Is it time to enter the market?

Firstly, look at the overarching economic and market resilience. Previously, like most observers, it was difficult to see the logic of the full-scale invasion of Ukraine that is currently unfolding. However, we now know that this invasion is also a protracted stand-off between Russia and the West. The invasion of Ukraine affects the policy landscape such that there will be fast-rising prices exacerbating supply-driven inflation. The central banks will need to normalize policy to pre-covid settings, and they will find it tough to respond to any slowdown in growth. This would mean higher policy rates. The geopolitical risks have escalated, and global equity markets have declined further from the January lows to a full 10% correction from the start of the year, which will tempt many investors to buy this dip. This is not an uncommon thing because, in the last 20 years, virtually all corrections arising from geopolitical risks have been an opportunity to buy at a better valuation. The corrections from the Iraq War in 2003, the invasion of Crimea in 2014 and the North Korea tensions in 2017 saw the market rebound and recover after the market correction. Indeed, the market can be more resilient than we ever imagined.

Secondly, consider the rising interest rates. Warren Buffet has pointed out, “The value of every business, the value of a farm, the value of an apartment, the value of any economic asset is 100% sensitive to interest rates. The higher interest rates are, the less that present value is going to be. Every business, whether it’s Coca-Cola or Gillette or Wells Fargo — its intrinsic valuation is 100% sensitive to interest rates.” Growth stocks have a relatively high price-to-earnings multiple since investors base the company’s value on a history of high growth and future expected earnings, and thus when interest rates rise, these future cashflows will become less valuable. The cost of capital will also increase if these businesses rely heavily on debt. Value stocks, on the other hand, have lower price-to-earnings multiple and higher profit margins than high-growth companies, and the majority of them rely less on debt resulting in a lower cost of capital. Thus, they tend to suffer less during periods of high-interest rates. A good read on the impact of rising interest rates can be found here. The global equities measured by the MSCI AC World Index declined by 8% in January largely on concerns of rising inflation and interest rates, and this correction has caused a large number of global investors to be more defensive. Jerome Powell has signalled that elevated inflation and a strong economy makes it appropriate to hike rates in two weeks’ time. Now, due to the geopolitical tension caused by Russia’s invasion of Ukraine, there is uncertainty with regard to the pre-set path for rate hikes. After the January Federal Open Market Committee (FOMC) meeting, markets went as far as to price a 90% chance of a 50bp Federal Reserve hike on 16 March and up to 160bp of interest rate hikes for the year. However, expectations have been scaled back sharply in response to Russia’s invasion of Ukraine. As of 1st March 2022, it has shifted lower to a mere 25bp hike in March and 120bp in total by the December FOMC meeting.

Thirdly, look at the fundamentals. Those who are investing through the lens of fundamentals tend to be more bullish in 2022. They highlighted that equity market performance is more correlated to earnings growth than to the central bank balance sheet. Historically, in every cycle of the last 40 years, volatility occurs around first-rate hikes but markets always went on to make new highs in the years after the first-rate hike, even in the face of sustained rate hikes. So, for these investors, if growth is sustained, then markets are sustained. Moreover, the growth outlook for 2022 is strong. Prior to the invasion of Ukraine, global GDP growth was projected to be 4.4%, which would be the 2nd highest growth rate over the last 15 years and would be in the top 20% of growth levels in the last five decades. Corporates have also been resilient in the pandemic, and an average of 84% of companies beat analysts’ earnings estimates over the past four quarters. Global corporate earnings are expected to be significantly higher than before the pandemic and this expectation is in line with the robust global growth outlook. It is thus important to look at fundamentals before entering the equities market.

Last but not least, consider the known unknowns. As investors, we should consider the different scenarios that might happen. As for the current situation with Russia, there may be a quick cease-fire. Just today, Russia and Ukraine agreed to a ceasefire to evacuate 2 cities, but hours later, evacuation of civilians was suspended as Ukraine accused Russia of violating the ceasefire agreement. We are in a highly volatile situation right now. The west has cut off Swift access to the top Russian banks and blocked the Central Bank of Russia from liquidating its foreign reserves to support their local currency. This might raise uncertainties around the banking system. For example, when Lehman Brothers failed, it didn’t seem like it should affect the global financial system, but it eventually did, and this was one of the highlights of the Great Financial Crisis. The connection of global banks is important, and the failure of Russian banks can pose a risk to the financial system, especially to the financial institutions that hold Russian Assets.