Geopolitical Divide and Stagflation Fears Keep Markets on Edge

Assessing the geopolitical landscape has become increasingly difficult without considering the actions of the U.S. President. Since taking office, the president has issued numerous executive orders, held meetings with foreign dignitaries, and made a series of announcements—both through official channels and personal social media accounts—heightening unpredictability. While Republican supporters view this as the mark of a proactive leader, critics argue that some decisions are reshaping foreign and trade relations in ways that could harm both the U.S. and the global economy. The most significant event of the past week was the altercation between President Trump and President Zelensky in the Oval Office last Friday, followed by the suspension of U.S. military aid to Ukraine. This decision reinforced European support for Ukraine and prompted European leaders to convene in London on Sunday for a Defence Summit. During the summit, European Commission President Ursula von der Leyen emphasized the need for sustained increases in defence spending after years of underinvestment. According to Bruegel, a Brussels-based economic think tank, securing Europe without U.S. support would require an additional 300,000 troops and at least EUR 250 billion in the short term to deter Russian aggression. As a result, defence companies could see increased demand in the coming quarters, presenting potential investment opportunities. Investors seeking exposure to this trend may consider defence-focused ETFs. On Monday, European defence stocks surged, driving European indices to record highs. The STOXX 600 closed at 563.13 points, up 1.61% over the week. The SXPARO (European Aerospace and Defence Index) also reached an all-time high, closing at 2,253.81 points—gaining 13.6% over the past week. Top performers included British aircraft and ship engine manufacturer Rolls-Royce Holdings (+28.52%) along with German Industrial conglomerate Rheinmetall (+20.12%), and British defence multinational BAE Systems (+17.94%).

Another key issue is the U.S. president’s approach to running the country as if it were a boardroom. While corporate decision-making prioritises efficiency and profitability, national policies have broader economic and social implications. For instance, layoffs can improve efficiency at the firm level, but mass layoffs induced by the Department of Government Enterprises (DOGE), combined with large-scale deportations of immigrants, could weaken aggregate demand, as fewer people in the economy means lower consumption. Similarly, while cutting expenses improves corporate margins, reduced government spending directly lowers GDP, as it is a core component of the GDP equation. It also has an indirect impact on GDP as government spending has a multiplier effect, creating spillovers across the economy. These factors, alongside the persistent threat of tariffs on Mexico and Canada, have weighed on U.S. growth expectations. Recent economic data suggests a softening labour market, with rising initial jobless claims over the past weeks. Market participants will closely monitor the upcoming Non-Farm Payroll report to gauge the impact of DOGE’s policies on employment. Unsurprisingly, rising jobless claims have also dampened consumer sentiment. Both the University of Michigan and the Conference Board reported contractions in their respective consumer sentiment indices last week. Adding to concerns, the Atlanta Fed’s GDPNow model projects a 1.5% contraction in U.S. GDP for Q1 2025, driven by weaker-than-expected consumer spending and a widening trade deficit. The latest ISM Manufacturing PMI report, released on Monday, indicated that raw material costs rose at an accelerated pace in February, while New Orders and Employment contracted. This further reinforced concerns over persistent inflation and slowing growth, fuelling fears that the U.S. may be heading towards stagflation. Expectations of lower growth triggered another inversion of the U.S. yield curve, with long-term rates falling over the past weeks. This led to gains for bond investors, with the TLT rising 3.2%. In contrast, equities closed in the red with the Dow Jones falling 7.66%, the Nasdaq down 4.86%, and the S&P 500 declining 2.23%. Meanwhile, market volatility increased, with the VIX rising 20.02%.

Locally, the Ministry of Commerce announced the implementation of a maximum markup on frozen and canned vegetables to curb consumer goods prices. Under this policy, the total markup from import to retail shelf has been capped between 25% and 30%. To understand the impact at the firm level, it is important to note that this margin includes both the importer’s and retailer’s markups, which cover their operational costs. The extent to which companies are affected will largely depend on their relative bargaining power, as this will determine how the reduced markup is distributed between importers and retailers. Market dynamics between these two players differ significantly, particularly in terms of barriers to entry. Over the years, entering the import business has become relatively easier, while opening a retail outlet requires substantial capital investment, making it a more exclusive market. As a result, retailers generally hold greater bargaining power, as they can choose from multiple suppliers offering substitute products. The surge in household consumption in recent years has further reinforced this trend, attracting more competitors to the import segment. Consequently, the primary impact of the new markup policy is likely to be felt by importers, who may see their margins shrink. Over time, this could raise barriers to entry in the import sector, potentially pushing smaller players to seek alternative business opportunities. For consumers, however, the policy is largely positive, as it should lead to a modest improvement in purchasing power. Given that these goods were already part of household consumption before the government intervention, the anticipated 20% to 30% price reduction will generate what economists refer to as consumer surplus—additional savings that can be redirected towards other expenditures. Since the regulation targets essential consumer staples, a broad segment of the population is expected to benefit. Overall, this initiative will be reflected in the next Consumer Price Index (CPI) release as a one-time drop-in price level.

On the equity front, a shorter week due to a public holiday and cyclonic conditions saw the SEMDEX close on a positive note on Friday, inching up 0.29%. However, the broad market index took cues from foreign indices and closed lower on Monday (-0.20%). The index finally settled at 2,524.76 points on Tuesday, little changed from the previous session. Heavyweights underperformed the broader market, as the SEM-10 inched down 0.03%. The index was weighed down by the drop in MCBG’s (-0.53%) share price during the period, which was compensated however by gains from PBL (+9.27%) and Ciel (+2.7%). Overall total market turnover (TMT) reached Rs 125.m in the past week, down from 334.9m in the past week due to sessions missed on Wednesday and Thursday. Average daily turnover for the week fell 37% to reach Rs 42.0m, down from 67.0m in the week prior. Turnover was geared towards MCBG and PBL, with both stocks making up 28.6% and 26.6% of total market turnover. Foreigners were net buyers to the tune of Rs 6.3m (OM+DEM) with PBL being the main driver of foreign inflow (+26.1m). Contrastingly, foreigners were net sellers on MCBG to the tune of Rs 14.6m. Among individual names, SBMH gained 0.68% to Rs 5.96, ahead of accounts publication for the FYE Dec-24 at the end of this month. On the finance front, CIM gained 8.20% to Rs 16.50. Among Conglomerates. Ciel gained 2.70% to reach Rs 9.88. Contrastingly, IBLL fell 2.63% to Rs 37.00. Similarly, ENLG inched down 0.19% to Rs 26.65. Among hotels, NMHL gained 0.72% to Rs 14.00. Contrastingly, SUN fell 1.20% to Rs 41.20.