Hello there,

A terrific Thursday to you as stocks trend higher thanks to perceived dovishness from the U.S. Federal Reserve that should help to pushback policy tightening amidst geopolitical turmoil.

In brief (TL:DR)

• U.S. stocks were higher Wednesday with the Dow Jones Industrial Average (+1.79%), S&P 500 (+1.86%) and the Nasdaq Composite (+1.62%) all up.

• Asian stocks rose Thursday in the wake of reassuring comments on monetary-policy tightening from U.S. Federal Reserve Chair Jerome Powell.

• Benchmark U.S. 10-year Treasury yields fell three basis points to 1.85% (yields fall when bond prices rise) as demand for safe havens persisted.

• The dollar ticked higher.

• Oil extended gains with April 2022 contracts for WTI Crude Oil (Nymex) (+1.64%) at US$113.52 as concerns over energy prices continued to persist as Russia's supply looks at risk of going off the tap.

• Gold held gains with April 2022 contracts for Gold (Comex) (+0.44%) at US$1,930.80.

• Bitcoin (-0.35%) was at US$43,797 with traders taking some profits off the table and the benchmark cryptocurrency looking to trade sideways for the immediate term.

In today's issue...

1. U.S. Federal Reserve Sticks to Smaller Rate Hike

2. What can investors do about inflation?

3. In a World of Sanctions Cryptocurrencies are King

Market Overview

U.S. Federal Reserve Chairman Jerome Powell in testimony to U.S. lawmakers backed a measured interest-rate liftoff and vigilance on inflation, while indicating the world’s biggest economy can weather higher borrowing costs.

Powell voiced support for a quarter-point Fed rate hike later this month and also indicated the central bank may have to take tougher action if price pressures don’t start to ease.

The sanctions imposed on Russia have caused traders to back away from its resources, stoking fears of shortfalls in energy, grains and metals.

Asian markets were higher Thursday with Tokyo's Nikkei 225 (+0.60%), Hong Kong's Hang Seng Index (+0.52%), Seoul's Kospi Index (+1.61%) and Sydney’s ASX 200 (+0.77%) were all up in the morning trading session.

1. U.S. Federal Reserve Sticks to Smaller Rate Hike

• U.S. Federal Reserve Chairman Jerome Powell affirmed his support for a quarter-point rate rise at the next central bank policy-setting meeting in March, confirming what most market participants had been pricing in anyway and sending stocks surging.

• Any hopes that the Fed may have had that inflation would start to subside by the end of this year looks to be delayed or deferred indefinitely, as will a return to a more normal monetary policy.

Amidst the din of rockets hitting Ukrainian buildings, one voice that is perhaps more important for investors than Putin’s is that of U.S. Federal Reserve Chairman Jerome Powell who told lawmakers yesterday that the central bank is prepared to push forward with rate hikes.

Powell affirmed his support for a quarter-point rate rise at the next central bank policy-setting meeting in March, confirming what most market participants had been pricing in anyway and sending stocks surging.

In testimony before the U.S. House Financial Services Committee, Powell couched his language in typically ambiguous fashion, ensuring that he has more than enough wiggle room should the situation change dramatically,

“I’m inclined to propose and support a 25bp rate hike. The bottom line is that we will proceed, but we will proceed carefully as we learn more about the implications of the Ukraine war for the economy.”

“Inclined” is not set in stone and the Fed has of late adopted a monetary policy of “nimbleness” which is probably the most appropriate given the circumstances.

With the full extent of Western sanctions on Russia yet to arrive on American shores, some of the early fallout has already hurt wallets, with oil rising above US$110 for the first time in 8 years and the price of natural gas skyrocketing.

Any hopes that the Fed may have had that inflation would start to subside by the end of this year looks to be delayed or deferred indefinitely, as will a return to a more normal monetary policy.

Given the raft of defaults that excluding Russia from the global financial system is likely to set off, the Fed may need to be on hand to step in with liquidity to ensure that money markets continue to function smoothly.

Raise rates too aggressively and policymakers risk being the last straw that breaks the economy’s back, throwing it into recession, given that inflation is likely to weigh heavily on margins and dampen growth prospects.

Investors can expect another source of market volatility given Powell’s testimony,

“Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook.”

2. What can investors do about inflation?

• Figuring out how to inflation-proof an investment portfolio is a bit like taping up your windows before a bomb attack – it helps, but not as much as hoped.

• Given the fundamental shift in geopolitics and an infinitely more dangerous world, increasing bets on defense company stocks, long considered unattractive and unsexy, may just be the bet that balances out a portfolio, inflation be damned.

The world has suddenly turned to a far more unpredictable place and with inflation soaring in most major economies, not helped by the surging price of oil, investors are understandably struggling to figure out what they can do about it.

Doing nothing of course, is not an option. Leaving savings in the bank is like storing treasure that is rapidly being eaten away by wormwood.

Yet figuring out how to inflation-proof an investment portfolio is a bit like taping up your windows before a bomb attack – it helps, but not as much as hoped.

Because rising prices generally reduce the purchasing power of assets, those on fixed incomes will suffer the most as the same amount of money buys less stuff.

