Professional investors are growing increasingly gloomy about the future, with the majority now predicting that stocks will fall into a bear market this year and the U.S. economy will be plagued by stagflation—meaning high inflation and slow economic growth—according to Bank of America’s latest Global Fund Manager Survey.
Investor sentiment is growing increasingly bearish, with expectations for global economic growth plunging to their lowest level since the collapse of Lehman Brothers during the Great Financial Crisis of 2008, according to Bank of America’s monthly survey of roughly 300 respondents managing a collective $1 trillion in assets.
Concerns over inflation, which had appeared to be abating earlier this year, came roaring back in March, with over 60% of investors predicting the U.S. economy will take a hit from stagflation—more than double the amount who said so last month.
With surging inflation and geopolitical uncertainty from Russia’s invasion of Ukraine dragging the U.S. stock market into correction territory this year, fund managers are now holding more cash, at a rate not seen since April 2020, when pandemic lockdowns plunged the economy into a short recession.
The majority of professional investors see rising recession risks ahead once more, with 60% predicting a bear market in 2022 and over 50% expecting that high inflation will be “permanent.”
Markets historically don’t do well in periods of stagflation: When the U.S. economy faced stagflation toward the end of Richard Nixon’s presidency, the S&P 500 fell roughly 17% and 30% in 1973 and 1974, respectively.
Despite the current uncertainty in markets, “investors should remind themselves not to become their portfolio’s worst enemy and let emotions rule their decision making,” says Sam Stovall, chief investment strategist at CFRA, who argues that there are still plenty of opportunities in the form of high quality and high dividend stocks.
“It’s hard to ignore what we see and hear other people forecasting—there’s an old saying, ‘Don’t be wrong for too long,’” says Stovall. While he predicts stocks could slip into a “baby bear market” this year, “that said, I don’t see us heading into a 1973/1974 scenario where we had a more than the two-year bear market and the S&P 500 lost almost 50% of its value.”
WHAT TO WATCH FOR:
The Federal Reserve is expected to raise interest rates, by 0.25%, for the first time since 2018 after the central bank concludes its two-day policy meeting on Wednesday. While a lot of the survey indicators point to a “recessionary” outlook, investors still expect on average 4.4 interest rate hikes this year, which is up slightly from last month, according to Bank of America’s survey.
The stock market has had a rough start to 2022, with investors not only whipsawed by the Federal Reserve’s war on inflation but also the ongoing conflict between Russia and Ukraine, which has led to a surge in energy prices. The S&P 500 now sits in correction territory—more than 10% below its record high earlier this year, while the tech-heavy Nasdaq Composite is in a bear market, 20% below its highs last November.
“The risk of a recession over the next 18 months is higher than before Russia’s invasion, but the U.S. economy is still likely to see continued growth, though at a slower pace than seemed possible at the start of the year,” according to a recent note from Bill Adams, chief economist for Comerica Bank.
China as Russia’s Backdoor to Western Sanctions
The Unforgettable Picture between Putin & Xi
On February 4th, after the opening of the Winter Olympic Games, Putin and Xi affirmed their deep bonds and strategic cooperation. After the declaration of war by Russia on Ukraine the world has been asking, what are the limits of this new friendship? As Western sanctions bite deep into the core of Russia’s economy, China is increasingly being viewed as Vladimir Putin’s economic lifeline to sustain the nation’s economy. Moreover, on Monday, March 14th, Jake Sullivan The White House’s National Security Advisor held a seven-hour meeting with Chinese Politburo Member Yang Jiechi in Rome where he put pressure on Chinese officials to clarify their stance and support for Russia. Sullivan said, “We do have deep concerns about China’s alignment with Russia at this time,” and the national security advisor made clear those concerns and the potential implications and consequences of certain actions. It is widely believed that the U.S. could also include sanctions on various Chinese entities, which is currently impacting certain Chinese companies in Shenzhen. On March 8th, U.S. Commerce Secretary Gina Raimondo said that “Chinese companies that defy U.S restrictions against exporting to Russia may be cut off from American equipment and software they need to make their products.” To make matters worse, Chinese stocks listed in Hong Kong decreased by 11% having their worst day since the global financial crisis, as concerns over Beijing’s close relationship with Russia and renewed regulatory risks sparked panic selling. This market sell-off was precipitated by a report citing U.S. officials that Russia has asked China for military assistance for its war in Ukraine. Chinese and Russian officials denied the report, however, traders worry that Beijing’s close relations with Vladimir Putin could bring a global backlash against Chinese firms, even sanctions. These allegations coupled with a Covid-induced lockdown in the southern city of Shenzhen, a key tech hub, and the northern province of Jilin also contributed to markets taking a plunge.
