The week that was

On the face of it was a fairly quiet week leading into the Easter break with most markets ending flat for the shortened week. However, you didn’t have to look too far below the surface to find volatility which continues to manifest itself in energy markets and US tech stocks, sectors whose fates have become strangely intertwined. The increasingly intractable and deadly outlook in Ukraine is forcing European politicians to consider boycotting Russian oil and gas (or at least weaning their economies off it sooner) which is sending energy prices and inflation higher. Even stripping out usually volatile energy and food prices the flow on effects of higher input prices combined with tight employment markets is potentially stoking a wage price spiral and cost of living concerns that are affecting people and politics from France to the US. So even though there were grounds for tentative optimism in last week’s US CPI numbers (used car prices at least started to abate) the pressure on the Fed to tighten monetary policy has increased, even amid signs of a slowing global economy. The upwards pressure on short-term interest rates is well documented but the winding down of the Fed’s balance sheet (discussed in this week’s video with Andrew Hunt) is less well understood. The idea is that the Fed buying bonds suppresses long-term interest rates and lowers the cost of capital for companies who borrow. It has elevated the values of houses and tech stocks whose long duration earnings are particularly sensitive to shifts in long-term interest rates.

All of that resulted in a noisy environment for energy and inflation, leading to long-term interest rates seesawing on successive days and the NASDAQ index moving up and down by 3% all week, ending up down more than 2%. The more industrially focused US Dow Jones index, and most European and Asian markets were down only slightly. The Australian market was again one of the best performing markets and ended slightly up for the week mainly due to the contribution of the iron ore and gold miners.

Credit spreads eased again slightly so, with rates heading up as well, this year has been death by a thousand cuts for many bond investors. In the US and globally, blue chip investment grade corporate bonds were down another 1.5% last week bringing year to date losses to almost -15%, of which 2/3rds is due to interest rates and the rest higher credit spreads. While credit spreads in the small but relatively high-quality Australian bond market have remained quite tight most diversified bond managers in Australia have also been paddling against the wind, usually with some interest rate risk in their portfolios and local government bonds also down by 6%. That means most of these diversified bond funds are also down 1-3% for the year but last week there were signs of life and we saw some of the managers we follow closely up over 0.5%. Many local bond managers feel that the market, especially in Australia, has moved too far with local 10-year rates surpassing 3% last week and have positioned for a risk-off rally in bonds. Incremental, one-way upwards pressure on yields and credit spreads has provided little scope for opportunism but maybe the noisy cross-currents of inflation, geopolitics, post-COVID earnings and monetary policy will provide a more fertile environment form this higher yield starting point.

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