Markets are recovering as the bad news continues to roll in

Three horsemen of the apocalypse have arrived: war in Europe, plague in Asia and interest rate hikes in the US. The market’s reaction: shrug and keep buying risky stuff.

It’s hard to believe that European stocks have now fully recovered from the shock of the Russian invasion of Ukraine. The Stoxx 600 index fell more than 10 percent from immediately before the invasion in late February to the March 7 bottom. It’s back to where it started after the biggest weekly rally since late 2020. Roughly the same applies to Germany Dax, which collapsed even more and is now close to the starting point again.

This despite an overwhelming consensus that the EU economy may suffer badly from the war next door, mainly from the impact of painfully high energy prices. Goldman Sachs, for example, has lowered its growth forecast for the year from nearly 4 percent before the war to 2.5 percent now. But it seems that the evolving narrative that the war in Ukraine will foster greater EU cohesion and, most importantly, higher government spending on defense is gaining the upper hand.

In Asia, this week brought a rather depressing reminder that Covid-19 is not over yet. Chinese stocks in Hong Kong on Monday had their worst day since the global financial crisis, down more than 7 percent after authorities announced a six-day lockdown in Shenzhen to stem another coronavirus outbreak.

Analysts at ANZ calculated that shutting down the region for just a week could hurt growth by as much as 0.8 percentage point for the year. Clearly, the road back to well-functioning global supply chains will not be smooth.

To make matters worse, investors are worried that China will soon have to choose sides in the Ukraine conflict more clearly. “There is a concern that China will somehow get caught up in sanctions,” said Ron Temple, head of US equities and co-head of multi-asset at Lazard Asset Management.

Fast forward again to the end of the week, however, and Chinese stock markets are back in business after Liu He, the Chinese President’s closest economic adviser, promised actions to stimulate the economy, along with unspecified “market-friendly policies.” Details weren’t announced immediately, but that doesn’t matter – investors can see a decent shot of additional monetary or fiscal stimulus from 50 steps.

And, of course, the Federal Reserve eventually did. It increased interest rates for the first time since 2018, with a quarter-point rise that is likely to be just the first of several later this year.

The feared end of monetary stimulus has been hovering over riskier assets for months. In the end, however, the S&P 500 index shot up more than 2 percent on Fed day and just kept going from there.

The Nasdaq Composite, crammed with the very high-tech stocks considered most vulnerable to tightening monetary policy, had its best week in a year. Sure, it’s down nearly 13 percent so far in 2022, and Goldman Sachs’ index of underperforming tech stocks is still down about 60 percent so far this year. But a 6.5 percent gain in the Nasdaq in one week is not to be scoffed at.

“I still think some of the speculative technology stocks in the US are overvalued,” says Lazard’s Temple. “But there is still a strong case for US stocks. Maybe we’ll let the profits flow into the valuations in the next few years.”

The game has changed; Tracking indices higher and calling yourself a genius is a ploy that’s worn out. Investors have “overdosed” on clinging to broad stock market indices in recent years, says Michael Kelly, global head of multi-asset at PineBridge Investments.

Putting the blunt rate hikes aside, the Fed’s process of trimming the $9 trillion balance sheet it has built to boost the financial system becomes difficult for investors to navigate, he notes. “It’s very hard for the markets to push it,” he says. “I don’t believe in the ‘priced’ story. I don’t think that can be priced in.” Using niches rather than following the herd will be important from here, he says.

Still, investors are clearly determined to take advantage of the positives. In a note this week, Credit Suisse’s investment committee said it had decided to switch to an overweight position in equities after an ad hoc meeting.

The benign response to the Fed’s rate hike suggests that “markets have had ample time to digest the changed economic outlook,” it said. “Glimmers of hope” about a ceasefire in Ukraine have surfaced, she added. And a fall in commodity prices suggests that the Russian shock “could allow the global economy, including Europe, to remain on a solid growth path.”

Analysts at UBS Global Wealth Management said the rise in US stocks since the Fed meeting shows “how quickly markets can turn as investor perceptions of geopolitical risks shift”.

“It also reinforces our view that simply selling risky assets is not the best response to the war in Ukraine,” they said.

In short, the markets are all about how fears line up with reality and things could have been worse. Let’s hope that doesn’t tempt fate. Markets are recovering as the bad news continues to roll in

Adam Bradshaw

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