U.S. Equities: Although U.S. equities rallied in March, they remain in negative territory year-to-date and may continue to face challenges from a dramatic increase in inflation and monetary tightening by the Federal Reserve. Recent comments from a number of Fed Governors about the need to begin to draw down the Fed’s balance sheet sooner and more dramatically than previously thought highlight the Fed’s newfound urgency in addressing elevated inflationary pressure. In addition, a recent widening of the TED spread (the difference between the rate banks charge one another and interest rate on U.S. Treasury Bills) could be an early warning sign of the potential for stress in the financial system. However, in the near term the outlook for U.S. equities remains mixed since the market could continue to benefit from the Fed’s prior extraordinarily easy monetary policy. There are areas of the U.S. equity markets that are more fairly valued and may provide some respite in these volatile markets, e.g., more value-oriented equities with higher quality balance sheets and growing dividends that could be less sensitive to rising rates and inflation.
European Equities: Elevated and rising inflation in Europe, alongside a still dovish ECB, does not bode well for Europe’s capacity to fight inflation which has been exacerbated by the war in Ukraine and the subsequent increases in the cost of energy. Coupled with negative investor psychology and the recent widening of European credit spreads, the outlook remains negative for European equities. However, should there be a cessation of hostilities in Ukraine, European equities could rebound.
Japanese Equities: Continued credit spread widening and flattening yield curve measures in Japan indicate the prospects for slowing growth in the region. The model maintains a negative outlook for Japanese equities in the near term.
Chinese Equities: In the first quarter, China equities were the worst performing equity asset class that we model, down nearly 28% at one point before China’s finance minister intervened to assuage the markets with stimulus that allowed the market to claw back approximately half of those losses by the end of the quarter. Negative factors impacting China include a flattening of the yield curve, widening credit spreads, and negative investor psychology. Recently, China has also struggled with the re-emergence of outbreaks of coronavirus, which could negatively impact prospects for economic growth.
Indian Equities: In the first quarter, India was the best-performing equity asset class that we model – down less than 3%. Positive factors for Indian equities include a steepening yield curve, well-behaved inflation, and tightening credit spreads. However, investor psychology in India is weakening. Along with the overall decline in the outlook for global equities, the outlook for India equities is mixed.
Fixed Income: Inflationary pressures and negative real interest rates continue to pose a threat to the income earned from owning bonds. At the same time, rising interest rates weigh on the value of bond holdings through price depreciation. Our research continues to favor U.S. Treasury Inflation-Protected Securities (TIPS) and U.S. Treasury Floating Rate Securities, which may perform well in an inflationary and rising rate environment. The outlook for Credit remains negative as the risk of continued credit spread widening could reduce the principal value of corporate debt..
Gold: Gold enjoyed solid investment performance in the first quarter, benefitting from a dramatic increase in inflation and the geopolitical uncertainty caused by Russia’s invasion of Ukraine. Although real interest rates remain negative (a positive indicator for gold), nominal bond yields rose more than expected inflation during the first quarter, meaning that real interest rates became less negative. Should real rates climb meaningfully in a sustained manner, gold would be vulnerable to a correction. Longer term, we value gold as a portfolio diversifier and a hedge against both global market turmoil caused by geopolitics and any abandonment by the Fed of its latest attempt to normalize monetary policy.
Commodities: Commodities were the top-performing asset class in the first quarter of 2022. The war in Ukraine and sanctions imposed on Russia by the west caused food and energy prices to rise and exacerbated already fragile supply chains and stocks of natural resources. However, like gold, the outlook for commodities can be negatively impacted should nominal bond yields continue to rise more than inflationary expectations. In addition, the influence of the model’s negative outlook for economic growth in China is a negative factor for commodities. However, by our measures, the yield curve in the U.S. remains steep enough to indicate the potential for economic growth in the near term, which would benefit commodities. Consequently, the commodities outlook remains positive.
DISCLOSURES: This commentary and analysis is intended for information purposes only and is as of March 11, 2022. This commentary does not constitute an offer to sell or solicitation of an offer to buy any securities. The opinions expressed in View From the EDGE® are those of Mr. Folts and Mr. Biegeleisen and are subject to change without notice in reaction to shifting market conditions. This commentary is not intended to provide personal investment advice and does not take into account the unique investment objectives and financial situation of the reader. Investors should only seek investment advice from their individual financial adviser. These observations include information from sources 3EDGE believes to be reliable, but the accuracy of such information cannot be guaranteed. Investments including common stocks, fixed income, commodities, ETNs and ETFs involve the risk of loss that investors should be prepared to bear. Investment in the 3EDGE investment strategies entails substantial risks and there can be no assurance that the strategies’ investment objectives will be achieved. The regions included in our Equities category are measured based on the S&P 500 and MSCI indices. Real Assets (Gold & Commodities) includes precious metals such as gold as well as investments that operate and derive much of their revenue in real assets, e.g., MLPs, metals and mining corporations, etc. Intermediate-Term Fixed Income includes fixed income funds with an average duration of greater than 2 years and less than 10 years. Short-Term Fixed Income and Cash includes cash, cash equivalents, money market funds, and fixed income funds with an average duration of 2 years or less. Past performance is not indicative of future results.