scenario the ECB has projected real GDP at 2.3% at year-end, which either means super-flat growth throughout 2022, or a contraction at one point. Exposure to Russian trade, the energy shock and deteriorating confidence would be driving the downturn. Uncertainty remains high, but considering how enthusiastically European leaders are embracing the prospect for future hardship for the sake of stopping Putin, the worst case could easily become the base case. In China achieving growth above 5% would have implied no covid lockdowns in 2022 and starting meaningful stimulus much earlier. It could be very difficult now for infrastructure investments to drive a sustainable up-trend in growth, considering the poor conditions of the real estate sector, accounting for one quarter of GDP.

Now, paradoxically, Fed officials must be hoping that Europe grinds to a halt and China struggles further. This way, the negative spill-over effects from overseas plus the planned removal of stimulus would manage to curb aggregate demand in the United States, avoiding a Fed-induced recession due to overtightening. And while Jay Powell looks forward to receiving some help from the other struggling economies, the tightening of financial conditions to be yet achieved remains so significant, that, “If Stocks Don’t Fall, the Fed Needs to Force Them”, as ex Fed vice chair Bill Dudley wrote on his Bloomberg column.

Once the Fed was enticing investors to buy the dips, now they are suggesting that rallies be faded, and we hold the view that only selective dips should be bought. Financial conditions have not yet tightened enough to warrant much risk taking.



Fixed Income Update

The March FOMC meeting minutes released last week set the cat among the pigeons. The post-minutes market reaction saw a sharp sell-off US Treasuries with a steepening of the curve. The 10-year yields increased by more than 30 bps last week. Moreover, there were a lot of details mentioned about the Quantitative Tightening plan. The max run-off rate will be at $95bn, and the phase-in period will be three months starting from May. As mentioned in the last weekly, this is a much faster pace than the previous 2017-19 cycle. The markets currently price in nine rate hikes in the next six meetings till the end of the year, and the terminal rate currently priced in is 3%. We believe we are very near peak hawkishness, and it might be a good idea to lock in some of that attractive yield available now. Moreover, the March hawkish pivot of Powell & Co forces us to relook at our year-end fair values.

All the long-duration assets were poorly affected due to the rates sell-off. US Treasuries lost 1.6% while EM Debt lost 2.2% last week and took over the dubious mantle for the worst-performing segment within Fixed Income from Asia HY, which rallied by 0.3%. The rally in Asia HY is not driven by fundamentals but is a relief rally. Big institutions have pulled out money from the segment during this rally. In March alone, there was an outflow of $400mn from the segment. So, investors should be cautious while bottom fishing in the segment.

The credit sell-off presents us with several opportunities to put new money to work. We finally have some respectable yields in various parts of the asset class. We highlight four such opportunities that are i) locking in short term yields – The 3-5 year part of the UST yield curve is approaching multi-decade highs, and with spreads relatively wider to the start of the year, investors can look to locking short duration yields in solid credits, ii) Subordinated bank debt – moving down the capital structure of banks offers an attractive opportunity for investors looking to secure yield in quality papers, iii) Floating rate instruments should generate positive returns if the Fed can move forward with its tightening plan and iv) Asia USD IG debt currently offers an attractive 250 bps+ spread for the 5-10 year duration papers. The area we would avoid adding is long-duration High Yield. We anticipate spreads to widen from current levels as we are at peak quality in High Yield. In addition, historically, a flat yield curve cautions against high-yield as they have underperformed treasuries on average when the yield curve inverts.

GCC spreads look quite tight and returns from current levels will be driven by duration and UST yield movements. In spread terms, up to 5yr maturity of IG names widened by 5bps and on the long end tightened by 10-13bps w/w. On high yield names, Oman traded soft for the week – down by about 0.875c on the long end of the curve specifically. Away from GCC, talks of Turkey's sovereign bonds' inclusion in credit indexes helped boost flows on the name.


Equity Update

After 3 weeks of gains, global equities fell 1.5% last week with inflation at decade highs, raising concerns that a more aggressive monetary tightening cycle will affect global growth and corporate profits. The US Treasury 2s 10s temporary yield curve inversion continues to be a key focus as it is indicative of recession. And US equity performance as per statistics is positive the first year following a yield curve inversion. Economic data points to slower but not negative growth. Recent PMIs and the labour market remain strong in most economies. However oil and food prices will meaningfully impact consumer spending. Food is 17% of the consumer basket in DM and upto 40% in emerging economies. It’s not the same everywhere, with Europe more affected than the rest of the world by gas and oil supply issues from Ukraine/Russia. European economic growth downgrades lead at almost double the rest of the world. Many Middle East countries depend on wheat and sunflower oil from Russia/ Ukraine.

Profit expectations were muted for Q1 and Q2 to start with and analysts are still hopeful of a resolution to the Russian invasion of Ukraine and improvements in the supply chain. However, key supply hubs such as China still have Omnicron and other Covid variants at play. It’s also the start of demand destruction as rising prices are reducing purchasing power.

Equity markets are now showing longer streaks of gains and losses but volatility remains high. Our positioning is mildly constructive with a preference for the US and energy exporters, the GCC and the LATAM countries. The latter continue to add to positive year to date gains now approaching over 20%. GCC corporates have also grown dividends and income remains one of the best investment strategies in an inflationary environment. New issuance from the UAE has been received well and the DEWA IPO as per reports had 37X orders for the number of shares offered. Whilst we are neutral India as we were concerned about the impact of higher oil prices, Indian equities continue to outperform.

There are still plenty of tailwinds for equity performance however earning growth has a straight beta to economic growth. As per FactSet, for the S&P 500 for 2022, analysts are projecting earnings growth of 9.8% and revenue growth of 9.5%. For Q1 2022, the estimated earnings growth rate is 4.5% revised down from 5.7% as at end Dec. However, as some costs are being passed onto consumers revenue growth expectations have been revised up to 10.7%, compared to 9.7% as at end December. Estimated Net profit margin of 12.1% for Q1 is lower than the year before which was 12.8%. Labor costs and shortages are expected to be mentioned frequently in guidance. Over the past five years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 8.9% on average, so a reasonable 5% upside to the current 4.5% would indicate a 10% Q1 EPS growth. This week sees the big banks reporting including Citigroup, JPMorgan and Wells Fargo and profits are expected to be impacted by a reinstatement of provisions. Q1 2021 had seen a reversal of Q1 2020 pandemic provisions. Lending growth data will be closely watched as consumers face high inflation and reduced support from fiscal stimulus.



Written by:
Download PDF
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
Share or Bookmark the news

Next Up

Emirates NBD on Social
You are currently browsing

Personal Banking

Personal Banking
Other segments

Products

Products

About us

About us

Helpful links

Helpful links

Customer support

Customer support

Download our apps

Download our Mobile App

Bank securely anytime and from anywhere

Download our more App

More fun, more rewards

Copyright © 2023

Emirates NBD Bank (P.J.S.C.) is licensed by the Central Bank of the UAE, Baniyas Road, Deira, P.O. Box: 777, Dubai, UAE

Emirates NBD