A New Era of De-globalization

Leo Wealth

For the third consecutive month, most financial assets posted negative returns in March. The global equity market has been down about 6% since the start of the year. Caused by on the one hand, the war in Ukraine and its impact on global commodity markets, and on the other hand, by the increasingly aggressive rhetoric from the Federal Reserve.
Fixed income markets performed especially poorly amid heightened inflation pressures globally. The global bond market lost 6.6% in the first quarter, a big loss especially compared to the low yields.
Positive returns from U.S. stocks were the exception among global equities in March. Chinese stocks were the major underperformers, highlighting concerns about the economic impact of COVID-19 lockdowns during already weak domestic demand. European stocks also performed poorly last month on the back of the economic risks due to the war in Ukraine, which also caused the EUR/USD to fall below 1.10.
Commodity markets were again the outperformers in March, continuing the trend from the prior two months. Notably, industrial metals prices rose sharply. This performance highlights both the negative impact on supply stemming from Russia’s invasion of Ukraine and Europe’s need to diversify energy supplies which will increase demand for industrial metals. Among the other commodities, upside pressure on oil prices persisted while gold benefitted from its role as a safe haven asset and hedge against inflation.
We continue to expect above-trend growth and above-target inflation in the U.S. and other developed economies this year. Q1 growth in the U.S. is likely to be around 4% as the pandemic continues to recede in the coming months. Given the rise in consumer prices in the U.S. and other developed economies, above-trend economic growth explains the hawkish monetary policy shift by central banks.

The Economic Consequences Of The War In Ukraine

Vladimir Putin’s invasion of Ukraine is probably best characterized as a severe misjudgment, not an irrational decision. That is good news for investors. The likelihood of a major escalation beyond Ukraine’s borders is low, as are the odds of an escalation to nuclear war. However, it seems likely that most of the imposed Western sanctions on Russia will be permanent and thus will impact economic activity and consumer prices beyond the near term.
The evolution of the war in Ukraine will ultimately determine the performance of financial assets going forward. The conflict will continue to weigh down on financial markets as the situation there remains unstable and is generating upside pressure on inflation and inflation expectations. This will likely mean that the market will remain unsettled and volatile near term.
Given that macroeconomic fundamentals remain favorable, we are more optimistic about the outlook for risk assets in the second half of the year, once the conflict stabilizes and inflation peaks.
While the direct economic effects of the war on global growth are likely to be modest, given that Russia and Ukraine represent less than 2% of the global economy in dollar terms, the indirect effects could be sizable.
Russia is a key player in the global energy and metals markets. Ukraine is also a sizable agricultural producer. Ultimately, the war’s impact on global growth will depend on how long it lasts.
The war broke out because Russia viewed a Western-allied Ukraine as an intolerable threat to its national security. Its grand historical strategy calls for buffer space against western military forces. Moscow feared that time would only deepen Ukraine’s bonds with the West, making military intervention difficult now but impossible in the future.
As long as Russia fails to neutralize Ukraine in a military-strategic sense, the war will continue. President Putin cannot accept defeat or the current stalemate and will likely intensify the war until he can declare victory, at least with the goal of “de-militarization” of Ukraine.
So far, Ukraine’s battlefield successes and military support from NATO make an outright Russian victory unlikely, further extending the war. A ceasefire might be possible if Ukraine and Russia provide each other with acceptable security guarantees. But up to now, Ukraine is unwilling to accept de-militarization and the loss of Crimea and the Donbas, which are core Russian demands.
Stocks should rally in the second half of the year as the war stabilizes or a potential ceasefire is agreed and energy prices come down. There are still many tailwinds supporting the global economy, which would support higher equity prices on a  12-month horizon.


The longer-term impact of the Ukraine war can be significant. China, Brazil, and India’s refusal to condemn Russia’s attack on Ukraine will drive a further wedge between the West and the rest of the world.
The disruption in energy and commodity supply will force every government to rethink its long-term energy and industrial strategy as part of its national security strategy. Countries dependent on importing energy, like Europe, China, and Japan, will try to speed up the transition towards renewable energy sources. This time not for environmental reasons but out of national security considerations.
The second part is the successful financial war that the U.S. and Europe are waging on Russia by excluding the country from the global financial systems and effectively confiscating half of its national reserves. Russia can withstand this better than other countries as it is self-sufficient in energy and agricultural production. Such financial sanctions would be economically devastating for countries with a more trade-oriented economy.
The world has become more globally integrated in the past two decades, with countries reliant on the global supply chain. The pandemic and Ukraine war have severely disrupted the supply chain and will encourage countries and companies to bring the supply chain more under local control again. This shift will likely lead to a reversal of globalization in the coming decade. The impact on financial markets remains to be seen, but the market will likely experience more volatility in the years ahead.

Is There a Risk Of Stagflation?

