By Ginger Szala, ThinkAdvisor
What you need to know
Russia’s invasion of Ukraine has reverberated throughout the world, intensifying already tight commodity markets.
The Federal Reserve’s tightening will make value stocks a better option.
Energy markets, which already are near capacity, will face increased tightness as Russia’s output drops.
The Russia-Ukraine war has increased volatility in stock and bond markets around the globe and pushed up energy and commodity prices, which has goosed inflation — already on the rise — to 40-year highs
To give an overview of the situation, Northern Trust Asset Management chief strategists discussed in a recent webinar what to expect in markets with unexpected high inflation and post-COVID supply chain and labor shortages.
Noting that Russia’s invasion of Ukraine has “reverberated throughout” the world, Wouter Sturkenboom, chief investment strategist for Europe, the Middle East and Africa and the Asia-Pacific region, said NTAM pivoted away from Europe and focused portfolios on U.S.-centric markets — equities and high-yield bonds — while using natural resources as a hedge for inflation and geopolitical positioning while turning away from Treasury inflation-protected securities.
This strategy has reduced the group’s risk exposure in the past month. And as the Federal Reserve grows more hawkish, they see that the Fed will ratchet interest rates up 50 basis points in the short term, with more increases ahead. Yet a key risk is higher inflation and lower growth.
Here are 7 economic predictions from Sturkenboom; Tim Johnson, fixed income chief investment strategist and portfolio manager; and Jackson Hockley, senior energy equity analyst.
1. Value stocks will outperform growth stocks.
The tightening of interest rates will weigh on growth stocks. Therefore, NTAM believes value stocks are a better option for now.
2. The geopolitical environment is highly fluid.
Russian President Vladimir Putin may be more aggressive as his plans for a swift Ukraine invasion don’t play out, possibly invading the Baltic states or other NATO countries. This may push equities lower. Also, there is an increased economic risk in China as COVID regains footing and the country once again shuts down.
3. The good news: A recession is not imminent.
The good news is that historically, there was a soft landing when the Fed raised rates and the yield curve was inverted and the growth was high. Now the U.S. economy is coming off real GDP growth of 5.7%, which “gives the central bankers some cushion to hike interest rates without pushing economies into a recession,” Johnson noted.
4. As monetary policy tightens, liquidity will dry up.
That said, balance sheet liquidity, from corporations to households, is generally good, largely due to the lower interest rates over the last several years. But financial transaction liquidity, or how much it costs to buy a Treasury security, has been “exacerbated” by Fed tightening and by what’s happening in Ukraine.
In fact, recently the cost of a Treasury security has risen to near-2007 levels. NTAM will keep a close eye on the unwinding by the Fed and its impact on the yield curve, especially in the third quarter.
5. The Russia-Ukraine war will continue to squeeze the world’s energy supply.
Global oil demand is about 100 million barrels a day and could grow to 102-103 million a day in the second half of 2022, depending on what happens in China and its COVID lockdowns, said Hockley.
Russia produces about 11 million barrels per day, exporting about 7.5 million barrels per day in crude and refined products. The U.S. now produces 11.8 million barrels per day, which is off the peak of 12.8 million barrels per day.
Hockley noted that any oil wells that could be brought online have been, and that “there’s no excess left in the system that can quickly be brought into the system.”
“Self-sanctions” on Russia, both by countries and companies, could reduce Russian output by 1 million to 3 million barrels per day. There is potential to increase production within OPEC, including in Iran and Venezuela, as well as in Norway, Brazil and Canada. But the main onus will be on U.S. production and how much energy can be “brought online.”
A major problem is that conventional oil discoveries have dropped to near zero, while liquid consumption has grown. The situation will continue to tighten, he said. And renewable energy won’t account for enough production to fill that gap.
6. Europe’s LNG needs will affect global distribution.
Europe gets about 30%-40% of its natural gas from Russia, and will try to wean itself off that going forward. But for now, it looks like the U.S. will have to redirect LNG it produces for Asia to Europe. That means Asia will have to find some other fuel, most likely coal.
As far as emerging markets, Romania and Hungary (and other emerging markets in the region) are most at risk as they get almost all their LNG from Russia, Strukenboom said.
“[Cutting LNG from Russia] currently isn’t on a sanctions list, but the fact that that debate is open is something that’s weighing on equity markets in that region,” he said.
7. Other commodity markets will get tighter.
In addition to energy, Russia produces over a third of the world’s palladium and diamonds. It is also a large global exporter of wheat (20% global share), thermal coal (19%) and barley (14%). These markets are already tight.
Also, despite Russia’s being a smaller exporter of nickel, aluminum and copper, Jackson noted that global capital expenditures for the mining industry are at a 30-year low, so “the ability of the mining industry to bring on all of the materials that we need for that transition to clean energy look to be really stretched at this point in time.”
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