The market had a down week in the face of a hawkish tone from several Fed speeches and events that make it look like the bond market may have been more correct than some assumed. Of course, the Fed may be attempting to jawbone the market and it may not end up acting as aggressively as some fear. However, our Head of Global Portfolio Strategy Brian Rauscher has heard from trusted sources Powell has been made a genuine convert to the hawkish side. The hawks took him to the river and dipped him in, so to speak. Of course, the inner workings of the world’s most powerful central bank can be perplexing so only time will tell. If what looks like a persistent conflict in Ukraine continues to curtail growth and results in a further economic escalation of things like sanctions, they may have to change their tune. It was a risk-off week for sure. The defensive sectors of Health Care, Consumer Staples, Utilities and Real Estate were the clear leaders. The Energy sector was a gainer as well but had weaker relative gains. Industrials, Technology, and Consumer Discretionary all got slammed by more than 2%. So, markets are not happy that a very hawkish Fed might not only take the punch bowl away but try to physically break up the party like small-town cops. There was an op-ed from Former New York Fed Governor Bill Dudley that was contended the Fed will not be able to tighten financial conditions effectively without a severe drop in equity prices, which it must force if such a drop doesn’t occur on its own. The logic behind this argument is that the financial confidence households gain from high asset prices interferes with the Fed’s objective of slowing inflation. Our Head of Research, Tom Lee, will address this peculiar note in more detail below. While this could have been part of Powell’s messaging strategy, it may have also been Dudley simply speaking his mind. Fed officials still officially would like to have a soft-landing but hearing this tone from the Fed is generally not something markets like. The flattening of the Phillips-Curve has complicated how the Fed must approach monetary policy, but his conclusions probably are not shared by a majority of current Fed members.
The thing is, there does appear to be some pressure boiling off the tea kettle with regards to inflation. Of course, we have multiple sources of episodic inflation that may be distorting how the data comes out. Nonetheless, the kind caused by elevated demand for goods over services associated with the pandemic seems to be slowing. The container shipping rates from Shanghai to Los Angeles, New York, and Rotterdam are all showing themselves to be beginning a downtrend. Of course, the newest episode of inflation is caused by the grinding ground war in Ukraine and the associated Western sanctions on Russia. As Russian forces pulled out of the Kyiv area, they left behind appalling evidence of war crimes. The reason this is significant for inflationary outcomes is that if Russia’s wanton violence continues it could lead to a full-on European boycott of all Russian energy. Some believe this could push oil prices to $200 which would probably be high enough to start menacing consumer wallets on a large scale.
Of course, Energy is not the only concern, although it is probably the most acute concern in the immediate/short term of the conflict with regards to markets. A more medium-term to the long-term problem could be the multi-faceted supply shock to the global food supply chain. World food prices hit record highs this week and there doesn’t appear to be relief in sight.
Obviously, the war crimes being committed by Russia also reduce the chances of negotiations as Ukrainian resistance and negotiating positions are only likely to harden with the atrocious actions of Russian soldiers. Putin appears to be reorganizing his forces for an offensive in the Eastern and Southern sections of the country which should begin in days. While Russian airpower may be more of a factor in the East where Ukrainian air defense networks are less robust, the cream of the Ukrainian military has been fighting in this section for years. Many defense experts expect Russia’s combat power is too impaired from their heavy losses to achieve the envelopment of Ukrainian forces likely needed for victory in this theatre.
This may make it more tempting for beleaguered and humiliated Russian military brass to achieve a breakthrough with chemical or biological weapons. Obviously, this would be an extremely perilous development and could prove a negative catalyst in the coming weeks. Another factor at play may be the very high casualties amongst generals and leadership in the Russian army. Unlike NATO forces, the Russian army does not have a backbone of non-commissioned officers and its lack of encrypted communications has led to alarmingly high losses in the officer corps not seen in any modern military action for decades. Apparently, about a third of funds for investment in Azart encrypted radios was embezzled. There is clearly a direct price for the ossified kleptocracy that has sprouted under Putin’s watch being paid for with the blood of Russian soldiers.
There are dark clouds on the horizon, but that doesn’t mean the storm will be strong enough to derail exceptionally strong US consumers and corporate balance sheets. Of course, there’s always the possibility of an unexpected peaceful resolution in Ukraine. The tide is going out with regards to liquidity though and we are trying to look very closely to find out who is not wearing their swim trunks before it is too late. Our team is paying heightened attention to potential weak spots that could be sources of financial stress as tightening continues to progress. While there are macro headwinds, innovative currents and the benefits of loose capital over the last years will continue to accrue. For example, our cryptocurrency team and Tom Lee were in Miami at the Bitcoin conference this week. One thing they noticed was a significantly more mature mining industry than in previous years. The market has shifted from investors shooting at the side of a barn to them having to be more discerning. This is a market where stock picking is more important than ever. Let’s also remember that much of Technology is also already in a bear market. Times like this can be good to buy quality stocks you think will benefit from medium and long-term themes at a discount. Of course, we’re always cognizant that markets have a unique ability to climb a wall of worry, even if that wall appears quite ominous to us at the individual level.
