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Investment outlook: Risk appetite on the rise

Gaurav MehraManaging Director and Senior Partner - Head of Macro Trading

Decisive's Head of Macro Trading, Gaurav Mehra and Chief Investment Officer, Patricio Demaria, share our market outlook: 

The worst effects of risk-aversion may already be behind us. We believe that the conditions are in place to support further rallies going into the second quarter of 2022. 
Four factors have driven a rally as uncertainties fade:

  1. The Fed’s focus on fighting inflation
  2. Lower crude oil prices may point to peaking inflation, lowering recession risks
  3. China’s determination to steady capital markets
  4. Russia is meeting payments on its sovereign debt

This year’s pessimism suddenly ran out of momentum. A rally came as many, though not all, of the uncertainties that had framed recent market sentiment faded. The outlook for the second quarter of 2022 just turned a lot brighter. Four factors contributed to the mood swing, lifting risk appetite.

1. The US Federal Reserve kicked off its rate hiking cycle with a promise to prioritize the fight against inflation while highlighting that recession fears were not an imminent threat. Chairman Jerome Powell has made clear his priority is getting ahead of inflation and didn’t rule out a 50-basis point interest rate hike in May. Mr Powell is determined to avoid surprising markets.Fixed income markets, no one needs reminding, have had their worst start to a year in decades. Markets are now close to pricing in all of the Fed’s interest rate hikes and we are closely tracking the spread between two-year and ten-year US Treasuries. This has recently narrowed to around 20 basis points. An inverted yield curve, with two-year paper paying more than the ten-year benchmark bond, is a classic recession warning. While investors are now assessing the risk of a US recession, keep in mind that may take another 12-to-18 months to filter into the economy. In the meantime, history shows that markets tend to rally.

2. The price of crude oil fell from highs of more than USD 130 per barrel, after testing highs last seen in 2008, to around USD 100/barrel. Crude now trades around USD 110/barrel. Much of the fear around inflation is based on recent oil price spikes.

We believe these uncertainties will fade and prices stay lower than the highs we saw in 2008. That would moderate the outlook for consumer prices, in turn helping to curb fears over a US recession and so improving market risk appetite still further.

3. China’s authorities spelled out their determination to steady capital marketsPolicymakers pledged to support ADR listings on US exchanges, call a halt to regulatory crackdowns on technology firms and manage property development risks. The announcements triggered one of the strongest moves in Chinese markets on record.

4. Contrary to market expectations, Russia is meeting its sovereign debt payments and there were hints that the two sides in the Ukraine war are moving toward more substantive ceasefire talks.

Europe’s equity markets have already recovered much of their recent losses, and in the US, the VIX measure of volatility on the S&P500 is now reading closer to 20, rather than the 40 level of just weeks ago. With that fall in volatility, risk appetite is rising, and flows into US stocks have jumped, suggesting that the conditions are right to see gains in the hardest-hit sectors. As a result, we expect technology names to begin to outperform the wider market.

As we close on April and 2022’s second quarter, the greatest tail risk is of course the war in Ukraine. However, in contrast with just a few weeks ago, the worst of the investor risk-aversion may be behind us.

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