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By William H. Witherell, Ph.D.
While the year 2022 began on a positive, generally optimistic note for investors, the scene changed dramatically over the course of the quarter. Russia’s invasion of Ukraine led to a violent shooting war between the two countries, a financial war that is global in scope, millions of refugees fleeing to other countries, and the ongoing risk that the war could become broader, engulfing the NATO members in the response against Russia. Inflation has risen more steeply than most expected, led by surging oil and energy prices and very high food prices. In response, most central banks, Japan’s being an exception, accelerated their plans to reduce the ample monetary support they have been providing. The global battle against Covid, which governments were coming to believe they were winning, has experienced setbacks, particularly in China and some other Asian economies and in Europe, where cases again are rising. Uncertainty about the future has increased markedly, and equity markets around the globe have faltered. When this was being written, indications that Russia is changing its strategy in Ukraine, withdrawing in some areas, and that peace talks are progressing, were causing a relief rally in financial markets, which since has paused with an easing in the earlier optimism.
As we come close to the end of the quarter, the iShares MSCI ACWI ex-US ETF (ACWX) has declined 5.85% year-to-date 3/28/2022 on a total return basis, despite recovering some in March, a pattern like that seen in the US and most other national markets. European stocks, for example, have had a similar experience, with the broad Europe Stoxx 600 Index (STOXX) being down 5.75%. In Asia, Japan registered a similar drop, with the iShares MSCI Japan ETF (EWJ) down 6.30% over the same period. China stocks have been on a downward trend since last year, as we discuss below, and year-to-date the iShares MSCI China ETF (MCHI) lost another 15.42%. Over the past twelve months, that ETF is down 32.43%. Energy and other commodity exporters are about the only sector of national equity markets seeing a positive gain for year-to-date. The iShares MSCI Canada ETF (EWC) gained 5.62%. Similarly, the iShares MSCI Australia ETF (EWA) gained 6.73%, despite difficult trade relations with China. Among the emerging markets, commodity exporter Brazil, recovering from severe surges of Covid, is experiencing strong equity market gains. The iShares MSCI Brazil ETF (EWZ) has registered a 34.27% gain, following a six-month declining trend during the second half of last year. In general, global equity markets, while volatile, have been shown to be resilient, holding up well thus far this year despite the headwinds noted above.
Looking forward, we are not able to forecast the outcome of the Russia-Ukraine war nor further developments in the Covid pandemic. Despite the uncertainties, economists are lowering their projections for global economic growth in the current year, with last year’s 6.3 % growth looking likely to be followed by an advance at a pace no better than half of last year’s rate, and maybe less.
March data now becoming available are showing the economic impact on Europe of Russia’s invasion. The S&P Global Flash Eurozone PMI for March indicated a loss of momentum in the rapid pace of expansion created by the reopening of economies from anti-Covid restrictions. Firms reported that their costs, including surging energy prices, were rising at an unprecedented rate; and supply chain delays have increased. New export orders fell after having increased in each of the past 21 months. Business optimism dropped. This change in sentiment follows the improvement in European business confidence reported for February. There are country differences. Business activity slowed in Germany in March, whereas France bucked the slowing trend, with activity increasing at the fastest pace since last July, driven by a recovery in services. Even if a ceasefire is achieved and maintained, European central banks face a challenging inflation problem that will require more restrictive monetary policies. Financial and energy sanctions are likely to remain in place. The economic recovery that was underway at the beginning of the year in Europe will likely continue at a more moderate pace, avoiding recession.
In Asia, manufacturing output in Japan turned up at the end of the quarter as Covid restrictions were eased. The flash Services Business Activity Index for March also increased. Business sentiment is the weakest in 14 months, in part due to concerns about the Russia-Ukraine conflict. Retail sales remain weak. Unlike most other central banks, the Bank of Japan is maintaining a very easy monetary policy, which has led to the yen declining some 20% since early 2021. Japan looks likely to be one of the few advanced economies that will see somewhat stronger growth this year than in 2021.
In China, the globe’s second largest economy slowed dramatically towards the end of 2021, with Covid outbreaks a major factor. However, the economy had a better-than-expected start to 2021, with industrial value rising 7.5% and fixed-asset investment in real terms rising a similar amount in the first two months. In March, the latest Covid outbreak and renewed restrictions, including the lockdowns in Shenzhen and Shanghai, will impact consumption and supply chains. Also, the Russia-Ukraine War will impact China through higher energy and commodity prices, supply disruptions, and slower global trade. The government is providing increased fiscal stimulus to stabilize the economy and has set an ambitious economic growth target of 5.5% for the year. In view of recent global developments, 5% at best looks more likely.
Chinese stocks have sold off dramatically, about a third since early 2021, falling to oversold levels that have led officials to step in to provide support. Large Chinese companies like Alibaba are providing support through massive share buyback programs that the government must have approved. There have been some indications that relations with the United States with respect to securities markets are improving. The China Securities Regulatory Commission has told some US-listed companies to prepare for discussions and disclosures for the audit reviews that are now required by the US Public Company Accounting Oversight Board. This signal suggests that China will allow companies to comply, a welcome development that would reduce concern about possible widespread delisting of Chinese stocks in the US market. A speech by Liu He, vice premier and President Xi Jinping’s economic advisor, indicated that China is seeking to maintain Chinese companies’ access to overseas capital markets. Also, Chinese authorities appear to be completing their regulatory reining in of internet and tech firms. China’s distancing itself somewhat from Russia, reducing the risk of being caught up in the sanctions, is another positive development.
Our International Equity ETF Portfolio remains almost fully invested as we seek to identify those markets best positioned to weather the uncertain future that lies ahead.
The following ETFs mentioned in this note are currently in the firm’s investment accounts: ACWX, EWJ and EWC. None of the ETFs mentioned are in the author’s investments.
Sources: Oxford Economics, ETF.com, South China Morning Post, chinalastnight.com, HIS Markit Ltd, S&P Global, Goldman Sachs Economic Research, Financial Times.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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