Russian roulette
Then there are the current tensions between Russia and Ukraine, though investors would do better looking at the value of credit default swaps (CDS) than the 100,000 Russian troops massing on the Ukrainian border, Van der Welle says.
“The current Russian government CDS spreads are only one-third of the levels observed around the peak of the 2014 crisis when they annexed Crimea,” he says. “Back then, CDS spread levels were at 600 basis points, and now they’re about 210 bps. We can therefore be quite confident to say that this risk is underpriced.”
“Putin could try to conquer the disputed Donbas region of Eastern Ukraine after returning from the Winter Olympic Games in Beijing, but his broader ambitions face constraints given severe retaliatory sanctions from the West. One thing to remember is that any country with a disputed border is very unlikely to become a NATO member. So this could all be short lived.”
“The crisis is therefore unlikely to create a new bear market, though it could push the oil price up from the present USD 89 a barrel above the sensitive USD 100 level. But all in all, that seems to be a manageable risk.”
A less-friendly Fed
The fourth and final risk is more serious, and not that easily countered, and this circles back to what caused the January correction in the first place – a less market-friendly Fed. Hiking rates is one thing, but quantitative tightening is quite another, he says.
Stock market multiples could decline accordingly with a shrinkage in the Fed’s balance sheet, reversing the process observed during quantitative easing, Van der Welle warns.
“The US stock market valuation is still historically elevated when you look at the conventional price/earnings ratio of the S&P 500,” he says. “Multiples all fell when the market sold off in January, but the S&P 500’s P/E ratio is still 30% above its 40-year historical average.”
“The big question is whether the Fed is indeed becoming less market friendly, and that remains to be seen. If inflation risks are decelerating then the Fed guidance could become less aggressive in the second or third quarter, and that could also lead to rate hikes moving further out.”
Still constructive on equities
“So long as growth rates in developed markets remain above trend – and that is our base case – we think that equity markets can handle a further rise in real interest rates and take all this in their stride.”
“Though dips are not as easily bought as in recent years, this correction does not herald the end of the bull market in equities, nor does it signal the passing of the expiration date of the TINA (There IS No Alternative) trade.”
“Current relative valuation metrics like the equity risk premium tell us to be guarded, as downside risk is rising, though history shows that stocks typically still outperform bonds at these levels. We are still constructive on equities for the next 12 months and retain a modest overweight in the multi-asset portfolio.”
