Geopolitical risk remains at the fore; Fluid situation in Ukraine suggests need for vigilance
The S&P500 remains close to a record level as better than expected February jobs data in the U.S. offset ongoing uncertainty over the situation in Ukraine. Russia said its cash-strapped neighbor must pay off almost US$2 billion owed to Russia for natural gas by today and signaled it may cut supplies, ratcheting up the pressure as the two nations scrap over the future of the Black Sea Crimea region. The U.S., meanwhile, sent six F-15 fighter jets to Lithuania, will dispatch 12 additional F-16s to Poland, and sent the guided-missile destroyer USS Truxtun into the Black Sea in what it called a routine visit unrelated to events in Ukraine. We remain concerned about the situation’s potential impact on global investor risk appetite and the fragile economic recovery currently underway in Europe. A plan by Western nations to isolate Russia diplomatically and maybe economically means most commodities are likely to remain well bid until the crisis subsides. Considering that Canadian and U.S. equity markets remain close to the top end of a technical range and fairly valued fundamentally, we continue to recommend maintaining higher than average cash positions.
Equity markets recover, bonds sell off, and commodities mixed
At the time of writing the S&P500 was +0.8% over the week after a Tuesday rebound reversed a Monday sell-off, while U.S. 10-year Treasury yields increased approximately 14 bps to 2.79%. The S&P/TSX posted a +0.6% return and Canada 10-year government bond yields increased approximately 10 bps to 2.53%, while the Nasdaq added +0.7%. On the commodities front, WTI advanced US$0.22/bbl over the week to US$102.81, copper declined 3% after China’s first onshore default sparked worries rising debt will curb demand, natural gas was roughly flat, and gold gained less than 1% after falling back from north of US$1350/oz on Monday as a safe-haven trade.
Geopolitical risk leaves us cautious
Warren Hastings, Associate Director, Portfolio Advisory Group wrote: “Earlier in the week, the S&P500 moved higher into record territory after Russian President Vladimir Putin instructed 150,000 troops to end military exercises near the Ukrainian border and return back to base. Although it appears that an armed conflict has been averted in Ukraine (for now?), we think the temperature in the region has only been turned down a small notch. So long as Russian troops occupy critical infrastructure in Crimea and Putin maintains an aggressive stance, we think the celebratory mood of equity markets may be premature. Indeed as noted above, on Friday, Russia ramped up the rhetoric with Ukraine over amounts due for natural gas, while the U.S. deployed aircraft and a naval destroyer close to the region. We continue to recommend higher than average cash positions.”
Andrew Mystic, Director, Portfolio Advisory Group wrote: “A few key factors have conspired to keep rate markets relatively well bid over the past week including (1) The suggestion by Fed Chair Yellen that the Fed needed to get a firmer handle on exactly how much of the recent softer data could be explained by weather related considerations – raising the possibility that some of the softness could be resulting from a below trend outlook. As well, Yellen did open the door, albeit slightly, to the prospect of a pause in tapering. (2) Geo-political risks stemming from the Russian-Ukrainian crisis. The underlying geo-political impact likely poses the greater risk as the compromised relationship between Russia and the West could drag on global growth – potentially in the form of slowing German exports and rising energy costs. (3) Within this context, the crisis in Ukraine has once again raised the prospect of EM volatility. Although the U.S. recovery still has the capacity to gain traction as weather related concerns abate, the risks highlighted above likely keep rates somewhat contained in the near term, in our view. We would look at rate sell-offs (e.g. if the U.S. 10-year Treasury were trading around the 2.85% level) as an opportunity to take on a tactical rate trade. We continue to be of the view that rates in the back half of 2014 may be more vulnerable – barring an escalation of recent geo-political risks and assuming the resumption of better trending U.S. data, once weather related distortions have dissipated.”
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