Rumors of War Negotiations, Lower Oil Prices, and Predictable Fed Lift Stocks
U.S. stocks had their best week since November 2020, with the S&P 500 +6.2%. Oil fell for the second week in a row. The themes cited included oversold conditions, depressed sentiment, cooling commodities, overstated recession fears, and China’s statements about market support. The best sectors were consumer discretionary (+9.3%), technology (+7.9%), and financials (+7.1%); the only sector closing down was energy (-3.6%).
CHANGING THE GLOBAL WORLD ORDER?
Last week was some week. The Fed (finally) raised interest rates after an unprecedented easing cycle due to COVID-19 and laid out what it sees as the path for rate increases for the remainder of the year. Despite concerns over inflation, slowing growth, more supply chain disruptions, and a flattening yield curve, clients seemed pleased just to have an understanding of the framework. At the same time, our forward-looking clients continue to speculate on what a possible path is for ending the Russia-Ukraine war. With Russia’s Plan A off the table for now (a quick victory with a new government in place), Plan B is to take eastern Ukraine and trade peace for land. What some clients see is Russia gaining most of eastern Ukraine and using that as leverage for peace negotiations. The big question is whether this is a temporary position. A case can be made that with that new land, Russia can regroup to build better logistical positions to attack central and western Ukraine with better efficiency. If I know that, so too do military planners, which makes it difficult to get a deal in the short term, and the attacks will only escalate from here. Still, investors are now able to put bookends around potential outcomes. Longer term, the biggest news of the week was that the Saudis are contemplating making oil trades in Yuan, potentially removing a key portion of stability in the US reserve currency status. This came up in every client conversation in the second half of the week. So even if this does not happen, investors are already thinking about it. If we take Xi and Putin at their word that the world order is changing, a China-Saudi-Russia alliance is probably the path to that scenario.
Watching For A Yield Curve Inversion
With the Fed beginning a rate hiking cycle last week, all eyes are now on the yield curve which had been flattening for the past few months creating nervousness among investors, ourselves included, about whether the U.S. is on the brink of tipping into recession. At 20 basis points, the curve is at the lowest level since March of 2020.
2s/10s U.S. Yield Curve Inverts About 12-Months Before Recession
Since 1978, there have been six dated recessions by the National Bureau of Economic Research and on average the yield curve inverted about 12 months before the recession occurred. Of course, some periods are shorter like the most recent recession while others are longer like prior to the financial crisis. There is one instance, 1998, where the curve inverted and the Fed was able to prevent a recession by quickly cutting rates. Unfortunately, they do not have that luxury today.
Asset Class Performance Around U.S. Yield Curve Inversions
With the yield curve at 20 basis points, we have received numerous questions about what are the best performing areas of the market leading up to and following an inversion. The table below shows the average performance of various asset classes around yield curve inversions. The most notable takeaway from the data is the lack of negative returns. Generally speaking, it shows there is still time in the near term for markets to perform well.
Sector Performance Around U.S. Yield Curve Inversions
The sector data is less robust in terms of data availability, however, the message is similar as it relates to returns. Historically, Technology has been a strong performer leading up to the inversion with Financials performing well in the months after. The data also shows defensive sectors perform best in the 12-months following an inversion.
Source: Strategas
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by Refinitiv.
Sincerely,
Fortem Financial
(760) 206-8500
team@fortemfin.com
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