MarketMinder Europe 

MarketMinder Europe

MarketMinder Europe provides our perspective on current issues in financial markets, investing and economics. Our goal is to analyse key topics in an entertaining and easy to understand manner, helping you see the news of the day in a unique perspective.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.


Russian Default’s Financial Fallout Likely Limited

Commentators we follow continue to track the horrific war in Ukraine this week. But amongst them, a related factor is also gaining prominence: Chatter over a Russian sovereign bond default is rising after the country failed to complete an interest payment to foreign holders of Russian bonds last Wednesday.[i] The miss starts the clock ticking on a 30-day grace period.[ii] If that expires and bondholders don’t receive their money, it will be in technical default.[iii] Although this prospect seems to be stirring some warnings amongst commentators we follow—and memories of 1998’s Russian default, part of a larger Emerging Markets (EM) debt crisis—we don’t think a chain reaction is likely to stem from this.

Interestingly to us, reports we saw suggested Russia’s debt service failure appeared to be mutual at first blush. Whilst Russia’s Ministry of Finance sent coupon payments to foreign holders of rouble-denominated sovereign debt—known as OFZs (the Russian abbreviation for Federal Loan Obligations)—the Central Bank of Russia (CBR) halted Russia’s National Settlement Depository from making payments to foreign clients.[iv] Russian President Vladimir Putin overruled this policy on Monday, stating that he would permit the payments to go through—even to creditors in nations he considers hostile.[v] However, another issue remains: Western clearing systems used to settle these payments stopped accepting them due to sanctions.[vi]

Whilst such a default is unusual, in our view—Russia has plenty of roubles in its coffers to pay if allowed—it doesn’t change the effect on bondholders.[vii] We think foreign investors in Russian OFZs could face substantial losses, if not complete write-offs—on top of the huge rouble depreciation they have already felt. The same fate could await foreign holders of dollar- and euro-denominated Russian debt, too. Payments on such bonds are scheduled for 16 March, and markets reflect a high likelihood they will go unpaid as the difference in yields between Russian bonds and US Treasurys soars.[viii] (Exhibit 1)

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January Pointed Positively for the US Economy

In some non-Russia-Ukraine news, January numbers came out for several widely watched US economic datasets last Friday. Whilst many market observers we follow forecast weaker results due to headwinds ranging from rising prices to Omicron, the official numbers largely exceeded expectations. In our view, January’s growthy figures suggest the US economy is on solid footing and remains more resilient than many economists we have seen argue—useful perspective given all of today’s alleged economic headwinds.

The latest personal consumption expenditures (PCE) price data featured in most financial publications we monitor, as the US Bureau of Economic Analysis’s (BEA’s) headline price index is the US Federal Reserve’s preferred gauge for tracking price trends. Due to that, we have seen financial commentators argue PCE price data will sway Federal Reserve officials’ decision-making. The PCE price index rose 6.1% y/y in January, its fastest rate since 1982.[i] The core PCE price index (which excludes volatile food and energy prices) accomplished a similar feat, rising 5.2% y/y—its quickest pace since 1983.[ii] On a monthly basis, the PCE price index climbed 0.6%, in line with its growth rate over the past three months.[iii] Now, we don’t think the BEA’s price data reveal much new since other widely watched US price gauges, including the Bureau of Labor Statistics’ Consumer Price Index (CPI) and Producer Price Index (PPI), have shown similar trends recently.[iv]

However, the BEA did find January consumer spending held up despite rising prices. January retail sales, released by the US Census Bureau, which rose 3.8% m/m, first hinted that today’s elevated inflation (economy-wide rising prices) wasn’t denting spending, though the gauge has limits.[v] The Census Bureau doesn’t apply inflation adjustments to retail sales, and retail trade doesn’t include most services spending, which comprises nearly two-thirds of total household expenditures.[vi] We think PCE data help address those questions. January’s real (i.e., inflation-adjusted) PCE rose 1.5% m/m, with goods spending (4.3%) stronger than services (0.1%).[vii] We don’t think the split between the two types of spending is a big surprise, given the Omicron variant kept workers and consumers home. Our research shows COVID-related fallout weighed on people-facing services industries in particular, including restaurants and bars (-1.3% m/m), hotels and motels (-3.5%) and air travel (-0.9%).[viii] Whilst one month’s data, positive or negative, doesn’t make a trend, we think growth in the face of higher prices reveals strong consumer demand—and counters arguments elevated prices are an automatic negative for a large swath of US economic activity.  