One option, if investors have access to them are inflation-protected bonds or I Bonds. Investors in these inflation-protected U.S. savings bonds are guaranteed to recover their principal plus inflation over 30 years.

I Bonds offer a fixed rate for up to 30 years, plus an inflation rate that adjusts semiannually that tracks the U.S. Labor Department’s CPI-U, a consumer price index with an urban inflation measure and can be purchased directly at TreasuryDirect.gov

Today, the yield on a plain vanilla U.S. 30-year Treasury is 2.24%, while the I Bond equivalent has an initial annualized yield of 7.12%.

With a fixed rate currently at zero, the I Bond won’t beat inflation, but at least help investors keep up.

One major downside? Investors are limited to only US$10,000 of I Bonds a year and there is a liquidity price as well, as they can’t be cashed in for the first 12 months and lose 3 months’ worth of interest if redeemed within the first five years.

And if you’re not a U.S. citizen, then no I Bonds for you!

So, if global investors can’t get their hands on I Bonds or even Treasury Inflation Protected Securities, are there other options?

In a 2021 study, Finance Professor Campbell Harvey from Duke University’s Fuqua School of Business and four others papered a study that examined 8 periods of the past century when U.S. inflation was 5% or higher for six months or more and found that the inflation-adjusted return on stocks averaged -7% annualized.

Based on that research Harvey and his co-authors suggest that rather than holding on to losers, investors may be better off rotating out of economically-sensitive stocks and into energy and natural resource stocks that fared better.

In addition, historical data in that study suggests that real estate investment trust or REITS could do well since landlords were able to raise rents to keep pace with inflation, an observation that could bear proof in our current period as rising wages allow tenants to stomach higher rents.

Harvey and his co-authors also noted that commodities, especially the prices of metals, oil and agricultural products tended to hold their value or even outperform inflationary surges.

But, because commodities can have big price swings, they can introduce significant portfolio volatility which is why investors would need to consider that when planning their strategies and allocation size.

In addition, with prices this high at the moment, investors risk buying commodities at the high point in the cycle.

How about gold then?

Gold keeps up with inflation only over very long periods, typically over centuries and well in excess of the average investor’s timeframe, but over much more meaningful periods, gold’s high volatility has undermined its value as a hedge against inflation.

Does that mean investors can’t do anything about inflation?

In many ways, yes.

Because fiat currencies are by design not intended to be held but spent, anything that is stored, will necessarily be at risk of devaluation over the long run.

Instead of focusing purely on inflation, investors may actually be better off managing existing risks in their portfolio (perhaps it may be time to pare down some holdings in stocks of companies that have little hope of ever achieving profitability) while doubling down on others with enduring themes to find temporary safe haven.

In this regard, given the fundamental shift in geopolitics and an infinitely more dangerous world, increasing bets on defense company stocks, long considered unattractive and unsexy, may just be the bet that balances out a portfolio, inflation be damned.

3. In a World of Sanctions Cryptocurrencies are King

• On Sunday, Ukraine’s Vice Prime Minister called on all major cryptocurrency exchanges to block addresses of Russian users, but many have pushed back on the request.

• Many Russians are using crypto as a means to facilitate capital flight and to swap rapidly depreciating rubles for cryptocurrency as one way to cope with the sanctions.

The pushback may be unpopular but is completely in line with the ethos and ideology of cryptocurrencies – they are meant to work regardless of government intervention.

That ideology was on full display when some of the world’s largest cryptocurrency exchanges resisted mounting pressure to block all transactions with Russia, as Western politicians fear that the provide a loophole for Russian money to continue to circulate globally as they seek to shut out Russia from the global financial system.

As Western sanctions shut Russian banks out of the SWIFT messaging system, which is used for international banking transfers, Russian ruble trading with Bitcoin and other cryptocurrencies surged to as high as US$60 million a day, according to data from Chainalysis, a blockchain data provider.

On Sunday, Ukraine’s Vice Prime Minister called on all major cryptocurrency exchanges to block addresses of Russian users, but many have pushed back on the request.

The world’s largest cryptocurrency exchange by volume Binance, which is registered in the Cayman Islands, declined the request to ban Russian users,

“To unilaterally decide to ban people’s access to their crypto would fly in the face of the reason why crypto exists.”

That position, whilst likely to be unpopular, also forms the cornerstone of the cryptocurrency ethos and to do otherwise would represent a major break from the early pioneers of blockchain technology who conceived of cryptocurrencies precisely to cater for situations such as the present.

U.S. cryptocurrency exchange Kraken’s founder Jesse Powell echoed that view noting,

“(Kraken’s mission is to) bridge individual humans out of the legacy financial system and bring them into the world of crypto, where arbitrary lines on maps no longer matter, where they don’t have to worry about being caught in broad, indiscriminate wealth confiscation.”

“Bitcoin is the embodiment of libertarian values, which strongly favor individualism and human rights.”

Nevertheless, cryptocurrency exchanges have acted to freeze the accounts of individuals who have been sanctioned and have sought to comply with the legal requirements imposed on them through Western economic measures against Russia.

And it’s not as if Moscow is dying to let its citizens trade crypto either – with many Russians using it as a means to facilitate capital flight and to swap rapidly depreciating rubles for cryptocurrency as one way to cope with the sanctions.