Not all market lows are V-shaped occurrences. In fact, many take months to form a new base from which to propel higher. Today’s range-bound market continues to make lower highs and lower lows. Wednesday’s nearly 3% pop was followed by a 0.4% drop yesterday where declines were led by technology. In the short run, returns are driven by war news, both good and bad. The most beaten-up stocks rally hardest on any hints of an end to the war in Ukraine, while winners like Energy get whipsawed. Day traders love this volatility, but patience continues to be warranted for long-term investors. Every day this invasion continues, the more likely GDP growth will continue to slow. This morning’s vague but positive comments from Putin on negotiations are propelling futures higher yet again.
Although markets are a great indicator of economic conditions 9-12 months down the road, day-to-day volatility can certainly be misplaced. This has been front and center ever since Russia invaded Ukraine, primarily in commodity markets that have been upended with volatility at record levels. Nickel jumped over 100% in one day, resulting in exchanges shutting down trading this week. Oil just saw its largest negative intraday reversal Wednesday on the thought of OPEC increasing production, and some optimism that a ceasefire deal could be reached yesterday, which did not happen. Some movement is necessary to account for supply disruption, but this rate of change is not entirely fundamentally driven. Most models show oil trading ~$30 above what supply/demand justify.
Russia is a sizable commodity exporter, but they hardly corner the market on anything outside of gas with respect to Europe. They account for 7% of the world’s nickel supply. Their nickel will still make its way to the market via different supply chains, likely China, at an added delivery cost. Does that mean nickel should double in price? They also produce 6% of the world’s aluminum which can easily be replenished from previously closed mines. Russia accounts for 3.5% of global copper production and 6% of platinum. Assuming global growth continues to slow, there may not be enough demand regardless of their mining disruptions. Russian supplies are certainly important, but nowhere near the impact that commodity traders have priced in. Obviously, some short covering and necessary hedging is moving markets more than the 12-month outlook would dictate. This can and should unwind. Maybe not this month, but likely over time. A ceasefire or end to the invasion will go a long way to getting prices back to normal. To that end, commodity buyers are stuck paying higher prices today and tomorrow.
The direct impact for U.S. consumers is even smaller than one might think based on pricing action:
Granted, there are ancillary effects, as one commodity is linked to another. For instance, farmers see the rise in wheat prices, and plant more on their land instead of corn. Then we have a corn shortage so soybean farmer’s switch. China will purchase more oil from Russia that is not making its way to the U.S. It comes with an added expense on the shipping side but does not entirely crimp global supplies. So on and so forth across the commodity chain. It is not a zero impact on markets, but the past few weeks probably overdid it on the upside for many items.
Globally, near-term inflation metrics will be even more eye opening than in prior months. Anyone filling up their gas tank is experiencing sticker shock. Even higher income level consumers feel the pinch emotionally, if not directly, in discretionary budgets. Actions change. More may choose to work from home, if allowed. Airlines are raising prices by $60, on average, to offset higher jet fuel prices. One may choose a Zoom meeting instead of traveling to visit clients. Higher costs always change demand to some extent, but avoiding oil entirely is impossible. Oil is an input to many everyday items such as paint, soap, lotions, detergents, feedstocks, waxes, yarn and even crayons. There are real consequences of spiking prices, both directly and indirectly. The $64,000 question is what tipping point will severely impact consumer balance sheets and finally crush demand. It is estimated that today’s oil equivalent (after taking into account better mileage vehicles, electric cars, higher income levels, etc.) would be $300 per barrel of oil as opposed to the $150 price we saw at the peak in 2008 before the global financial recession. Demand destruction will occur at lower price points.
Prior to this, things were looking up on most fronts in the U.S. from an inflation standpoint. Labor force participation rates were accelerating back to normal. Last Friday’s jobs report showed nearly twice as many newly employed in February than expected. 600,000 jobs, this far into a recovery when unemployment is sub 4%, is very strong. Remember, we only need ~100,000 jobs per month to keep up with population growth. Even better from an inflation standpoint, wages were flat as opposed to rising 5% like prior reports. More people coming back to the labor force is a huge driver in getting wage inflation back to an acceptable 3% – 4% range. Further on the inflation front, inventories are rising (real retail inventories ex-autos are at record highs), job openings slowed, shipping rates collapsed and even used car prices saw another monthly decline. Inflation was finally starting to revert back to normal, albeit at a snail’s pace. At least the trend was moving in the right direction. That is certainly not going to be the case now. From here, it almost entirely depends on Russian actions and timing which are impossible to predict.
To be clear, this is not over. Wars are inflationary, and things will get worse. GDP estimates are coming down, with more to go. Europe will feel the brunt of a global slowdown while also facing much higher inflation than pre-invasion. Near-term economics are as cloudy as ever. That is already being reflected in the stock market to some extent:
• 47% of the Dow Jones Industrial Average stocks are in a bear market (down 20%).
• 72% of the Nasdaq and Russell 2000 (small caps) are in a bear market.
• This is the 2nd worst start of the year for U.S. equities in 123 years, rivaled only by the 1920 recession caused by deflation and 2009 during the Great Financial Crisis. 2009 was a great buying opportunity, while 1920 was not.
For now, stocks and commodities will trade off of emotions, hedges unwinding and forced liquidations more than long-term fundamentals. Global growth is slowing, but to what extent is unclear. Inflation is going to impact spending into the Spring and Summer seasons at a minimum. Stocks now reflect a 17 P/E instead of 22x last year. Not all stocks bottom on the same day. Some are in buyable zones after breathtaking declines, but risks remain elevated. This is no time to get aggressive on either side. Having built up cash over the past few months, many investors are ready to pounce once the economic clouds clear up. Nibbling, with a focus on a multi-year trend, could prove profitable from here, but not all purchases are created equal. This is a different environment than “free money” for everyone like the past few years.
Brief note on Russia and Ukraine:
Wars aren’t just fought with guns and ammunition anymore. Cyberwarfare is more powerful in some cases and has been ramping up for years. Governmental economic sanctions were used in previous skirmishes, but this pressure on Russia is more than many expected. Tom Friedman of the New York Times characterized this round of sanctions as equivalent to an economic nuclear bomb for Russia. They could collapse, economically, within a couple of months. Lastly, and most importantly for the “New Normal” world we live in today, is social media. Consumer demands and pressure on corporations is real and influential. The list of Fortune 500 companies pulling out of China is shocking. The weight of social media pressure corners many who have assets or business lines in Russia. Once that ball gets rolling, it is hard to stop. Just in the restaurant world alone, we have seen multinational conglomerates forcefully close up shop. McDonald’s#, Coca-Cola#, Starbucks#, PepsiCo#, and Yum Brands among many others are suspending operations. This list is well over 200 companies already freezing their interests in the country. While Russia invades with soldiers, tanks and ammunition, it is becoming clear that economic and corporate sanctions will yield a lot of pain over the coming months, likely years. This is a disaster by any measure and I’d fathom an unexpected shock to Putin and the Oligarchs. Hopefully that means this invasion ends sooner rather than later.
Philip John Clapp, AKA Johnny Knoxville, turns 51 today. “Empire” star Terrence Howard is 53. Rupert Murdoch is 91 years young.
James Vogt, 610-260-2214