Published March 11, 2022
The market mess enters its fourth month with Chinese stocks now getting hit (down -15% in the first 10 days of this month). Credit spreads, a proxy for risk concern in the bond market, have risen sharply as the chart below shows. So plenty of reasons for hand-wringing, all of which builds to a buy point for stocks, eventually.
In the meantime, we turn to Delta for a good synopsis of the recent events on the inflation/commodity front.
“Last year, Russia was the second largest producer of oil behind the United States. One 42-gallon barrel of oil creates 19.4 gallons of gasoline. The rest (over half) is used to make things like: solvents, fertilizer, tires, deodorant, shoes, insecticides, CDs/DVDs, dashboards, all plastics including all plastic packaging, roofing, tennis rackets, skies, surf boards, toothpaste, clothes, refrigerators, detergents, aspirin, luggage, furniture, etc.
Since the Russian invasion of Ukraine on February 24, crude oil has appreciated by about 20%. Not only does this make gasoline more expensive, it is broadly inflationary. The cost of thousands of mainstream products and almost all product packaging and transportation rises. Inflation stemming from a supply shock from the second largest oil producing country in the world is unlikely to be corrected by the Fed raising rates.
Prior to the war in Ukraine, there were good reasons to think that currently high inflation would be transitory. With Russian and Ukraine coming off-line as major producers of oil, natural gas, wheat, and nickel (used to make lithium-ion batteries), there are good reasons to believe inflation will remain higher for longer.
Total CPI (Consumer Price Index – measure of inflation) increased by 7.9% in January. Core CPI (excludes food and energy) was up 6.4%. This was the consensus expectation – not a surprise to institutional investors. The Fed’s target inflation rate is 2%.
In the January CPI report, the food index was up 7.9% year-over-year, the largest increase since July 1981. The gasoline index was up 38% year-over-year. Commodity prices have risen faster this year than any year since 1915. On a year-over-year basis, commodity prices are up 144%. The scale on the graph below stops out at 60%.
The range of possible outcomes from the war in Ukraine is broad. One potential outcome is that high prices slow economic activity and eventually push the US economy into recession. For the moment, recession appears to be unlikely in 2022. However, the recession risk has to be watched carefully. For now, economic data is holding up well but many stock investors are on pause until the outlook becomes clearer.
On February 23, 2022, the S&P 500 index closing price was 4,225.50. Russia invaded Ukraine on February 24. Since the invasion, the stock market has been volatile with daily moves of 1-3+%. But even with the elevated volatility, the S&P 500 is roughly flat with where it was just prior to the invasion at the market close on February 23.
When the Russia/Ukraine crisis resolves, growth should eventually become the main driver of sentiment and positioning. If economic damage is contained and growth remains positive, we would expect the stock market to move higher as the bullish case to own this asset class in an inflationary environment remains strong.”
Oil prices surged above $130 per barrel in Sunday night trading setting the stage for a very difficult Monday on Wall Street. The S&P 500 tumbled -3% with European stocks sliding -10% in three days, culminating with Monday’s dismal session. A U.S. ban on Russian oil purchases added to the oil market chaos Tuesday leading stocks to post another -0.7% dip, though oil prices had little reaction to the ban. Of course, oil prices had already moved from $95 to $130+ in little more than a week, an extraordinary surge. And one that went too far too fast, apparently, as Wednesday brought a sharp counter-move. Oil prices plunged on the possibility of a Ukraine-Russia cease fire and/or some fresh source of supply. The -13% drop gave back the bulk of the 7-day rally in oil. Meanwhile, stocks roared higher with the Nasdaq recovering a substantial +3.6%. When the cease-fire talks ended with no real progress, markets resumed their negative ways, urged on by another very hot inflation reading. Stocks slid -0.4% Thursday avoiding a steeper loss by a solid +5% rise in Amazon shares. The consumer giant announced a 20-for-1 stock split, a move that will position the company to potentially be added to the Dow Jones Industrial Average at some point. Friday saw the market unable to hold an early gain with investors unwilling to take risk into the weekend. Stocks fell -1.3% on the day while oil prices rebounded a bit. Goldman Sachs downgraded economic growth prospects as inflation remains stubbornly high and the Ukraine war casts a cloud over sentiment.
This week marked the return of a 1970s term: stagflation. The associated economic concerns pushed stocks lower by -2.80% this week. The Nasdaq 100 (QQQ) slumped -3.82% despite the massive gain in Wednesday trading. Smallcap stocks (IWM) continued to hold up relatively better, though still down -0.97% for the week. The Nasdaq has dropped more than -20% since November.
Warm wishes and until next week.