The first quarter of 2022 has drawn to a close, and US stock markets have delivered the first quarterly loss in over two years due to a range of factors like the ongoing geopolitical situation in Ukraine, surging global inflation and a hawkish change from the US Federal Reserve. Inflation had already reached 40-year highs in Q4 last year, with a +6.8% CPI reading in November 2021 and a +7.9% CPI reading in February 2022. The US Fed's George (FOMC voter and hawk) recently stated that it's appropriate to raise rates to the neutral level expeditiously. Balance sheet size needs to decline significantly if inflation is still high at the neutral funds rate; more hikes will be needed. Puts neutral rate at around 2.5% 'as a starting point'.
The ASX 200 has ended Q1 2022 with a +2.61% gain and was a relative outperformer of the US and global equity counterparts due mainly to the surging prices seen in the commodity space, buoyant Financial and Technology sectors. In Q1, Iron Ore has gained +40%, Nickel +55% and Natural Gas +61%, all pushing local producers skyward. For the month of March, the ASX 200 gained +6.35% on a total return basis to end just shy of the 7500 level, outperforming the S&P 500 by +2.77% on the month.
Commodity prices and interest rates have risen in unison over the past months, while the world's economies are adjusting to the supply chain issues and changes in consumer spending impacted by COVID. The Russian invasion of Ukraine was the fuel to the fire, pushing commodity prices even higher as harsh sanctions were imposed. Interestingly enough, the major US equity indices bounced a day after the initial invasion of Ukraine and have been trading higher since.
- US equity markets experience the first negative quarter in two years
- Commodity prices continue to soar, with agriculture, metals and energy rising rapidly
- Inverted yield curves seen in the US 2y/10y and 5y/30y spreads due to a fast rise in short-term rates
- Fed Funds Futures are now pricing 8-9 25bp increases in the federal funds rate by the end of 2022
- President Biden announced a release of 1 million barrels of crude oil per day from the Strategic Petroleum Reserve for six months
Australian Interest Rates
The RBA has so far taken a patient stance regarding any changes in the cash rate, but that didn't stop the AU 3Y yield from rising as high as 2.47% as inflation continues higher and the market begins pricing more aggressive action from the RBA down the track. Yields pulled back to close the month, in line with the US. However, in March, the AU 3Y yield still gained 80bps to close at 2.34%. Rising yields were also seen in the longer duration Australian Government Bonds, with the 10Y (+71bps) and 30Y (+63bps) yields trading higher, closing March at 2.84% and 3.24%, respectively.
US Interest Rates
In the opening days of 2022, futures markets were pricing in only three 25bps hikes for the entire year. Markets are now pricing in 8-9 interest rate increases of 25 bps, implying a 2.4% interest rate at the end of 2022. We saw the first 25bp increase at the March 16 FOMC meeting, with a unanimous agreement amongst all voting members, besides Fed President Bullard, who wanted to raise rates by 50bps. The statement released after the meeting was more hawkish than the market had anticipated, including the committee member's interest rate projections. As a result, the US 2Y and 3Y yields have risen the most so far this year, and we see inversions in the longer end of the yield curve. The 30Y yield is below the 20Y yield. The 10Y yield is below the 3Y, 5Y and 7Y.
Inverted Yield Curve
In the last week of the month, both the US 2Y/10Y and 5Y/30Y spreads inverted, and while curve inversion can be associated with an eventual economic recession, it's not of immediate concern as there can be a lag from between 1-2 years before we see a top in asset prices and the onset of a recession. Notably, the 3 month/10 year spread usually trades in a similar direction to the 2Y/10Y; however, it has currently blown out to 233bps, which could be a reflection of how far behind the curve the Federal Reserve is, rather than an economic signal.
US Equity Markets
Energy was the only sector out of the eleven to finish in the green for Q1, posting its best gains since 1989 (+38%) on the back of surging oil and gas prices. Communications stocks fell the most in Q1 (-12%), closely followed by Discretionary (-9%) and Technology (-8%) which had the largest drawdown in the period of (-21%). In the month of March, the Utility sector bounced (+10%) and broke out from a previous pre-pandemic high in February 2020.
Rates and Stocks
The large-cap Russell 1000 Value Index outperformed the Russell 1000 Growth index in the first quarter by more than +8%, while the respective Small-cap Value Index outshone the Small-cap Growth Index by over +10%. In the large-cap sector, this is the Value component's most significant outperformance since 2002. The Nasdaq 100 (-20%) and Composite (-19%) fell the most from the 1-year highs posting the largest drawdown of all indices. The S&P500 and Dow Industrials posted relative outperformance compared to the tech-heavy Nasdaq.
Growth Sector Bounce
After posting the largest drawdown of Q1, the Growth and Small-cap indices had a sizable bounce from their 2022 lows, although it may be temporary, and the real test lies in the weeks and months ahead. In March's closing days, IWM, an ETF tracking the Russell 2000 Index, ran into a critical technical resistance area that previously acted as support in the last 18 months around the $210 level, which is one to keep an eye on.
Commodities
After posting a gain of +27% in 2021, which was the largest annual performance since 1979, the Bloomberg Commodity Index surged a further +25% in Q1 2022. At the highs seen in early March, the index was up +42% YTD, its most significant quarterly advance since 1973. Brent Crude was up +79% at the high point in March before closing at +39%. This pullback in prices was partly due to the optimism around peace talks between Russia and Ukraine and President Biden announcing the largest Strategic Petroleum Reserve release ever. Other notable commodity market gains for Q1 include Palladium +18%, Soybeans +20%, Cotton +23%, Aluminium +24%, Corn +26%, Wheat +30%, Iron Ore +40%, Nickel +55% and Natural Gas +61%.
Looking Ahead
The March NFP jobs data highlighted that the labour market is increasingly tight, putting upward pressure on wages and prices in the economy. With the unemployment rate dipping further to 3.6%, compared to the prior month's 3.8% and wage growth lifted further from 5.6% up from 5.2% in February. The labour force participation rate is picking up; it's certainly not keeping up with the rising demand for workers. Economic data shows that the economy is robust, although increasing inflation is likely to slow things down in the months ahead and impact corporate earnings further. Although there seems to be little progress in talks between Russia and Ukraine, credit spreads are trading back around pre-crisis levels, which should be supportive of equity prices in the short term.