Geopolitical tensions, central bank actions and a global market slowly recovering from its post-pandemic slowdown has made the past year a challenging environment for investors. Market volatility is expected to remain elevated, and largely sentiment driven. As institutional investors rebalance their positions closer to the end of year, we can expect more downward pressure on the equity markets in the short term.
The war in Ukraine continues with Russia annexing four more regions and the ongoing conflict costing thousands more lives. The sanctions placed on Russia also threatens the global food and energy supplies. Natural gas provides most of the power requirements for Europe during the winter and last year, 40% of the natural gas requirement was supplied by Russia. Although European countries have scrambled to build stockpiles during the summer and secure alternative energy sources, tough winter conditions could place pressure on reserves at the tail end of winter.
Negative surprises due to the pandemic have been widely reduced due to the development of vaccines and antiviral remedies. Positive surprises related to post-pandemic easing could provide a much needed boost to the economy. Savings rate of households were high during the pandemic and household spending along with the reinstatement of supply chains could offer much needed relief. On the flip-side, rising wages could cause inflation to be more entrenched and necessitate more central bank action to bring inflation down to target levels.
Investors can expect another round of negative Q3 earnings releases combined with credit downgrades as borrowing costs go up and the easy monetary conditions enjoyed in the post-financial crisis era begin to reverse. On a brighter note, the FDA has approved Biogen’s Alzheimers drug leading to a surge of 38% in the healthcare company’s stock. Given the current macroeconomic environment, a defensive tilt is preferred with healthcare, consumer non-discretionary, utilities sectors are preferred to more cyclical stocks.
Commodities, FX and Bonds
The US dollar strength continues with EUR/USD below parity and GBP/USD breached the 1.10 mark last week, USD/JPY is above 140 and USD/CNY above 7. Although the temptation remains to offset the position, USD strength has not yet peaked and will continue to remain strong buoyed by US Fed increase in rates with a rate hike of 75 bps expected in November, 50 bps expected in December with a final hike of 25 bps in February 2023. Post which, the Fed would take a more wait-and-watch approach.
The UK government has done away with the plan to cut the highest band of income tax- the most controversial aspect of Chancellor Kwasi Kwarteng’s fiscal plan the saw the dislocation in UK gilts last week. Investors should still be negative on UK gilts. OPEC+ led by Saudi Arabia and Russia are expected to meet this week to discuss removing 1 million bpd from the market in November to bolster energy prices in view of anticipated reduction of demand due to recessionary concerns.
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