Equities: New extremes and a challenging opportunity set
Discover insights on the future of equity markets in Q1 2024 and navigate the potential recession with strategic investment choices.
Summary: Russia launched multiple attacks on Ukraine overnight, hitting military targets with missiles in many parts of the country and launching what the Ukraine government is calling a full-scale invasion. The move shocked global markets, with equities in a nosedive, oil prices jumping over five dollars per barrel, and gold rising sharply. The inevitable heavy sanctions that Western powers will impose today could aggravate the risks of higher energy prices from here.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equity futures are extending lower this morning with S&P 500 futures trading around the 4,110 level taking US equities back to levels seen in May 2021. Equities are reacting to geopolitical risks and energy security concerns which could feed inflationary pressures even further. Where can we go in the S&P 500 Index? The pandemic selloff took S&P 500 29% below the 200-day moving average, so if we assume 21% selloff to this average if things escalate further the 3,500 level in S&P 500 is not unthinkable.
European equity markets – today it is all about gauging risks of energy and metals security for Europe and the three countries and equity markets that are the most vulnerable are the Netherlands, Germany and Italy so these markets should be watched today.
Hong Kong’s Hang Seng Index (HSI.I) & China A Shares’ CSI300 (000300.I). It was all about risk-off, following Russian’s attacks on Ukraine. Hang Sang Index fell 3.1%, breaking below 23,000 and Hang Seng Tech Index ((HSTECH.I) was down 4.3%. Large tech names fell over 5% across the board. Alibaba (09988) fell almost 7% to new low. The Company is reporting results today. Auto and Chinese property names declined in excess of 6%. Energy stocks traded in Hong Kong were steady to modestly higher. A-share oil, oil services and gold mining stocks surged more than 4%. CSI300 fell 1.3% by mid-day and was down 2.7% at the time of writing.
EURCHF and JPY crosses – the preferred safe havens for FX traders are the USD, JPY and CHF, with the JPY absorbing considerable strength overnight as the shock of the Russian move in Ukraine is seeing the market lowering expectations for central bank policy tightening and seeking safe haven in long sovereign bonds. The action will remain very headline driven here, but JPY traders may be especially poorly prepared for a further strengthening of the JPY as it has traded at all-time lows in broad CPI-adjusted terms as the market is anticipating higher rates around the world.
USDRUB – the Russian ruble dropped nearly 10% at one point – nearly touching 90.00 overnight on the news of the Russian moves against Ukraine. The US has vowed harsh sanctions, which could include severe options making trade and financial transactions with Russia difficult. That 90.00 level may be something that the Russian Central Bank is defending, with USDRUB pushing back lower toward 85 as of this writing after the Russian
Bitcoin and Ethereum - The crypto market plummeted overnight with the total crypto market cap decreasing by 9 % over the past day. This morning Bitcoin is trading below the USD 35k level, being one of the major cryptocurrencies with the relatively "smallest" loss of 8 %, and Ethereum just above USD 2,300.
Dutch TTF gas futures (TTFMJ1) surged more than 40% on the opening to €125/MWh (last at €115) as the market attempts to price in the risk of Russia, depending on the scale of EU retaliations, cutting off gas supplies to Europe. This puts further fuel to the current energy crisis in Europe which in recent years has relied on Russia for 40% of its gas supply. Hardest hit in terms of lower supplies from Russia are likely to be Germany and Italy. In the event of a prolonged disruption, EU gas inventories cannot be rebuilt before next winter, and as a result the winter 2022/23 TTF gas price is now trading above €100, more than six time the historical average.
Crude oil (OILUSAPR22 & OILUKAPR22) jumped overnight after Russia attacked cities across Ukraine. The rally was led by Brent, the global benchmark, which surged above $100 for the first time since 2014, and in the process its premium to WTI widened above $5 per barrel. Depending on the response from the U.S. and Europe, oil and gas prices are at risk of significant further rises, thereby reinforcing inflationary pressures and weighing on global growth, and eventually demand for crude oil. Worries about near-term supply shortfalls drove the prompt Brent crude oil spread as high as $3.3 overnight. Focus today being the U.S. and European response, comments from Saudi Arabia and China, the world’s biggest producer and consumer of oil.
Gold (XAUUSD) and Silver (XAGUSD) reached a fresh cycle high overnight in response to the depressing news from Ukraine. The rally was supported by a drop in US bond yields as investors took shelter from the carnage unfolding in the stock market. Gold priced in euros meanwhile trades near the 2020 high with safe-haven demand more than offsetting the negative impact of a stronger dollar. Gold and silver are likely to remain in demand with bonds struggling to provide the usual safe haven as this conflict comes with even higher inflation as a product. In addition, central banks must balance rate hikes against an accelerated economic slowdown, and any lowering of the current 7 rate hike expectations will further support the metals. Having broken above $1823, now support, gold’s next level of resistance is at $1960 followed by $2000.
