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Market Insights – February 28, 2022

Each week, our Investment team shares its market views with you !

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Essentials

Oil prices continued to rise, ending last week on a recent high. The increase has been fairly steady, since none of the parties to the conflict wants to stop the flow of gas and oil from Russia to Europe for the moment. 

Eurozone bank stocks have been hit particularly hard by the rise in geopolitical uncertainty surrounding Ukraine.  This should be a short-lived trend, but we still think it’s too early to increase exposure to that sector, which will continue to be weighed down by the sanctions against Russia and by a potential economic downtrend. Among financials, our tactical preference is for insurance companies. 

The value of Russian assets has plummeted as a result of the sanctions imposed by Western governments in response to the invasion of Ukraine. However, other emerging markets have not yet been affected. The Russian stock exchange makes up less than 2% of the emerging-market index – by far the smallest weighting among the BRIC countries (Brazil, Russia, India and China).

War in Ukraine – central banks may bide their time

Over the past few days, Ukraine has become the setting of an all-out war. And the way things stand, it may sadly be a prolonged conflict. It’s difficult to imagine the two sides coming to a truce anytime soon, given that Russia is far from achieving its main aim of overthrowing the Ukrainian government. Even though Ukraine’s army is outgunned and outmanned by Russia’s, it doesn’t look ready to lay down its weapons just yet.

Western countries have so far been firm in ruling out the possibility of any direct involvement in the conflict. But they have ramped up their financial and economic sanctions, targeting the Kremlin’s finances and those of Russia’s elite. It’s hard to tell whether these measures will swiftly dull Putin’s determination or erode his public support. But Russia is already feeling these sanctions, especially those aimed at its central bank and wider banking system.

The rouble has crashed, as have most Russian financial assets listed on the Moscow exchange and the international markets. The world’s major central banks are no doubt keeping a close eye on the impact that the West’s strategy is having on the financial markets. In addition to heightened stock market volatility, we’ve also seen early signs of tension on the money and interbank markets, although there’s no cause for alarm at this stage.

The US Federal Reserve (Fed) and the European Central Bank should be ready to inject more liquidity into the financial system if the markets drop sharply. Generally speaking, the major central banks should be much more cautious than previously expected while the conflict lasts. Given the sharp rise in inflation in the States, the Fed is unlikely to go back on its decision to begin tightening monetary policy soon, especially since the US economy is showing signs of picking up again now that Omicron infections have dropped off.

But at its mid-March meeting, the Fed could raise rates by less than expected – we might see a 0.25% hike instead of the 0.50% forecast a few weeks ago. After experiencing a lot of upward pressure at the start of the year, long-term interest rates could also cool off. As stock markets are looking to bottom out, volatility is likely to remain in the short term, but it is more likely to be triggered by geopolitical developments than by interest rate trends.

 

USA – valuations still aren't attractive enough

At our investment strategy meeting in January, we spoke about how excessively high US stock valuations had weighed on the market’s performance in 2021, and we decided to underweight that region in our asset allocation.

Just two months later, and US multiples have dropped across the board, mainly because of the Fed’s upcoming tightening – stubborn inflation has convinced Jerome Powell to bring an end to this long period of ultra-loose monetary policy. As a result, the stock market has struggled since the start of the year.

This is particularly true for growth stocks that had been buoyed by the pandemic and by the ensuing lockdowns and rise in remote working and whose valuations had hit unreasonably high levels.

The geopolitical crisis in Ukraine has caused US stock valuations to return to normal more quickly than expected. The S&P 500 average price/earnings ratio has gone from 22x to 19x, and sentiment indicators are in extremely bearish territory. So is now the time to increase our exposure to US equities? We think it’s still too early, given the total lack of visibility about how the situation in Ukraine will pan out in the short term and about how it will impact global economic growth.

What’s more, at 19x forward earnings, we still don’t think that multiples are aligned with the current environment of rising interest rates. If stock prices continue to return to normal, we will have to start thinking about whether to increase our exposure to the US market, especially if geopolitical tensions subside.

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