Investors should be cautious about re-entering the stock market after the correction in January, says strategist Peter van der Welle.
US equities plunged by almost double digits on fears that persistently high inflation will force the US Federal Reserve to more aggressively hike interest rates. Five rate hikes together adding 1.25% to borrowing costs are now expected after US inflation hit a record 7%.
Normally a significant market wobble would tempt investors back into the market while stocks are cheaper. They should however watch their step, as four headwinds stand in the way of the bull market resuming, says Van der Welle, strategist with the Robeco multi-asset team.
“The overarching question bothering investors now is when is it time to buy the dip?” he says. “That's a valid question, because when you look at the sell-off in developed market equities in the year to date, it roughly matches the historical average sell-off around the time of a first Fed rate hike, which we envisage will come in March.”
“The historical drawdown averages at 11%, and the S&P 500 Index lost 9.8% in January, so that’s close to bottoming out. Nonetheless, there are four main risks that markets need to navigate now, which keeps us a bit cautious about buying this dip in the multi-asset fund. Basically, this dip is not as easy to read as previous corrections.”
He says the main problem remains inflation, which has spiked following supply shortages as the Covid-19 lockdowns ended and energy prices soared, leaving companies and consumers with much less purchasing power.
“The first risk is that we think inflation risks are still skewed to the upside over the next few months, although we expect them to drop steeply after that,” says Van der Welle. “Financial markets are recognizing that the Fed is now in inflation-fighting mode and have priced in five rate hikes for 2022 to address this inflation risk.”
“This could create some further turbulence, but afterwards we think the markets will recognize that inflation is decelerating, at least in the cyclical parts of the economy. When you look at the base rate effects of oil prices dropping out, then overall CPI inflation should still drop to about 3.5%. This means it will have halved compared to current year-on-year levels.”
“The inflation risk premium – the compensation investors are demanding to shield them against unexpected inflation – has been declining lately. The inflation story has been top of mind over the past year, but this signal from the bond markets tells us that the market can navigate this.”
The second risk is decelerating demand for durable consumer goods such as household appliances and cars as the pandemic ends and the service sector reopens.
“Durable goods consumption has skyrocketed on the back of all the elevated lockdown intensity over the last 18 months, when people could not go out to fancy restaurants, so they ramped up spending on durable goods instead,” says Van der Welle.
“That will likely come down as economies further reopen once the Omicron wave has fizzled out. Declining goods consumption could result in declining manufacturing indicators such as the ISM. That could raise the risk of a growth scare, especially if the ISM were to drop below the 55 level (a reading above 50 signals growth).”
“The consensus real GDP growth forecast this year of 3.8% is consistent with an ISM of around 56. If we were to see a drop below that level, then the markets could be negatively surprised by it. Any growth scare could be short lived because a rebound in services activity should keep growth above trend, so it’s a risk that could be overcome by markets.”
Then there are the current tensions between Russia and Ukraine, though investors would do better looking at the value of credit default swaps (CDS) than the 100,000 Russian troops massing on the Ukrainian border, Van der Welle says.
“The current Russian government CDS spreads are only one-third of the levels observed around the peak of the 2014 crisis when they annexed Crimea,” he says. “Back then, CDS spread levels were at 600 basis points, and now they’re about 210 bps. We can therefore be quite confident to say that this risk is underpriced.”
“Putin could try to conquer the disputed Donbas region of Eastern Ukraine after returning from the Winter Olympic Games in Beijing, but his broader ambitions face constraints given severe retaliatory sanctions from the West. One thing to remember is that any country with a disputed border is very unlikely to become a NATO member. So this could all be short lived.”
“The crisis is therefore unlikely to create a new bear market, though it could push the oil price up from the present USD 89 a barrel above the sensitive USD 100 level. But all in all, that seems to be a manageable risk.”
The fourth and final risk is more serious, and not that easily countered, and this circles back to what caused the January correction in the first place – a less market-friendly Fed. Hiking rates is one thing, but quantitative tightening is quite another, he says.
Stock market multiples could decline accordingly with a shrinkage in the Fed’s balance sheet, reversing the process observed during quantitative easing, Van der Welle warns.
“The US stock market valuation is still historically elevated when you look at the conventional price/earnings ratio of the S&P 500,” he says. “Multiples all fell when the market sold off in January, but the S&P 500’s P/E ratio is still 30% above its 40-year historical average.”
“The big question is whether the Fed is indeed becoming less market friendly, and that remains to be seen. If inflation risks are decelerating then the Fed guidance could become less aggressive in the second or third quarter, and that could also lead to rate hikes moving further out.”
“So long as growth rates in developed markets remain above trend – and that is our base case – we think that equity markets can handle a further rise in real interest rates and take all this in their stride.”
“Though dips are not as easily bought as in recent years, this correction does not herald the end of the bull market in equities, nor does it signal the passing of the expiration date of the TINA (There IS No Alternative) trade.”
“Current relative valuation metrics like the equity risk premium tell us to be guarded, as downside risk is rising, though history shows that stocks typically still outperform bonds at these levels. We are still constructive on equities for the next 12 months and retain a modest overweight in the multi-asset portfolio.”
The information contained on these pages is for marketing purposes and solely intended for Qualified Investors in accordance with the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”) domiciled in Switzerland, Professional Clients in accordance with Annex II of the Markets in Financial Instruments Directive II (“MiFID II”) domiciled in the European Union und European Economic Area with a license to distribute / promote financial instruments in such capacity or herewith requesting respective information on products and services in their capacity as Professional Clients.
The Funds are domiciled in Luxembourg and The Netherlands. ACOLIN Fund Services AG, postal address: Affolternstrasse 56, 8050 Zürich, acts as the Swiss representative of the Fund(s). UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zurich, postal address: Europastrasse 2, P.O. Box, CH-8152 Opfikon, acts as the Swiss paying agent. The prospectus, the Key Investor Information Documents (KIIDs), the articles of association, the annual and semi-annual reports of the Fund(s) may be obtained, on simple request and free of charge, at the office of the Swiss representative ACOLIN Fund Services AG. The prospectuses are also available via the website www.robeco.ch. Some funds about which information is shown on these pages may fall outside the scope of the Swiss Collective Investment Schemes Act of 26 June 2006 (“CISA”) and therefore do not (need to) have a license from or registration with the Swiss Financial Market Supervisory Authority (FINMA).
Some funds about which information is shown on this website may not be available in your domicile country. Please check the registration status in your respective domicile country. To view the RobecoSwitzerland Ltd. products that are registered/available in your country, please go to the respective Fund Selector, which can be found on this website and select your country of domicile.
Neither information nor any opinion expressed on this website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco Switzerland Ltd. product should only be made after reading the related legal documents such as management regulations, prospectuses, annual and semi-annual reports.