Geopolitical Developments: The Status Quo Returns And That Will Protect Markets From The Bears

Both the Russian Bear and the market pessimists are waiting to pounce again but neither are likely to send global equity markets into real bear markets. The correction that began in the New Year is set to resume in a few days but the next leg lower will be the last and set the stage for a new rally back to old highs later in February. For now the markets are relieved at the prospect of little change to expectations about the economic and geopolitical course of 2022 and are moving higher to test key resistance levels. The volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is short-term bullish. Yesterday's cross-asset action brought several positive factors for US stocks. Copper's chart is signifying global growth. The action in the € & EM currencies indicates the $US is weak. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to rise modestly over the next few days before making one last leg lower in this correction phase.

While inflation hawks suggest the Fed will raise rates 5-7 times and thus force valuations permanently lower the opposing case is the status quo is extending in both political and economic terms with only modest changes. The case for such optimism lies in confidence that global policymakers are sound and in touch, with little desire to rock the boat. China is handling its problems while gradually shifting to the left, giving markets time to digest a new regulatory regime. Biden is making progress on an Iran deal that would presumably help bring energy prices down, while shoring up US-EU unity in response to Putin’s threats. Domestically he can take some credit for slightly increasing vaccination rates, and for dealing with Mexico to keep border crossings from flaring up. In Europe Germany has gotten into line with the US and NATO on Russia, while Italy is keeping the political status quo and reform agenda.

On the eve of the Olympics China wants to increase its stature rather than slide off the radar, consequently Putin is unlikely to do anything militarily in Ukraine, other than modest cyber warfare. The key risk for China is actually Myanmar and the newly battailous Kim Jong Un, two issues the market has discounted and which can only affect investors if something shocking were to occur. So the beginning of February is calming and that will help keep markets from trading far below last Monday’s lows.

The global economic backdrop is also supportive for earnings. China is gradually shifting leftward, which poses no immediate risk to Western MNC earnings. Fitch notes “The shift of China’s top economic goal in 2022 to stabilise growth is likely to moderate concerns over regulatory shocks in the corporate sector as the government refines industry policies to avoid economic disruptions, says Fitch Ratings. Strict supervision and scrutiny of private capital, however, is likely to become a new norm, with the aim of directing capital to the state-encouraged areas…The policymakers are likely to accelerate infrastructure investments as a key economic stabiliser, and bolster domestic consumption while overseas demand remained uncertain.”

And inflation is highly likely to decline severely in the West, while in Asia it’s not even an issue. ING notes Asia is not raising rates like eastern europe because it doesn’t have a major inflation problem: “In very general terms, the main reasons why any Asian economy might want to aggressively raise rates are simply not present. Namely: Inflation – Asian Inflation is reasonably well behaved. There are some exceptions to this, but generally, inflation is not a big problem. Currencies are also fairly well-behaved – there has been some modest weakness vs the US dollar, but not much. In the case of China, the Chinese yuan has actually appeared to decouple from euro/US dollar movements thanks to enhanced capital inflows. There’s consequently no blanket requirement for regional central banks in Asia to support currencies with higher rates. And current accounts are more balanced than they were. This is generally a strong current account surplus region anyway with floating exchange rates. But even where the external balance has historically been in deficit, the pandemic has tended to restore balance, and there is little need to squeeze domestic demand any harder on this account through higher rates.”

So I expect the markets to move a little higher this week and then fall again as the correction enters its deepest phase and then peters out. Only a shocking event can cause investors to reassess their forecasts for robust corporates earnings growth in 2022.

On Monday I sold some of my position in the levered ETF UPRO, and consequently I have a sizable cash position again. My other current positions are: Amgen (AMGN), American Express (AXP), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.