Sanctions on Russia
Western sanctions have been focused on Russia’s financial, energy, transport, and technology sectors with the later SWIFT sanctions significantly impacting Russia’s overall ability to participate in global trade. While these sanctions are robust some effects may take months to be felt by Russia. Besides oil and natural gas Russia imports more than it exports to Europe and the United States, this will leave them scrambling for a replacement for many of these items or face significant shortages in the coming months.
While oil and natural gas sanctions may hurt many European nations, they will also significantly affect Russia’s economy with oil and natural gas being their largest exports. Thus, finding a new buyer will be essential to Russia, and China is a prime candidate.
Going into the winter months, China has experienced multiple energy shortages and power rationing. This happened, in part, due to their ban on importing Australian coal after their Prime Minister wanted to investigate the causes of COVID-19. Other factors include soaring fuel prices and enforcing strict new emissions targets which include shutting down coal plants that don’t meet certain environmental standards. Add on to this, flooding and other natural disasters have impacted the nation’s power supply. These power outages have put pressure on China to resolve its energy shortages. However, China does not wish to be reliant on anyone’s source for its energy, especially without leverage on its sources.
During the meeting between Putin and Xi Jinping on February 4th the two leaders agreed to increase Russian Liquified Natural Gas (LNG) exports from Gazprom by an additional 10 billion cubic meters (bcm). There were also mentions of building another pipeline in addition to the Power of Siberia in Northeast China. This will increase China’s share and reliance on Russian LNG exports which is unusual for China’s energy strategy.
However, Xi Jinping and the Chinese Communist Party (CCP) may be more comfortable with using Russia to solve their energy problems because of Russia’s growing divide with the west. Sanctions mean that Russia will be reliant on China to help maintain its LNG exports. This will ensure that Russia will not cut off the supply of LNG to China, allowing them to feel more comfortable with this agreement.
Russia’s Backdoor to Western Sanctions
Many of China’s exports to Russia are overlapping Western Sanctions, with its top exports being electronics (including semi-conductors), machinery, plastics, and steel. China would be able to increase its exports to Russia in these fields to help blunt the effects of sanctions on the Russian economy. As Russia rebalances its imports from Europe to China, we could see Russians trading in their iPhones for Huawei phones.
Another area to watch is the trade deficit that Russia will start running up with China. Over the last eight years, Russia has closed the gap between imports and exports to China with two of the last three years running a trade surplus. However, as Russia needs to import more from China, it will run an increasing trade deficit. This could very well lead to Russia supplying China with more oil and natural gas.
Western Intelligence reports may indicate that Chinese Officials were not only aware of an imminent Russian invasion of Ukraine but had also asked Russia to withhold an invasion until after the Winter Olympics had ended. These reports could show an even stronger relationship between Russia and China than first thought. Sergey Karaganov, head of Russia’s Council on Foreign and Defense Policy affirmed this saying that “China is our strategic cushion… We know that in any difficult situation, we can lean on it for military, political, and economic support.” In addition, last week Chinese Foreign Minister Wang Yi referred to Russia as China’s “most important strategic partner.”
The United States has started to increase the pressure upon China to pick its side in this global conflict or potentially face its own sanctions. However, China has tried to consistently play both sides in this conflict. On one hand, they wish to receive oil and natural gas from Russia and keep the appearances of their former communist alliances and at the same time, China is eager to be seen as trying to help prevent the Ukraine crisis from deepening. Chinese Foreign Minister Wang Yi conveys these wishes saying “China is not a party in the Russia-Ukraine War.” The position of the Chinese Communist Party is to stay as unaffected by this conflict as possible, but there are voices within China cautioning that Russia is a dead weight and could drag down China’s economy with it. It is clear that China does not want to have to choose sides and rather enjoy the benefits from both Russia and the West. However, the U.S. has made it clear that China will pay a price if it continues to try to play both sides.
If Russia and China have negotiated an economic and energy alliance in an attempt to circumvent western sanctions, then many experts believe that a critical component of Russia’s objectives in being able to annex Ukraine relies on China being able to support Russia economically. For any sanctions package to effectively work, they would need either Chinese cooperation or include sanctions upon China as well. The proverbial phrase, “all roads lead to Rome,” should very well be replaced with “all roads lead to Beijing,” should the West aim to be more effective with sanctions vis a vis Russia.