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Earnings, Ukraine Forcing Investors Into Safer Assets


Geopolitical strife in Ukraine and weakness in the US earnings season is pushing investor funds into Treasuries and downside hedging.

US equity indices are having trouble getting to new highs as geopolitical tension in Ukraine and underwhelming corporate earnings are driving up volatility.

Tensions in Ukraine calmed for a number of weeks after Russia invaded the territory, but it looks as if issues may be reigniting. US President Barack Obama pressed European allies on Friday to impose more sanctions on Russian activity in Ukraine. The president said he would ensure European leaders shared his view that Russia had failed to live up to the terms on the Ukraine peace accord. The terms were agreed to in Geneva earlier this month and a pact was made between Russia, the United States, Ukraine, and the European Union to work towards disarming illegal groups.

The increased strife in the region has also begun to weigh on Russia's credit rating. Heavy capital flight out of Russia in recent weeks prompted Standard & Poor's to cut the country's rating on Friday. The move forced Russia's central bank to raise its key interest rate to stop a drop in the ruble.

Geopolitical conflict in itself is worrying investors, but alongside uninspiring corporate earnings, US equity markets may see further declines. Around 20% of S&P 500 (INDEXSP:.INX) companies have reported so far, but few have exceeded expectations. Only 67% of companies have beaten analysts' earnings estimates, and 51% have beaten revenue estimates. On the surface that is not too bad, but considering the four-year average shows 73% tend to beat earnings estimates and 58% tend to beat revenue estimates, it signals this quarter could be weaker than anticipated.

A trend that has emerged post-financial crisis is that analysts revise down estimates in the weeks and months prior to result announcements, which gives companies a very low bar to beat expectations. US companies' ability to beat these suppressed estimates have been a major reason why US equity markets have risen in such a drastic fashion the past few years. If the trend fails to continue, then it may end up being a catalyst for decline in stock prices across the globe.

Already investor anxiety over issues in corporate earnings and strife in Ukraine have pushed funds into safe-haven assets like iShares Barclays 20+ Yr Treasury Bond (NYSEARCA:TLT) and iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX). There have been notable spikes in the iPath S&P 500 VIX Short-Term Index every month this year. The volatility has not been enough to knock equity indices far from record highs, but cracks have begun to show in investor confidence. Similarly, Treasury bonds have trended higher since the beginning of the year. Investors are preparing defensively and hedging their downside by moving money into bonds and protective put options. The bull-run in equities is not over yet, but there are signs emerging that indicate a 100% equity portfolio may not be your best bet.

Andrew Sachais' focus is on analyzing markets with global macro-based strategies. He takes into consideration global equity, commodity, currency, and debt markets. Sachais is a graduate of Georgetown University, where he earned a degree in Economics.

Follow Andrew on Twitter: @MacroInsights
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