It was going to be the year of interest rate hikes, of the long-awaited banking rally, of the recovery of cyclical stocks versus growth stocks – the big winners after the shock of the pandemic – and of the European stock market versus the American, much more expensive and with a less cyclical profile. That was the bet of many managers for investment in 2022, which has been blown up with the Russian invasion of Ukraine.
The landscape for equities has been radically turned around. The year had already begun to decline due to the fear of unstoppable inflation, which is now going to run amok with the sudden rise in the price of raw materials caused by the conflict. The main stock market indices have already suffered declines of 20% from their latest highs, the level from which one begins to speak of a bear market. And hardly anyone now ventures to recommend buying equities at current levels. Even to the contrary, the withdrawal in exposure to the stock market is widespread and some even warn that the market could be underweighting the latent risk given the magnitude of the geopolitical earthquake of the war in Ukraine.
Prudence is the watchword, in the face of extremely high uncertainty that makes it impossible to make a clear forecast of the outcome of the conflict and its economic scope. The forecasts get old every week, especially those of the evolution of the price of raw materials. But for now, managers are ruling out talk of a recession, though it’s inevitable these days to look back to the 1970s, when the Yom Kippur War triggered an oil embargo that shrank the US economy for five straight quarters between 1974 and 1975. with inflation above 11%. In that period, the European stock market lost half of its value.
According to Citi in a report this week, “It is plausible to make some comparisons with the stagflation experience of the 1970s, but we would not go that far”. The US bank believes a global recession is unlikely and does not in fact expect a tough monetary policy against inflation. On the contrary, events could once again prompt central banks to be more accommodative.
Wall Street, and its technology stocks, will come out much better off than Europe, which concentrates recommendation downgrades
The greatest precautions affect the European stock market. The region is going to suffer much more intensely from the conflict due to its energy dependency on Russia. Lower growth this year and more inflation are taken for granted, a diagnosis that the ECB has just assumed, which it has preferred this week give up a rate hike just after ending its net debt purchases, the roadmap it had in place until now. The ECB has cut its growth forecast for the euro zone to 3.7% this year, from 4.2% previously. At Citi they have lowered it from 3.9% to 3.3% and at Credit Suisse they have a much more drastic forecast, of growth this year of just 1%.
In the opinion of the Swiss bank, according to a report published this week, the risk posed by the conflict in Ukraine is being underestimated, something that is reflected in the stock market increases with which the week ends, underpinned by the statements this Friday by Vladimir Putin, who assured that there were “positive changes” in the negotiations with Ukraine.
For Credit Suisse, there are more than enough reasons regarding the conflict for a defensive position on the stock market: the impact on Europe, and the magnitude of which is still unknown, comes through the prices of raw materials; there is a risk of disruption in supplies, a collapse in the economy of Ukraine and Russia and a negative effect on business confidence. Its position in Europe now goes through the electricity and renewable energy companies, such as RWE, Enel, Eon, National Grid and Acciona Energía, and the large pharmaceutical companies, which it sees as relatively immune to the rise in the prices of raw materials . For Citi, its defensive bet on the European Stock Market is also focused on the pharmaceutical sector and on giving priority to growth stocks over value stocks.
Setback for the European stock market
The sharp falls in recent weeks and, above all, the lower expectations of interest rate hikes are bringing the shine back to technology stocks and thus putting the big Wall Street companies back in the focus of investors. UBS has lowered its position on the European stock market to neutral this week and Bank for America warns that all the potential for a fall is not in the price. Instead, the omens for Wall Street are much more positive. Not surprisingly, 72% of the income of the S&P 500 companies is obtained in the United States, whose economy is not going to suffer in the first line from the Russian attack on Ukraine.
At UBS, he forecasts that the S&P will have risen to 4,800 points by the end of the year, an increase of more than 10% from current levels. And at Goldman Sachs they estimate that it will reach 4,900 by then. This bank in fact manages an estimate of a dividend of 67 cents per share for the S&P 500 this year, which implies an annual increase of 10% and a payout of 30%.
At Citi they also see room for Wall Street gains from current levels and although their forecast for the S&P at the end of the year, at 4,700 points, is below the consensus, the firm is overweight US equities and the whole of the technology sector. In his opinion, they should benefit, at least in relative terms, from the latest declines in debt yields. “Losses have been concentrated in financial securities and with direct exposure to Russia”, they add in Citi, where they affirm that the global stock market has ended with a rise of between 10% and 20% after previous geopolitical crises.
But the fulfillment of any forecast will depend on something as unpredictable as the course of a war, which in the case of the one being waged in Ukraine has an enormous economic dimension as well as war. The central scenario they run at UBS is one of a gradual withdrawal of Russia from the global energy supply due to sanctions, not an immediate interruption. In this scenario, your forecast for Brent is $125 in June, $115 in September, and $105 in December. Several months of very high energy prices that will hurt growth and corporate profits, which would still be positive for the year as a whole.
But in a much more adverse scenario, with a prolonged war and the sudden interruption of Russian energy exports, oil would go to $150 a barrel and gas would have to be rationed in Europe. In such an assumption, the decline for the S&P 500 would be 15% from current levels. And even lower for the whole of the markets if NATO intervened directly in the conflict, as warned by UBS. At Credit Suisse, without pointing to such an extreme scenario, they already fear that oil could shoot up to $150.
Paul O’Connor, head of Janus Henderson’s multi-asset team, acknowledges that much of the bad news is already priced into European stocks, which have fallen more sharply than US stocks. “However, As long as the political outcome remains so uncertain, estimates of the economic and financial impact of the conflict are difficult to trust. Things could get a lot worse.”, he warns. He further points out that euro zone equities are now trading at 30-year valuation lows against US stocks, something that also happened during the euro zone financial crisis.
The managers also recall that, in the face of past crises, debt is not this time an alternative refuge for equities. It is possible to take more defensive positions on the stock market, giving up cyclicals in favor of technology, luxury or food and electricity, but this year the balance of stock market investment will predictably be decided in the offices of Moscow, Washington and Brussels.
#Formulas #defensive #withdrawal #stock #market #falls