Commodities are soaring. Interest rates are falling. Stocks can’t get out of their own way. All of this is occurring while the first war in decades continues to rage in Ukraine. Seems to me that any gains in the market averages next week will remain dead cat bounces in this bear market.
Yes, I hate to be a squeaky wheel, but I’ve got to call it like I see it. We have a much greater chance of sliding lower from here than higher. Here’s why.
Investors received a new lease on life this week when Fed Chairman Jerome Powell, testifying before the Senate banking Committee, triggered a market rise in the averages. All he did was relieve a little market angst by stating that a 25-, rather than a 50-basis point, move should be expected later this month at the FOMC meeting. In that context, I would label the resulting short market bounce as simply a relief rally.
Initially, the markets rallied because the Fed is not raising rates as high as expected. That usually means higher stock prices, so the bounce was understandable. But the reason the Fed plans to raise rates in the first place is due to soaring inflation. What did investors do?
Prices of basic and precious metals like aluminum, nickel, copper, gold, and silver, and food commodities like wheat, fertilizer, and of course, oil and gas, were bid up leading the market gains. The combination of these Russian fear trades, plus inflation plays, continued to lead gains throughout the week. Technology and speculative areas were largely left in the dust.
This action has only pushed up commodity prices even higher. Now what will that do to the inflation rate? Push it even higher, and possibly make the Fed reconsider their plans. Those bond traders who were betting on a “one and done” interest rate hike have changed their forecast. The betting is that there will be at least two more hikes coming before June 2022.
On Thursday night, March 4, 2022, the Russians attacked Ukraine’s largest nuclear facility, which provides 20% of European electricity. Fortunately, there did not appear to be any leakage of radioactivity but that could have occurred. The U.S. dollar jumped more than 1%, an extraordinary event, indicating a “run for the hills” mentality overwhelming investors.
Unfortunately, this is the kind of market where most market participants are headline driven. Given the circumstances, that is understandable. Algo traders are careening from buys to sells as news pops up on the terminals. Whether it is testimony from Powell, Russian cease fire rumors, oil embargo news, or new atrocities in Ukraine, stock prices either crater or explode hour to hour.
Few of these traders know or care about things like price/earnings ratios, balance sheets, corporate earnings or even macro data like the positive gains in employment we saw last month. Remember, most market participants have little to no experience in a higher interest rate environment nor how to invest in equities when inflation is rising. As for maneuvering world markets on a war footing, few have any experience at all.
It is obvious that just about everyone is focused on the oil price. The higher oil climbs, the greater the probability that inflation will continue higher, and the greater the chance that global economic growth slows. Analysts at Bank of America, for example, have raised their forecast for oil to $120 per barrel by the middle of 2022.
At the present price of oil, the U.K.’s National Institute for Economic and Social Research estimates that the Russian-Ukraine conflict could hack $1 trillion off the value of the world economy. It could also add another 3% to the world’s overall inflation rate. Predictably, Eastern Europe would get hurt the most. Those numbers worsen as the oil price rises.
There are all sorts of worst-case estimates as to where oil prices could go depending on whether there is an embargo on Russian oil, a reduction in exports due to war damage, or if Russia curtails energy supplies to Europe in response to sanctions.
It appears to me that the markets have settled on a worst-case price of between $120-$130-barrel oil at this time. If that were to happen, and remain at that level over several months, the impact on the U.S. economy would be to slow growth and bring on the specter of stagflation. I believe it is way too early to predict that outcome. I did forecast back in December 2021, however, that this scenario would begin to make the rounds on Wall Street about now. In my opinion, the onset of stagflation would be a stretch, given the present robust growth rate of U.S. GDP and the Fed’s intention of tightening monetary policy beginning in mid-March.
As for the future of the markets, I am sticking to my guns. Stocks will remain in a box until after the March 2022 meeting of the FOMC. That means we could easily test the lows of January 2022 again, either before or after the Fed hikes interest rates.