A tumultous week for markets

A week ago, I warned in this column that geopolitics could throw a spanner into the market. It has happened.

Israel retaliated against Iran for its earlier missile strike, sending shockwaves through the market and investors scurrying for cover last Friday. 

All this could not have happened at a worse time for markets, which were already trending down after Jerome Powell said inflation was too high to contemplate rate cuts at the moment.

As is the case when geopolitics spins out of control, oil spiked to past US$90 pbl, while gold hit a new record close, and the greenback hit multi-month highs.

On Wall Street, a 10 per cent drop by Nvidia capped a tumultuous week.

A Friday recovery saw the Dow Jones Industrials close almost unchanged for the week at 37,986 points. 

The S&P 500 stumbled below the key 5,000 points level for the first time in two months, closing 3 per cent lower at 4,967.23 points. A sharp selldown on Nvidia led tech stocks southwards, hammering the Nasdaq down some 5.5 per cent to 15,282.01 points.    

 In Singapore, the Straits Times index fell 1.3 per cent to 3,176.51 during a week where trading volume was heavier than usual.

Jitters over events in the Middle East saw the SPDR Goldshares ETF gain 0.3 per cent on Friday to end the session at US$220.9/unit, but end the week down 0.4 per cent. A week ago, on 12 April, the SPDR GoldShares Exchange Traded Fund (ETF) traded above S$300 a unit for the first time in history, and closed again above that level last Friday.

So what next? 

After a retaliating against Iran’s retaliation for bombing its mission in Syria, Israel seems to be sitting back for now. Western powers, led by the US, are scrambling to get both sides to draw a line under the events of the week. If that happens some calm could return to the markets. 

As BCA Research observed: “The implication is that Israel chose not to escalate the risk of direct war with Iran. Hence we remain in our base-case “Minor War, Minor Oil Shock” scenario.”

If some semblance of calm returns to the Middle East this week, the focus will shift back to the Fed, inflation and interest rates.

Jerome Powell says inflation is too high to contemplate rate cuts at the moment: “Lack of progress” this year: “The recent data have clearly not given us greater confidence, and instead indicate that it is likely to take longer than expected to achieve fundamentals and a robust labour market, but added that current policy should remain intact.”

Fed policy rate is now at 23 year highs following 11 consecutive rate hikes since March 2022. High-for-longer rates will ultimately impact corporate bottom lines and consumer bank books. The question is when this will show.

So far, the job market remains resilient, and unemployment is near record lows. Consumer spending is robust. Corporate earnings remain resilient. Economy remains generally healthy. The markets have rallied to record highs. Whether they remain so is not a certainty.

Three weeks ago, Mr Powell confidently said that recent strong economic data had not altered the overall picture of inflation moving down toward the Fed’s 2 per cent target. Last week, after a  consumer price index reading, a producer price index print, a jobs report, and a retail sales update, his tone was significantly different. 

With the latest pronouncements, financial markets are calculating the probability of a June cut at just 14 per cent, according to CME’s FedWatch tool.

The Fed is now at the hardest part of its job juggling inflation, interest rates and the economy. Cut rates too early, inflation re-accelerates. Cut too late, the economy could ultimately crash into a recession.

Stephen Innes, managing partners at SPI Asset Management, reckons equities are now adjusting to the recalibration of the Federal Reserve’s less dovish monetary policy trajectory and broader interest rate dynamics. 

“Indeed, over the past trading week, there has been a collective reassessment of the likelihood of Fed rate cuts amid thoughts of a higher terminal rate, effectively setting a much loftier implied floor for market discount rates, which serves as the foundation for the rest of the yield curve, and a less bullish springboard for stocks.”

Meanwhile, the Middle East still remains an unpredictable tinderbox. Any further conflagration could seriously impact energy and commodity prices, send gold and the greenback even higher. All bad outcomes as far as risk assets are concerned.

How should investors be positioned?

Terence Wong, founder and CEO of Azure Capital, reckons investors would refrain from impulsively dumping their portfolio. 

“It’s wise to observe how the situation unfolds,” he said. “If the current tit-for-tat concludes with Israel’s latest attack, market reactions may stabilise. 

However, if the conflict escalates, it could trigger significant challenges in the Middle East, he added. 

“This could lead to a surge in oil prices, consequently driving inflation up once more. In 2022, when inflation surged due to Covid and the Russia-Ukraine conflict, the US Federal Reserve responded slowly. This time, the response may be quicker, potentially resulting in interest rate hikes in the US rather than cuts. Such actions could adversely impact global stocks.”

Thilan Wickramesinghe sees a need to recalibrate portfolios as the sands shift somewhat.

“We think investors should be weighted towards defensives in Singapore, with a track record of margin preservation amidst cost hikes,” he said. “We think banks, telcos, tech manufacturing sectors could offer value, earnings visibility and downside protection.”

Vasu Menon, managing director for investment strategy at OCBC Bank reckons in the short term, investors here will have to brace for more volatility and possible more downside for regional markets and the local bourse depending on how developments in the Middle East play out.

“Much will also depend on the direction of the US Dollar which may continue to strengthen against regional currencies given its safe haven status amidst tension in the Middle East. If the greenback strengthens then regional currencies will weaken and so will regional bourses and the local markets,” he said.

But as Kelvin Tay, regional chief investment officer for APAC at UBS noted, geopolitics don’t usually have a long-lasting impact on asset prices. 

“Capital markets are driven mostly by fundamentals, especially in the commodities space,” he said.

Also, while some companies and their stocks - notably those in travel and hospitality related sectors - during times of geopolitical tumult, others could benefit.

John Cheong, analyst at UOB Kay Hian, reckons oil & gas related names like RH Petrogas, Rex, Marco Polo Marine, Beng Kuang Marine, Atlantic Navigation and Mermaid Maritime could benefit from higher oil price.

But expect another bumpy ride for markets in the coming week as volatility is the only certainty for now as geopolitical uncertainties in the Middle East and inflation and interest rate fears continue to keep investors on the edge.

In the short term it makes sense for investors to be cautious. But the broader medium-term outlook remains positive given good economic and earnings fundamentals and an abundance of liquidity on the sidelines. These could come into play once the Fed and other major central banks begin rate cuts.

As such, sharp market pullbacks can offer buying opportunities for those with the risk appetite and patience.

Looking at key economic data for the week, all eyes will be on the closely watched March US Personal Consumption Expenditure inflation indicator scheduled for Friday. Any upside surprises will be unwelcome news for investors and could fuel more concerns about inflation and cause even greater market volatility.

The first estimate of the first quarter US Gross Domestic Product (GDP) growth will also be released this week. Market consensus compiled by Bloomberg is projecting a slowdown in growth to 2.3 per cent, from 3.4 per cent in the fourth quarter. 

The preliminary PMIs for the major economies for April will be released this week. There has been a clear upswing across almost all countries as the manufacturing sector seeks to put the threat of recession behind it. Markets could see at least a modest extension of that recovery.