Monday Espresso Podcast - 28th February 2022

[00:00:00] Sheldon MacDonald: It's the 28th of February. We saw quite a week last week, certainly in geopolitical terms and markets, as you would expect reacting, but certainly some interesting reactions that we saw.

[00:00:10] Normally in the face of global political events, developing as they did, you would expect to see a risk-off reaction.

[00:00:16] We did see that in emerging markets, which declined about 5%, but closer to home European markets, only down about 2-2.5%, the UK market also down less than that.

[00:00:26] So perhaps markets had already anticipated some of these moves, it certainly wasn't a surprise, we've been speaking about the Ukraine conflict and potential for escalation for some time now.

[00:00:36] Really the interesting one was US equities, which ended the week positive, up around 2% or so.

[00:00:43] Nathan Sweeney: Yeah, that's correct, so if we look at the us last week, the S&P was actually up 0.84% and the NASDAQ, which is the tech heavy benchmark, that was up 1.28%, so I'll share a couple of thoughts to you as to why we think that was the case.

[00:00:59] So firstly, if you think about the direct impact on the US and corporate earnings from the conflict within Russia and Ukraine, it's quite limited because the Russian economy is insignificant in relation to trade with the US so that's one point to mention.

[00:01:17] Secondly, if you think about the Russian economy, it's the 11th largest economy but it only accounts for 2% of global GDP.

[00:01:26] So to put that into context, if we look at Germany, it's about three times the size of that, and it has half the population, but I think the other reason, the real reason why you saw the US outperform, is because this uncertainty that we have is leading market participants to believe that actually the Federal Reserve will not raise interest rates as quickly as previously expected. So we were looking to see maybe a 50 basis point rate hike, and now the market is expecting our pricing in a 25 basis point hike at that March meeting.

[00:02:00] Sheldon MacDonald: We'll see, I go back to central banks in a second.

[00:02:02] Let's carry on with some of the direct impacts, the oil price did end the week up?

[00:02:07] Nathan Sweeney: Yeah. So if we look at the oil price had had a very volatile week, so at one point it spiked over $100 a barrel, but actually ended the week a bit lower than that.

[00:02:16] So it was up 1.5% for the week, but obviously we've had a continued escalation of the weekend, so we're seeing a bit more volatility within the oil price and it was up about 6% over the weekend.

[00:02:27] Sheldon MacDonald: Now we've noted before how the UK is a market that is quite oil heavy, you know, some of the big heavyweights in the index are the oil majors, BP and Shell and so on.

[00:02:37] Why was the UK market not stronger then in the face of this increase in oil price?

[00:02:42] Yeah, so if we think about the UK, it's definitely more positioned towards value or cyclical companies. Whereas the us is definitely more positioned to long-term growth companies, and because those expectations around central banks and raising rates, they may be delayed, you actually saw growth outperforming value.

[00:03:02] Nathan Sweeney: So it was more of a value growth dynamic, which was driving markets last week.

[00:03:06] Sheldon MacDonald: Further to market dynamics, earning season now just about finished. A review on that would suggest that companies cope pretty well with the higher inflation in Q4, managing to turn the stronger economic environment into decent returns. The outlook for this year, softening slightly, especially for the first quarter.

[00:03:26] Now remember many other countries are several weeks behind the UK in terms of the Omicron COVID wave, and so those effects will be felt in Q1.

[00:03:34] Importantly though, the economic outlook for the whole of 2022 remains fairly strong, estimates still around 4% for global GDP growth, which is certainly above trend.

[00:03:46] Now we said earlier on with circled back to bonds and central banks. Now in a risk-off week as we saw last week, you would have expected bonds to have done well.

[00:03:55] Bonds ending the week, also relatively flat. Now, this is an interesting dynamic that we've got playing out here.

[00:04:02] As I said, the risk-off situation you would expect bonds to do well and perhaps an intermediate or a short-term weaker growth picture for Q1, perhaps might also lead bonds to do slightly better.

[00:04:13] But on the other hand, we still have rising inflation, the inflation numbers in the US, certainly for the end of Q4, rising. And there's potential for higher inflation coming through now because we still have this post Omicron wave recovery, the back-to-work recovery with pent up demand.
[00:04:30] And an additional factor is that tax refunds have now started in the US.

[00:04:36] Every year taxpayers get their refunds. This year, refunds are running 63% higher than they did last year. The average tax check that goes out, their average refund check that goes out is over $3,000.

[00:04:50] So combining that with this potential for pent-up demand, there is potential for a very strong consumer-driven recovery facing us, so perhaps some good news on that front.

[00:05:02] Now, central banks, the US Fed is meeting this month, so is the UK, what are the expectations at the moment Nathan?

[00:05:10] Nathan Sweeney: Yeah, so if we look at central bank expectations around rate rises, we're going to continue to see those rate rises come through.

[00:05:16] So it's looking like the bank of England is going to raise interest rates by 25 basis points. And the fed is likely to do the same.

[00:05:22] Sheldon MacDonald: Thank you very much. It's been a slightly longer podcast this week, lots to speak about, and I'm sure that's carrying on this week, certainly lots of dynamics playing out in the market.

[00:05:31] We hope you'll listen in again next week. Thank you.

[00:05:34] Nathan Sweeney: Goodbye