Market Insights - February 7, 2022

Most of the Japanese companies that have published their earnings for Q3 of the fiscal year have so far delivered positive surprises. In addition, share buybacks are now back above pre-pandemic levels after falling briefly in 2021. 

In response to the surge in inflation, the Bank of England once again raised interest rates, from 0.25% to 0.50%. Despite this, pound sterling failed to gain ground against the euro because the European Central Bank (ECB) also released a statement about its plans to tighten monetary policy. 

Some 60% of S&P 500 companies have now published their quarterly earnings. The figures are good, with three quarters beating consensus estimates. However, they did so by less than in previous quarters, a sign that expectations are riding high. Volatility is therefore still strong, especially for companies that aren’t able to deliver any positive surprises.

Monetary policy changes course around the globe

Inflation is still a cause for concern. Early on in the supply chain, commodities prices continue to head upwards. On top of that, supply chains are likely to remain disrupted, as the spread of Omicron means that an ever-increasing number of workers are absent.

With both consumer spending and capex bouncing back sharply, companies have been able to pass on some or all of the increase in cost prices to their end-customers. This, in turn, has led to a steep rise in consumer prices.

The situation is particularly critical in the States: not only is inflation still surging, but wages are increasing too. This could lead to a second round of price rises on goods and services, triggering a wage-price spiral. Average hourly wages were up 5.7% year on year in January, a rate not seen in 15 years. In response, the Fed has decided to tighten its monetary policy. It started by tapering its asset purchases and will very soon begin raising interest rates. It looks like there will be an initial rate hike the next time the Fed meets, on 15 and 16 March.

The ECB’s change in tone last week also came as a surprise. Like the Fed, it is having to deal with unexpectedly strong and persistent inflation and now wants to prepare the market for some policy tightening, with an initial rate hike currently expected before the end of the year.

As a result, bond yields at last seem to be picking up pretty much across the board. The era of negative interest rates is coming to an end, at least on long-term paper. Ten-year German and Swiss yields were the last to move back into positive territory and now stand at 0.2%. Few bond market segments will escape this upward pressure.

We therefore recommend avoiding long-term bonds, which are more sensitive to interest rates, and even investing in floating-rate US-dollar-denominated bonds, which will be boosted by rising short-term interest rates.

We think that Chinese bonds in local currency are an attractive investment, mainly because China’s monetary policy is not in step with that of the Fed and the ECB.

Commodities – strong fundamentals

Commodities are continuing their bull run. Economic growth remains strong despite the renewed rise in COVID-19 infections, and demand in many segments is poised to surpass the highs reached in 2019. Supplies are still limited and output deficits are deepening, which often causes inventories to fall below their long-run averages.

Investors are currently focusing on the energy sector and on oil in particular. Oil prices have risen sharply and continuously this year, and a consolidation would be welcome in the short term, given how bullish investors are. Any dip would be an investment opportunity, since there are some major imbalances in the market.

In terms of demand, the Omicron variant appears to have had only a limited impact on travel. In terms of supply, inventories are getting close to levels last seen before the shale oil rush, when the price per barrel rose above USD 100. Any real improvement on the supply side appears unlikely, since exploration budgets and the number of new wells are 35% and 52%, respectively, below 2019 levels. As clean energies are not yet capable of meeting global supply needs, we believe energy prices will remain high in order to balance out supply and demand.

Gold prices, however, have been sluggish. Investors are simply not interested in this precious metal, which has recorded no net capital inflows since the end of Q1 2021. Gold did show some resilience when interest rates picked up recently, which offers some hope, as does the fact that gold tends to fare well in the first quarter of the year.