World equity prices declined in February as war worries and soaring commodity prices threatened to interrupt the post-pandemic global economic recovery. Steadily increasing Russian military buildup on three borders of Ukraine became the stark reality of war in the final week of the month as troops simultaneously piled into the eastern, northern, and southern regions of the embattled country.
US markets had already been unsettled by impending Federal Reserve tightening, which is scheduled to begin a series of measured short term interest rates in mid-March.1 Expectations of a possible initial ½% hike waned as crisis gripped Europe and were finally punctured by Fed Chairman Powell’s congressional testimony earlier this week.2
High P/E multiple stocks in the NASDAQ Composite continue weak as investors evaluate what price to pay for growth in the face of a potential slowdown of GDP expansion later this year.
International markets have been heavily impacted, especially European bourses, as investors are confronted by a hot war threatening energy and grain supplies, and the possibility of Russian incursions beyond Ukraine. February performance of global equity benchmarks is shown below.
Energy and metals have been leading commodity prices higher for most of this year, but as conflict in eastern Ukraine intensified beyond border skirmishes roughly a week ago, a near vertical rise in raw material indexes has resulted.
Grain futures have increased dramatically, with wheat and corn futures rising to levels not seen since 2011.3 Both are major Ukrainian exports. Coupled with the surge in energy quotes, spiking grain costs will impact a wide variety of products, from feed for livestock to cereals to breads. These increases will work their way into end products over the next few quarters, fueling more increases in inflation. DJ Commodity Index closing prices from January 3, 2021, through March 3, 2022, are below.
Source: Quotestream online quotation platform, www.quotemedia.com
There has been little change in the underlying components of either producer or consumer price inflation over the past six months. Energy still leads, but we can expect food costs to begin contributing a larger portion of overall increases going forward. The below data is as of January, when the price of West Texas Intermediate (WTI) oil averaged roughly $80/barrel. At this writing, WTI is above $105.
As oil prices increase, gasoline will follow. Americans can expect the nationwide average price of unleaded regular to top $4/gallon within a matter of weeks.4 Select areas are already well above that level (e.g., California).
As consumers feel the increasing squeeze of fuel prices on household resources, demand will likely wane somewhat, but the necessity of access to transportation means many will simply grit their teeth and pay. The demand elasticity that applies to non-essential products is muted in energy consumption.
The conflict in Ukraine has altered the dynamics of European economies. Germany’s government, which for decades has de-emphasized fossil and nuclear fuels, has wheeled its energy policy 180˚ overnight. Recognizing heavy dependence on Russian oil and gas as a strategic security threat, Chancellor Scholz has announced not only a halt in final deployment of the Nord Stream 2 pipeline from Russia, but also that Germany will begin construction of multiple LNG ports to source gas from alternate providers. The process, however, will not be as rapid as the reversal of policy.5
Germany is not alone. The below chart illustrates the degree to which European countries currently rely on Russian gas imports.
The US, world’s largest exporter of LNG, is the logical partner to supplant Russia.6 America’s energy sector can produce sufficient crude and natural gas to replace current Russian-supplied demand if recent government regulations and impediments to production and development are reversed.
President Biden had an opportunity to shift his administration’s energy policies during the State of the Union speech March 1st but did not. Only time will tell if the emerging European abandonment of Russian energy will prompt action from Mr. Biden, which would also lower domestic prices.
American energy producers possess the resources to fill gaps fuel supplies resulting from Russian sanctions. We can’t see into Mr. Putin’s mind, but his February 21st speech7 clearly suggested that his ambitions in Ukraine and beyond (the Baltics) may not be satisfied until a reshaping of Eastern Europe to resemble the post WWII map is attained.
Broad resolve against this end has crystallized and sparked a unity of purpose in the West rarely seen since World War II. The hard lessons of last century’s wars are well remembered in European capitals. Sanctions are isolating Russia (except, so far, it's energy producers) from the global economy and have collapsed the ruble. The Russian currency has plunged over 30% to less than $0.01 in recent days from its pre-sanction level of roughly $0.015.8
America’s role helping to prevent a reversion to Russia dominance of Eastern Europe and in countering Chinese expansionism in Asia and the Western Pacific will be crucial. As the “swing” energy producer capable of filling shortfalls in world oil and gas supplies and as a manufacturing powerhouse, US workers will play an important part in the world emerging from Russia’s isolation.
The end of the Cold War led to an increase in global interdependence, or globalism, in the vernacular. China became the low-cost manufacturer of first resort for European and American industries and Russian gas fed demand for supplemental energy as green initiatives turned the continent away from fossil and nuclear fuels. That trend has been exposed as a serious strategic flaw and the source of widespread consternation in Western capitals.
Russia and China are deepening a bilateral alliance, with the West its opposing “tribe.” This could become a long-term positive for America, despite the tragic circumstances that will spark broad realignment of global trade and supply chains.
The implication for the US if globalism recedes is long-term economic expansion as domestic industries fill voids in a world rediscovering self-reliance and reduction in dependence on regimes anathema to individual freedom. If supply chains, manufacturing, and energy sources are reconfigured to promote trade with freedom loving allies instead of tyrannical enemies, the aftermath of these heartbreaking, dark days will ultimately be an economic positive.
Market volatility will continue abnormally high while conflict in Europe continues. Traders respond to real time news but investors who remember that long-term gains are built upon short term volatility and remain focused on their long-term plans will find an island of calm in a swirling ocean of daily chaos.
1 “Fed Officials Lean Against Expectations of Half-Point Increase in March,” www.wsj.com, February 18, 2022. 2 “US STOCKS-Wall St rallies over 1% as Powell says rate hikes on track,” www.NASDAQ.com, March 2, 2022. 3 “Russia’s Ukraine Invasion Chokes Food Exports From Global Breadbasket,” www.wsj.com, February 25, 2022. 4 “Oil tops $100: When will you see $4 a gallon gas in your state?” www.cnn.com, February 25, 2022. 5 “Nuclear, coal, LNG: 'no taboos' in Germany's energy about-face,” www.reuters.com, February 27, 2002. 6 “U.S. to be world's biggest LNG exporter in 2022,” www.reuters.com, December 21, 2021. 7 “Transcript: Vladimir Putin’s Televised Address on Ukraine,” www.bloomberg.com, February 24, 2022. 8 “From Ruble To Rubble,” www.forbes.com, March 1, 2022.
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