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Ukraine's Fog of War and Stock's Volatility

In our view, filtering information is one of investors’ most important tasks. It can be hard enough in the best of times, but right now, the fog of war appears to be making it all but impossible—and we aren’t talking about the myriad reports of fake images and video footage coming out of Russia and Ukraine. The fog also appears to be engulfing a lot of reporting from economic commentators we follow, potentially obscuring a clear assessment of developments’ impacts over the weekend and on Monday and stoking a lot of this time is different-style commentary.[i] But as tough as it may be to see, we don’t think much has changed for investors since our discussion of sanctions late last week. In our view, the latest measures still don’t inflict enough damage to knock a few trillion pounds off of markets—which we think is the amount needed to wallop global markets into a bear market (a prolonged, fundamentally driven, broad equity market decline of -20% or worse).

Yes, we know the US, UK and EU agreed to expel some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which facilitates international financial transactions.[ii] We know this theoretically complicates Russian banks' transacting with the developed world, effectively freezing commerce and overseas assets even for entities that aren’t under sanctions.[iii] And we know several Western leaders have referred to this, however unfortunately, as the “nuclear option.”[iv] Now they are patting themselves on the back, promising their actions will create a deep Russian recession (a broad decline in economic activity).[v]

Our response: perhaps. But we think there are reasons to doubt this outcome will be so clear. That isn’t an ideological statement, mind you, nor a political one. Rather, our job is to assess these things coolly and rationally, as markets do. Those we have seen argue the SWIFT expulsion will kneecap Russia’s economy point to the deep economic pain in Iran after US sanctions effectively barred all Iranian banks from SWIFT.[vi] Thing is, those sanctions included measures targeting Iran’s oil and gas exports, which is what actually crippled Iran’s economy.[vii] So far, the West has done no such thing to Russia—the SWIFT ejection applies only to some (heretofore unspecified) banks, meaning there are other banks that still have access and can process oil and gas transactions.[viii] Some officials told the press Monday that they are doing so to avoid interfering with the oil trade.[ix]

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Weighing the Crypto Threat to the Global Financial System

Do cryptocurrencies threaten global financial stability? The Financial Stability Board (FSB), an international body of financial authorities and regulators, released a report last week voicing worries—adding to related murmurs amongst financial commentators we follow. Whilst we don’t think the FSB’s findings are a call to action, examining how the crypto space could impact broader global markets can help investors weigh the likelihood of the discussed potential negative outcomes actually coming to pass.

Before examining the FSB’s arguments, some background: Cryptocurrencies are digital currencies not created or controlled by national governments. According to many of their proponents, cryptocurrencies’ advantage is their strictly limited issuance (making them scarce) and use of a digital ledger called the blockchain, which records past transactions and prevents counterfeiting. Their rising popularity in recent years is due in part to some proponents’ expectation that cryptocurrencies are the future of money—spurring a broader industry aiming to capitalise on this potential growth.

The FSB focused on vulnerabilities in private sector crypto assets, from unbacked crypto (e.g., bitcoin, the first and most prominent cryptocurrency based on our financial news coverage) and stablecoins (cryptocurrencies with a fixed value that are backed by a basket of securities, much like a money market fund) to decentralised finance (DeFi) and crypto-asset trading platforms. Think of unbacked tokens and stablecoins as your general cryptocurrencies—i.e., something trying to be electronic cash—whilst DeFi and crypto-trading platforms aim to provide financial services (e.g., lending) using private-sector crypto assets. With digital coins expanding rapidly and becoming a larger part of the financial system, the FSB warns more regulation and oversight are needed, or else cryptos’ problems could spill into global capital markets—with potentially dire consequences.[i] For example, the FSB posits that a major stablecoin failure could roil short-term funding markets if the coin issuer had to liquidate its reserve holdings in a disorderly fashion—especially if it triggered holders of other stablecoins to liquidate en masse.[ii]

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Assessing the Impact of the Latest Sanctions on Russia

In the aftermath of Russian President Vladimir Putin’s full-scale invasion of Ukraine, the free world’s leaders announced fresh—and much tougher—sanctions Thursday.[i] What have the Group of Seven (G7—a group of major international leaders) allies announced thus far, which institutions are most exposed, and is there much risk of a downstream impact for the UK, US and Europe? Read on for the details and our analysis.

Now, to be clear, this article is a discussion of the intended effects of Western sanctions based on trade statistics and the announcements to date. However, our research shows sanctions’ real impact rarely matches the intent. Even rogue leaders like Vladimir Putin will likely find some third-party nation willing to trade with them, avoiding the sanctions for a small fee. Hence, we think sanctions’ likely economic impact—on Russia and the world—is smaller than the estimates that follow.

Until Thursday, the Western powers and their allies had refrained from some of the toughest measures in their arsenal, including banning Russia from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which facilitates international financial transactions, and cutting off semiconductor shipments. Instead, they opted for a gradual initial approach, promising to ratchet the punishment up if Putin didn’t back down.[ii] He didn’t, and now global leaders are starting to follow through on their earlier warnings.

