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Economy

Remain Confident in Markets Despite Geopolitical Concerns

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Remain Confident in Markets Despite Geopolitical Concerns

 

  • Geopolitical tensions between Russia and Ukraine have greatly escalated during last week. The crisis will likely mark a new security paradigm for Europe and the US.
  • Initial financial market reaction was strongly negative, however, by ring-fencing the energy trade from the sanctions, investors were relieved that spillover to the global economy is likely to be limited. Risk assets rallied strongly on Friday, with the S&P 500 actually ending the week 0.82% higher.

 

  • Citi analysts think Fed is still on track to hike in March despite rising geopolitical concerns. Besides, Citi analysts expect inflation to come down possibly by Spring 2022 and global economic expansion will survive into 2023 and beyond. When lasting slowdown in inflation becomes evident, the Fed might not surprise markets with greater hawkishness.
  • On investment implications, the crisis could accelerate the Unstoppable Trend of “Greening the World” as EU could focus on developing renewable energy capacity to be more independent from Russia. Also, a peak in long-term US interest rates – perhaps coinciding with peak inflation – may generate a stronger immediate return environment for US growth shares. In particular, cybersecurity and fintech, as their expected EPS gains are convincingly strong and valuations are no longer excessive.

 

                                                 Markets recover quickly after geopolitical events, especially as Ukraine is unlikely to lead to recession

                                             

  • The history of war is one of unexpected consequence and unexpected spread. For example, the US decision to pull air power from Afghanistan last year may have added to Russia’s confidence in its action against Ukraine. Whether the crisis will have spillover effects including China related issues remains uncertain.
  • Investors acted with remarkably cool heads to the latest news from Ukraine. While there was a day of widespread losses across world markets, investors did not liquidate equities indiscriminately. The dispersion of equity market performance stayed strong and investors looked for particular opportunities in what they thought might be a wave of panic.
  • Citi analysts think we are likely to remain in a “mid-cycle” environment for asset markets, favoring higher-quality equities and higher-quality bonds. US equity returns in the year following the economy’s peak growth rate in a new recovery have averaged 7.0% since WWII. The drop in shares in early 2022 have improved return prospects somewhat.
  • If energy prices do not collapse as they did at the start of the last Fed tightening cycle in 2014 – when crude oil fell 66% over two years – Citi analysts would expect broad emerging equity markets to perform well and offer diversification to global equity portfolios.

 

 

Three Areas Of Concern

  • While the 12% decline in US equities has improved valuation and forward-looking returns since December, the prior three years have already delivered gains of 19.8% per annum for the S&P 500. Future equity gains will be dependent on the delivery of increased corporate earnings in an almost linear fashion. Thus, Citi Analysts believe a future 9% gain in the S&P 500 to be roughly in line with EPS gains in mid- to high single digits, a pace that requires continued economic expansion.
  • While self-destructive for Russia’s economy, it remains possible that it may withhold oil and gas supplies in an act of retaliation to sanctions. If so, Russia’s optimal timing is soon as winter heating demand will soon wane in Europe. Markets may still react to Russian cyber-attacks on western firms and infrastructure despite widespread warnings akin to US warnings over the invasion itself.
  • The history of war is one of unexpected consequence and unexpected spread. For example, the US decision to pull air power from Afghanistan last year may have added to Russia’s confidence in its action against Ukraine. Whether the crisis will have spillover effects including China related issues remains uncertain.

 

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