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You could say “March Madness,” a phrase usually reserved for the NCAA basketball tournament, came to the capital markets this year. The tournament, so-nicknamed because of its tradition of bracket-breaking upsets and Cinderella teams, was nothing compared with the March madness of bonds, stocks, and commodities this year.
The largest war in Europe since the Second World War, Covid, a property crisis in China, and runaway inflation combined to see many global markets on track for one of their worst quarters of performance in many years. However, in what may end up being a classic case of markets “climbing a wall of worry,” equity markets finished positive on the month.
The fixed-income market has been the area for most of the excitement lately. Back in the summer of 2020, the U.S. 10-year bond yield was hovering around 0.50%. The move lower in yields for the past 40 years had made it simple for investors to just hold long-duration fixed income and sleep well at night. But because of the never-ending stream of fiscal stimulus and easy central bank policy, inflation has moved to a 40-year high. And it’s now very apparent to many that the U.S. Federal Reserve’s Federal Open Market Committee (FOMC) and global central banks are behind the curve.
This has brought a realization that the bull market in bonds is over. For the first time in years, investors are losing money in bonds. You need to be short duration in a rising rate environment, which is a message many had missed.
In March, the FOMC executed its first rate hike since 2018 and laid out a path to begin to normalize interest rates. While probably too late, this was welcomed by the market, as both equities and bond yields rallied.
It is also important to note that a week earlier on March 9, the FOMC ended its quantitative easing program, which had been aggressively in place since the pandemic began. Since then, bond yields have moved up aggressively, with the U.S. 10 year touching 2.5%, and the yield curve between 2- and 10-year bonds inverting for the first time since 2019. The latter is especially significant as it’s historically been one of the best recession prediction tools known.
If you had been given the tip that in March, we would see an inverting of the yield curve and bond yields moving higher by 25%, all things being equal, you would probably predict this would be a bad thing for equities. But this wasn’t that case. It might just be a consequence of how we entered March with many markets already negative in double-digit terms for the year, but not many expected these events to be bullish.
This is where many market watchers come out doubting this market move, calling it “madness.”
The explanation for the move higher in risk equities for March won’t be determined until we see how everything plays out in April, but it certainly feels like other forces were at play – be they a bear market rally, a short squeeze, or just an oversold bounce.
The move during the month for the commodities is also notable. Energy – and oil in particular – have had a great move to the upside, which justifies the gains in the equities. The world is just now coming to terms with the realization that the transition to clean energy will not happen overnight, and we will need to see a period of energy transition. Add to this that as a result of the lack of capital provided to this sector over the past few years and the sanctioning of one of the largest commodity-producing countries, and you see the potential for a sustainable rally in commodity prices.
Energy has been the leader, but we should see strength across the materials sector. Copper and nickel are key components of the move to electric vehicles and don’t have anywhere near the amount of capital to meet these needs.
Gold may be the next commodity to move higher. After a disappointing performance in 2021, this may be the year to get the yellow metal back on track. One of the most dramatic sanctions enacted by the world on Russia was the “voiding” of overseas central bank reserves. After years of central banks treating U.S. Treasury bills as the world’s safest assets, this may come into question. The fact can’t be ignored that an increase of gold holdings across global central banks to even 5% would result in a massive move higher for the price of gold.
As the quarter comes to a close, it will take time to fully understand what has taken place. Headlines that would normally dominate the narrative for a year are occurring on a weekly basis. Investors and markets are reeling from the volatility and may have used the month-end move to reset positions.
But don’t be fooled. The volatility is far from over. You don’t get moves like we saw in fixed income and commodities and not find out there was collateral damage that won’t come out until later. This time should be used to position for the next round of events, which could take prices to even more extreme levels.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
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