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Some Dos and Don’ts in Dealing With Market Volatility

In our experience, when market corrections (short, sharp, sentiment-driven -10% to -20% declines) strike amidst fearful headlines—like the present scenario involving Ukraine tensions—many investors feel an urge to do something. But for investors seeking long-term growth, we think reacting to short-term volatility is usually counterproductive. It is possible portfolio performance during—and investors’ reactions to—volatile spells may reveal some weaknesses worth considering, but we find this is best accomplished in a measured, forward-looking manner, not a knee-jerk move when stocks are falling. With that in mind, here are some dos and don’ts we think can help investors get through a difficult stretch of headline worries and rocky markets.

Do: Above all, in our view, investors should keep a longer-term perspective that prioritises their asset allocation—and the reasons for it. We think investors’ asset allocation—the mix of stocks, bonds, cash and other securities in their portfolio—should be based on their long-term goals, time horizon, ongoing cash flow needs and comfort with volatility. In our view, bouts of negativity alone shouldn’t cause investors to veer from a correctly designed allocation, since it should be likely to help them reach those goals over time regardless of near-term ups and downs along the way.

Keep in mind what an asset allocation’s components are there to do. Cash, in our view, is there for near-term cash flow needs, emergencies and known, upcoming purchases. Our research shows bonds reduce the magnitude of portfolio swings and, therefore, the likelihood of having to take scheduled withdrawals after a large drop.[i] To us, stocks are for long-term growth, which is the reward for their higher expected short-term volatility.[ii] We think it is beneficial to blend these to work in concert toward investors’ long-term goals.

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The Likely Market Implications of Putin’s Latest Ukraine Gambit

Is the dam finally breaking? Over the past couple of days, Russia disavowed Ukrainian sovereignty, formally recognised the country’s breakaway provinces—Luhansk and Donetsk—as independent states and sent troops into them. In response, the UK, US and EU announced some sanctions and Germany officially abandoned its pursuit of the Nord Stream 2 pipeline. Oil prices jumped closer to $100 a barrel, and whilst European stock markets were overall mixed, global stocks fell -0.8%.[i] In doing so, world stocks notched the first official correction of this bull market—the first drop below -10% from the prior closing high.[ii] With that in mind, if you are investing in stocks for long-term growth, we think it is most beneficial to stay cool. In our view, stocks are behaving as they normally do amidst escalating geopolitical tensions. Our research finds regional conflict can hit sentiment and cause short-term declines, as it has this year. But there is a long history of regional conflicts and corresponding stock returns, and none have been the proximate cause of a bear market (a lasting broad market decline of -20% or worse with a fundamental cause). We don’t think this time is likely to prove different.

Not that any of the present situation is good—it isn’t. War is tragic. Our hearts go out to the many Ukrainian people whose lives and property are at risk, and we hope conflict doesn’t escalate from here. Yet we find markets are cold-hearted and rational, so when assessing conflict’s impact on stocks, we think it is vital to be more detached and assess the facts. One tough fact most Western commentators we follow seem to broadly overlook: Russian presence in Luhansk and Donetsk isn’t new. Russian soldiers reportedly entered these areas back in 2014, in unmarked combat fatigues, earning the moniker of President Vladimir Putin’s little green men.[iii] As many in the region reported at the time, they were offering support to forces described as pro-Russian separatists in these provinces as Russia executed its annexation of Crimea. As with Crimea, Putin argued these areas were much more ethnically Russian than Western Ukraine, seemingly attempting to justify his actions on cultural grounds.[iv] Many observers we follow in the US and Europe expressed surprise when Putin didn’t annex Donetsk and Luhansk as well as Crimea, instead appearing to settle for fomenting chaos and severing them from Kyiv’s oversight. His diplomatic recognition of Luhansk and Donetsk this time is noteworthy, but we think it—and the official statement Russian troops are headed into these regions—is tantamount to Russia formally admitting to its stance from the last eight years.

In our view, the events of eight years ago highlight a critical point for stocks: Our research shows markets move most on surprises, and nothing happening in Ukraine today appears all that new or surprising. Considering stocks reflect all widely known information, we think it stands to reason they have known and dealt with the possibility of Putin carving up the country for many years now. Once official Russian troops amassed along the border, many geopolitical commentators we follow started portraying formal activity in Eastern Ukraine as a foregone conclusion. The chief question to us was how much the West would stomach before applying economic pressure, and we are now getting some clarity on that.