Both the war and recent developments in China have shifted the outlook further in a stagflationary direction. Stagflation would mean softening economic growth while inflation stays high.
Stagflation has a negative connotation because of the 1970s. However, the problem during the 1970s was the combination of high inflation and a bad labor market, leading to social and political unrest.
With the economy plagued by both high inflation and high unemployment, the Fed faced a dilemma back then: Keep interest rates high, and the already weak labor market would worsen, or keep interest rates low and inflation would spiral out of control. Throughout the 1970s, the Fed chose the latter option, causing inflation expectations to become unmoored.
Today the economic picture is very different. Union membership stands at only 10%, and there is also no labor supply shock on the horizon comparable to the baby boomers or women entering the labor force.
This makes the calculus for the Fed easier. With its employment mandate already met, it will simply keep raising rates until inflation is back under control. A strong labor market is positive for the economy longer-term.

Equity Markets

The earnings season will start again in the coming week, and the bar for positive earnings surprises for Q1 is relatively low. According to Refinitiv/IBES data, S&P 500 earnings are expected to fall by 4.5% in Q1 over Q4 levels. We expect earnings to surprise to the upside, and that could support equity markets, although the earnings outlook for companies will be more complicated.
Global equities currently trade at 18-times forward earnings. Relative to real bond yields, stocks continue to look reasonably cheap. Even in the U.S., where valuations are higher, the earnings yield on stocks exceeds the real bond yield by 570 basis points. At the market’s peak in 2000, the gap between earnings yields and real bond yields was close to zero.
Valuations are especially attractive outside the U.S. where equities trade at 13.7-times forward earnings. Emerging markets trade at a forward P/E of only 12.1.
Therefore we think international equity markets can outperform the U.S. market over the next 12 months. In general, international markets perform best in an environment of accelerating growth and a weakening dollar, precisely the environment we expect to prevail in the second half of the year. We continue to favor quality and value stocks.

Fixed Income

For years investors have viewed fixed income as the stabilizer in their portfolio that would steadily generate income and soften the losses of their equities. This has certainly not been the case as of late for bonds, with the Barclays Aggregate Bond Index down 6.6% YTD. Many fixed-income investors are left searching for alternative income sources, while others question whether they should continue holding bonds.
Since the start of the year, global government bond yields have been up aggressively. The U.S. 10-year Treasury yield is now at 2.7%. That is higher than we forecasted the yield to be by the end of the year. This created the unusual situation that this year government bond prices are down more than equity markets. The U.S. 10Y Treasury ETF is down almost 10% since the start of the year.
There are legitimate arguments in favor of aggressive Fed tightening. Still, our view is that seven rate hikes from the Fed over the coming 12 months are likely too aggressive. A peak in headline inflation over the coming months will help restrain longer-term household inflation expectations.
We believe it is likely that the Fed will initially seek to raise interest rates at a pace in line with current market pricing, but that it will likely slow the pace at some point beyond the next three to four months. As such, we expect that the Fed will ultimately raise interest rates five or six times over the coming year – less than investors currently expect.
The case for aggressive ECB hikes was weak even before Russia invaded Ukraine. European core inflation is nowhere near as strong as in the U.S., and the European economy has not yet recovered to its pre-pandemic trend. Russia’s invasion has disrupted natural gas flows that will keep European gas prices at elevated levels and has pushed up inflation. Nevertheless, we think it is unlikely that ECB policy will turn more aggressive in the near term.


Commodity prices were already rising because of rising inflation and a mismatch between supply and demand caused by a global energy transition that requires a lot of metals.
Russia’s aggression has caused Europe to pursue a rapid timeline to divest itself of Russian natural gas imports. While this plan will likely involve a period of increased use of conventional fossil fuels and the return of nuclear energy, it will also very likely involve the aggressive construction of renewable energy projects. In effect, Russia’s invasion of Ukraine has significantly sped up Europe’s decarbonization timeline, implying that commodity prices can rise further in the coming years.
The war in Ukraine also increased food and industrial metals prices. It will further upset the global supply chain at a time when global shipping costs had already been rising because of China’s Omicron-related lockdowns of major economic hubs.
Russia is a large energy producer, and the invasion has caused energy prices to rise. Russia’s largest customer, Europe, is still excluding energy from the sanctions. Meanwhile, we will see an increase in energy production in other parts of the world, notably the U.S. We expect oil prices to decline over the coming several months.

Portfolio Allocation

As highlighted above, equity markets are not overpriced, and we expect companies to continue to deliver solid earnings. Given the rising yield environment, we favor quality and value stocks. Also, we think that international markets could outperform the U.S. market going forward. Our core portfolios have been more defensively positioned since December, and we will stick to the strategy for the moment.
Despite the recent poor performance, we believe fixed income still plays a meaningful role in portfolios. We recommend remaining underweight duration in the short term and owning credit in the forms of Investment grade and High yield. For investors searching for higher yields and a negative correlation to equities, we recommend substituting a portion of your fixed-income allocation with private credit if that fits your portfolio objectives.
We remain bullish on commodities and we believe it makes sense to have a structural commodity allocation in their portfolio for most investors.


This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. 

Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

The Bloomberg Barclays US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the US bond market.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

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