Market Recap

Posted on March 25, 2022 by Gemmer Asset

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Large-cap U.S. stocks pushed higher this week and bond yields jumped. Most equity sectors performed reasonably well, with energy leading the way. Healthcare was the only sector in the red. Over the last month every sector is in the green, with gains ranging from +2.4% (consumer defensive) to +14.1% (energy) . Why the rally? Of course, there are no end of pet theories floating around, but in our mind it boils down to the recession bet. As you can see below, the correction in stocks this year is about on par with other large sell-offs that haven’t been accompanied by recessions (red bar is current decline, gold bar is the average sell-off).



If you don’t think a recession is on the horizon, the thinking goes, now is not a bad time to add some equity exposure. Of course, if there’s a recession this year all bets are off. But for the time being, the thinking is the recession risks are probably less than 1 in 3 despite the spike in energy prices and the inflation/Fed tightening headwinds. We will see.


Turning to the bond market, the jump in bond yields is becoming one for the record books. For example, the quarterly move in 2-year Treasury yield is now the largest since 1984 (chart below).



Maybe some of you remember Orange County’s bankruptcy back in 1994? It was trigged by a big jump in bond yields combined with a lot of leverage taken on by the County’s treasurer, Robert Citron. You have to wonder who is swimming naked this cycle?


The move in yields is underpinned by a Fed that is growing more and more sure about the need to hike rates this year. Last week they bumped up the Fed Funds rate by quarter-point. It is looking more and more likely we will see half-point hikes at the next two meetings. Goldman’s timeline below is the general consensus now.



As you would expect, the move in government bond yields is spilling over into mortgages. The rate on the 30-year fixed mortgage is quickly approaching 4.5%…



… and we’ve seen the largest two-week increase in mortgage rates in the last 30 years. The other two spikes are as follows:


1) +68 bps (June 2009)
2) +67 bps (April 1994)
3) +57 bps (March 2022)


This will be an interesting test for the sizzling housing market. How will buyers and sellers adjust to higher rates? Will inventory levels start to build, ultimately weighing on prices? Time will tell – maybe we end up with a situation where sellers can’t afford to sell (you still need to buy somewhere, right?) and buyers can’t afford to buy. It’s notable that pending sales are already starting to fall.



A Scramble for Fossil Fuels


Europe is in a tight spot when it comes to energy supplies. The graphic below captures the hole they need to fill if they cut off Russian oil and gas exports.



To put just one number in perspective – the shortfall of 11.4mm barrels of oil per day roughly equals Saudi Arabia’s entire production. That’s a big hole to fill!! To some extent Europe has put themselves in this situation. They have cut oil and gas production significantly the last few years with no clear alternatives other than Russian supplies. You can see below how much. European natural gas production has fallen since 2000 relative to the increased imports from Russia.



Be that as it may, it looks like a massive move towards liquified natural gas imports from the U.S. are in the works. But this takes time, and as it turns out Germany doesn’t have its own LNG terminal. This is all leading to a couple of interesting trends – one predictable, and one less so (at least before COVID changed the rules of the game).


The first implication, obviously, is that energy prices are rising. Crude oil, diesel, gasoline, natural gas – it doesn’t matter, it’s all getting pricier.


The second trend is the move by western governments to cushion the blow for consumers through more fiscal spending (deficit financed of course!!). This is a list of just the main announcements this week:


1. Germany. To quote the FT, “On Thursday, Germany’s ruling coalition decided on a €15 billion package aimed at ameliorating the impact of higher energy costs on households and businesses. In addition to cutting the fuel tax, Germany will also give taxpayers a one-time €300 payment and a €100 child support subsidy. In a bid to increase the appeal of public transportation, a €9 monthly ticket will be introduced.”


2. United Kingdom.



3. Quebec



4. Japan.



5. California.



And California being California, the checks will go out to owners of electric vehicles as well (at least according to Politico)!!


Put aside for a minute the logic of fiscal spending to support energy consumption. One clear consequence of COVID is that fiscal policy is now the policy option of choice to deal with any perceived crisis. Could you imagine the package of initiatives if we actually had a recession in the next few years?


It’s really no surprise why bonds are performing so poorly this year.


Charts We Found Interesting


1. COVID cases in the U.S. are down 97% from their peak in January. Now at their lowest levels since last July.



2. Why are death rates in Hong Kong suddenly so high? They’ve done a lousy job of protecting those most at risk.



3. The size of the Russian/Soviet economy relative to the rest of the world over time. How far can it fall?



4. The human consequences of this are very worrisome.



5. Egypt asked the IMF for help this week. They are unlikely to be the last.



6. If you think California has been unusually warm for this time of the year – take a look at Antarctica. Urrgh.



7. Africa is big – very, very big.





Have a good weekend.




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