US Treasuries (IEF, TLT). Uncertainty in the bond market remains extremely elevated. As tensions in Ukraine escalate, the market is evaluating a rise in inflationary pressures and a possible slowdown in growth. The 2-year breakeven rates rose to the highest level on record, approaching the 4% level. Markets are currently paring back rate hike expectations in light of a possible war, compressing the front part of the yield curve. We expect markets to remain volatile as the situation evolves and the yield curve to continue to flatten. Yesterday’s 5-year auction received strong demand stopping through by 0.1bps with a high yield of 1.88%. Despite stocks tumbled by the end of the day, yields from 7-year onwards continued to soar. Today’s 7-year bond sale is on the spotlight.
European Sovereigns (VGEA, IGLT). As the west imposes sanctions on Russia, the market Considers their impact on inflation. Two hikes are now priced in by the end of the year. The Bund yield curve continues to bear-flatten. In the UK, the yield curve steepened as the market pushes back on 50bps BOE’s rate hike in March, causing a steepening of the yield curve with the 2s10s spread now at 18bps. Today’s focus remains on Bailey and Schnabel speaking.
Junk Bonds (HYG, JNK). It’s time to reconsider credit risk. Junk credits have overperformed investment-grade bonds since the beginning of the year. However, there are signs that credit risk might start to crumble. No junk bond has been priced since February the 10th. Leverage loan indexes are falling on both sides of the Atlantic and real rates rise. Today, BellRing Brands (B2) should reopen the US junk primary market as it is looking to finance its spin-off from Post Holding. Demand for this issuance will be key to understand whether appetite for junk remains intact despite the escalation of tensions in Ukraine, and a spike in inflationary expectations.
What is going on?
Russia has launched what Ukraine describes as a full-scale invasion of the country, with missile attacks of military installations reported in multiple cities, including the capital Kiev, and with troop movements up from Crimea and down from Belarus, as well as from the breakaway regions in the east of the country. Russian president Putin claims that it is not aiming to occupy the country, but to “demilitarize and de-Nazify” Ukraine. Ukraine declared martial law already yesterday and claimed to have shot down a number of Russian aircraft.
Commodity market response to Russian attack on Ukraine: Apart from the above-mentioned price jumps in gas, crude oil and gold, other raw materials depending on supply from Russia and Ukraine surged overnight. Wheat and corn in Chicago both jumped by the allowed exchange limits of 50 and 35 cents on worries shipments from Russia and Ukraine, two major suppliers of grains and edible oils, could be disrupted. An already tight aluminum and nickel market could get even tighter on supply disruptions due to sanctions and due to soaring cost of production through higher input cost from energy. Alumínum on the LME surpassed the 2008 record peak overnight to reach $3375 while nickel surpassed $25k per tons, its highest level in a decade. Palladium, 40% of which is produced in Russia extended its annual gain to 38%.
EZ inflation for January is uncomfortably high – The eurozone annual inflation rate was 5.1 % in January 2022, up from 5.0% in December 2021. At the EU level, inflation climbed to 5.6% in January versus prior 5.3%. Several EU countries are experiencing much higher inflation: Spain (6.2 %), Romania (7.2 %), Netherlands (7.6 %), Poland (8.7 %) and Lithuania (12.3%), for instance. The market consensus expects annual inflation to drop in February around 4.4 % for the eurozone. This could partially reflect lower energy prices. Inflation is likely to remain a headache for European central banks. The services component could be the biggest issue for the eurozone this Spring.
What are we watching next?
The shape of the next Western sanctions and the degree to which these affect Russian commodity exports. Up to now, the approach of sanctioning Russia has cost the US and Europe very little, as commodity imports from Russia generally flowed freely despite multiple rounds of sanctions stretching back especially to Russia’s move into Crimea in 2014. But if this changes via a new round of harsher sanctions that either target Russia’s commodities exports specifically or Russia’s financial system and the large Russian banks involved in commodity trade, this risks aggravating already soaring energy and power prices in Europe and globally.
Energy security as it relates to equity sectors. The prices on energy and metals are soaring and that will put more pain on the utilities, industrials, consumer staples, consumer discretionary sectors, while energy and mining companies will likely benefit from the turmoil.
How central banks respond to this new potential driver of inflation, seems rather important, as the risk of significantly higher input costs from soaring commodity prices are a threat to growth and employment, but there are no good policy options in central banks’ toolkits to address the challenge. So far, the market has mildly lowered its Fed expectations, for example, taking about 10 basis points out of the anticipated hikes as longer yields have fallen by a similar amount - I.e., the entire yield curve dropping.
Earnings Watch. It is the most important day this week in terms of earnings, but these earnings releases will be overshadowed by the events unfolding in Ukraine.
Economic calendar highlights for today (times GMT)
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