Postponing the Apocalypse – at least for Now

Maybe the worst is already behind us even if we don’t realize it

09:00 | 2 декември 2022
Снимка: Michael Nagle/Bloomberg
Снимка: Michael Nagle/Bloomberg

By Nikolay Vanyov

Stock markets in the months since the start of Russian aggression against Ukraine have, like all financial markets, been a testing place for investors' nerves. The latest movements of the indices show us that certainly the volatility has not left the markets, but almost certainly the apocalypse, which was heavily talked about until the end of September, is postponed - at least for now.

As the autumn progressed, the major indices moved higher, with movements supported by some economic and geopolitical events. The development of the war in Ukraine has taken the direction of a Ukrainian offensive, with the offensive in the east and the recapture of Kherson giving reasons to some analysts to believe that the war may end with a victory for Ukraine, although the main opinion remains for a protracted conflict. Europe, on the other hand, trembled (somewhat literally) in anticipation of autumn, but with the onset of the colder months, this effect turned out to be rather the result of abstinence from Russian energy resources. Gas storage is full, and a warm October has kept gas consumption low, so the energy crash that many analysts predicted in the summer will certainly not happen. As its residual effect remains the storm in a glass of water related to the supply of diesel fuel in the EU.

Economists and monetarists are still staring to the inflation but the most recent data in USA and Europe shows a somewhat expected easing in consumer prices with the possibility of deeper declines to come. Central banks have acted decisively on interest rates, with expectations that future hikes will be more dovish (especially from the ECB). An economic recession may not take place, especially in the US, while no one doubts that at the first moment of calming inflation, central banks will again act actively to support growth.

The mixture of these factors was highly positive for the stock markets. The US gauges Dow Jones Industrial Average and S&P 500 have gained nearly 17% and 11% since the end of September, limiting their year-to-date declines to less than 8% and 16%, respectively. At the same time, however, the technology NASDAQ Composite is up less than 6% since the start of October, and is down more than 28% for the year. The differences in the movements of these indices deserve more attention, but the movements themselves from the beginning of October to the middle of November (let's recall the general tone in May, when an almost apocalyptic winter was foreshadowed) mean a lot.

Stocks gain back their attractiveness for the investors as it is yet to be found out for sure if this movement is a correction or turned upside down trend. It is for sure that the risks in the queue are still in full force (escalation of the war in Ukraine, use of nuclear weapons by Putin, deep stagflation, further escalation of the geopolitical situation along the US-China axis, etc.) and lead to both additional volatility as also to the possibility of deep and unexpected losses for investors. It's just that the situation now looks much better than it did in September. Delving deeper into the sectoral differences in stock markets, we can't help but be struck by the difference in the behavior of the NASDAQ Composite Index versus broader market gauges.

The technology sector turned out to be a more severe victim of uncertainty in 2022 than the real sector. Companies from the FAANG group have definitely surprised investors negatively - Facebook owner Meta has lost more than 66% of its market capitalization since the beginning of 2022, Google owners Alphabet has lost nearly 34%, Netflix is ​​down 50%, Amazon is down 41% , and Apple, with only 17%. Tesla Inc. stock prices and they lose 46%. By comparison, shares of Goldman Sachs have remained largely unchanged since the start of the year, despite a major hike in US key interest rates, as well as deep price declines in bond markets, which are sure to weigh on the banking sector's performance. At the same time, heavy machinery manufacturer Caterpillar Inc. has added 15% to its market capitalization since the beginning of the year, and mining company Chevron Corp. – nearly 60%.

This shows us that the most daring sectors of the stock market have definitely seen a period of sobering up. Whether it's about Mark Zuckerberg's metauniverse, about the expectation of infinite user growth at Netflix, about another concern about the sustainability of Tesla's business (and the health of Elon Musk, who created an unprecedented fiasco for $44 billion with the acquisition of Twitter, which indirectly costing investors in the electric car maker dearly as well), stocks in the broad tech sector fell victim to a serious market sobering. This process is related to the investors' realization that some of the projects and businesses in these companies can only be developed in an environment of constant economic growth and serious monetary support. With economic uncertainty and high inflation, the businesses themselves are running out of opportunities for investment in these projects, they are looking for reorganizations, and investors are looking for the security of established companies.

In Europe the situation is quite similar. The Euro STOXX 50, a gauge of the eurozone's biggest public companies, has risen 19% since the end of September, limiting its annual decline to just over 9%. Figures for Germany's DAX were similar, while France's CAC 40 rose 17% - to an annual decline of just over 7%. The weirdest on the Old Continent is the case of the English FTSE 100, which, despite the internal political cataclysm called Liz Truss, by mid-November is at its levels from the beginning of the year. If nothing else, these moves and results come to show us that investors don't think Europe is doomed to extinction without the services of a “Россия“ gas station. As well as that the prospects for the Continent are far from so gloomy.

What should investors do in the current situation? We hear about using the "buy the dip" strategy more and more which in its essence means buying shares in falling markets. With a good reading of index lows and bottoms, such a strategy in the broad S&P 500 could yield returns of over 50% for investors when applied inversely to past movements. However, it is highly speculative and can lead to serious losses.

The most sensible investment behavior in the stock markets, despite the volatile environment, uncertainty and serious tail risks, is to set a long-term horizon with achievable goals and consider the risk and the expected rate of return. Stocks have historically been a good refuge from inflation, although volatility in a high-inflation environment such as the current one has led to worse performance in the short run. That is why it is important for investors to structure their portfolios well according to their needs and ability to take risks, not forgetting that stocks remain and are a long-term investment tool. And the markets have shown us that, perhaps, the worst is already behind us, even if we don't realize it.

THE BOTTOM LINE An economic recession may not take place, especially in the US, while no one doubts that at the first moment of calming inflation, central banks will again act actively to support growth.