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We Don't Think Italy Needs the ECB's QE

A new theory about the European Central Bank (ECB) emerged amongst financial commentators we follow this week, and we think it is a juicy one: Evidently, the ECB can’t raise its benchmark interest rate aggressively because it has committed to not raising rates until it stops quantitative easing (QE) bond purchases.[i] Which it can’t do, because it would risk restarting Italy’s debt crisis.[ii] Whilst we won’t opine on the need or desirability of aggressive ECB actions, we have a couple of charts that disagree with the notion ending QE would trigger an Italian debt calamity.

Financial commentators we follow have long argued the ECB alone is propping up Italian debt and keeping the country’s borrowing costs low.[iii] Never mind that Italy’s 10-year yield was well below levels hit during the eurozone’s 2011 – 2013 debt crisis by the time the ECB announced its QE programme in January 2015.[iv] Never mind that in 2014, the average yield of all Italian bonds issued that year was just 1.35%—then the lowest on record.[v] And never mind that when the ECB stopped buying bonds in 2018, Italian yields fell on a cumulative basis. (Exhibit 1)

Oh, and never mind that even when the ECB stops buying Italian bonds whenever QE ends, it will still own over €650 billion (and counting) worth of them, and the Italian Treasury will still get back any interest paid on those holdings.[vi] As those bonds mature, barring a change in policy (which the bank hasn’t yet signalled), the ECB will use the proceeds to buy replacements. The pile of debt Italy will actually have to pay interest on is smaller today than it was when the ECB started QE, as its total Italian bond holdings dwarf the amount of debt Italy issued since QE began.[vii] We think those who dwell on the act of purchasing overlook that the stock of assets on the ECB’s balance sheet is probably more meaningful at this point.

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Into Perspective: UK Q4 GDP

Q4 UK gross domestic product (GDP, a government-produced measure of economic output) rose 1.0% q/q, leaving it just -0.4% below its Q4 2019 high, spurring rising enthusiasm amongst commentators we follow for a post-Omicron bounce.[i] Even monthly GDP’s tiny December contraction didn’t appear to dent their economic outlook. Yet we think a more measured view is in order. Whilst UK output is likely to grow, in our view, forward-looking stocks probably already reflect restrictions’ end, and a swift advance seems unlikely.

As Exhibit 1 shows, UK monthly GDP’s -0.2% m/m dip came mostly from consumer-facing services, which fell -3.0%.[ii] Based on our reading of the data, services’ slide stemmed largely from Omicron restrictions that are now gone and, judging from how the political winds are blowing, seem highly unlikely to return—hence the broad enthusiasm for a post-restriction rebound amongst commentators we follow. Perhaps adding to the cheer, overall output merely inched down from November’s new monthly high to February 2020’s pre-pandemic level.[iii]

Exhibit 1: Monthly UK GDP Back to Level Despite Consumer-Facing Services’ Lag

Source: ONS, as of 11/2/2022. Monthly UK GDP and consumer-facing services, February 2020 – December 2021. Consumer-facing services consists of retail trade, food and beverage serving activities, travel and transport, and entertainment and recreation.

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How We Think Inflation Warnings Are Shaping Sentiment

Inflation—economy-wide price increases—can take a toll, particularly for households on a fixed budget. This is likely, in part, why data releases like last Thursday’s January US Consumer Price Index showing prices rose 7.5% y/y spurred many warnings from commentators we follow.[i] Adding to the gloom, inflation has become increasingly politicised—on both sides of the Atlantic—which can make it difficult for investors to weigh its market impact, in our view. That is what we focus on, so what follows isn’t an ideological or political statement, but rather, something we think all investors benefit from keeping in mind: For markets, we don’t think the most relevant question is about when inflation moderates, how high it peaks or how monetary authorities respond. Rather, the critical issue to remember is that stocks price in all widely known information, including widely held expectations, based on our research. Seen in that light (and notwithstanding recent volatility), we think the vast, vast attention paid to rising inflation rates should help stocks: It further saps the shock factor, likely allowing markets to move on sooner than many commentators we follow seem to expect.

In our experience, volatility and widespread, frightening headlines often move together—and follow a recurrent pattern. It usually goes something like this:

  1. People warn thing X will happen and hurt markets.
  2. Thing X actually happens.
  3. Markets show some negativity, maybe even a correction (short, sharp, sentiment-driven -10% to -20% drop).
  4. This creates the mentality of, Oh X happened and it hurt stocks. Since it happened, we can move on.

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Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

This article reflects the opinions, viewpoints and commentary of Fisher Investments MarketMinder editorial staff, which is subject to change at any time without notice. Market Information is provided for illustrative and informational purposes only. Nothing in this article constitutes investment advice or any recommendation to buy or sell any particular security or that a particular transaction or investment strategy is suitable for any specific person.

Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.