NOTThere’s nowhere to hide, all asset classes are down. Stocks are at the forefront. They’re falling everywhere: -15.6% for the S&P in the United States year-to-date and -24.6% for the Nasdaq, which includes technology stocks.
Same story in Europe. The Euro-Stoxx in the Eurozone lost -14%, the CAC40 in France -11%, the DAX in Germany -12%, the FTSE250 in the UK -15%. In Asia, Japan’s Nikkei fell -8% and China’s Shanghai Composite fell -15%. On the Casablanca Stock Exchange, the MASI fell -5%. Only Turkey has escaped this trend with a plus of 10% since the beginning of the year. Three factors explain this sharp decline. First, the prospects for the conflict in Ukraine do not appear to be improving. Then disruptions in global supply chains due to lockdowns in major Chinese cities – including Shenzhen, Shanghai and now Beijing – to combat a resurgence in the Covid pandemic. Finally, monetary tightening by the major central banks to – partially – offset inflation.
Some inflation is good for stocks. We then assume that the companies best positioned in their market will be able to pass on the cost of inputs through a price increase, thereby preserving their margins. But here inflation is too high. Too high, to the point where it will require ever stronger crackdown action by major central banks to successfully control them. This very significant monetary tightening will slow growth and likely lead to a recession in the last quarter of the year. Suddenly the companies will be hit with half-mast results, hence the price drop to integrate this economic contraction.
The governor of the Bank of England has already publicly acknowledged that the UK economy is likely to slide into recession in the fourth quarter. Federal Reserve Governor Jerome Powell announced this week that “the US Federal Reserve would not hesitate to take extreme measures to curb inflation” and that “getting inflation under control would not be painless.” It was enough to crack markets now fearing a US recession. Especially as US inflation stalled at a 40-year high of +8.3% in April, compared to +8.5% in March but above economists’ forecasts of +8.1%.
The rise in central bank interest rates leads to a rise in bond yields and a sudden fall in their prices. The development on the bond markets is therefore also declining. In the United States, government bonds are down -10.4% year-to-date, corporate bonds are down -13% and high yield are down -10%. Government bonds fell by -8.9% in the eurozone and -15.6% in emerging markets. Gold offers a minimum level of diversification, even if it does not fully fulfill its role as an inflation hedge. Since the beginning of the year, it has recorded a stable price, down -1.76% year-on-year. Bitcoin is also having a tough year, falling -37%; nevertheless, it remains at a five-year high.
Only energy and agricultural products show amazing increases. Brent barrel up +43% year-to-date, natural gas up +116%. With a price per barrel of 111 dollars, it is to be feared that a higher price will weigh more heavily on the already weak global growth. Of course, these high prices benefit the exporting countries, who are using them to rebuild their financial positions after the ordeal of the Covid. A new element that could change the game, Mario Draghi, former European Central Bank President and now Italian Prime Minister, has proposed the idea of forming a cartel of oil buyers. In the same way, OPEC organizes the major oil exporting countries to align their positions for optimization of their interests, Mario Draghi put forward the idea of a buyers’ cartel that would include Europe and the United States or even other major consumers. It would function similarly to OPEC, to counterbalance the historical organization: aligning members’ positions to optimize their interests.
One can imagine this group announcing in advance the quantity and price at which they are willing to buy the output of the exporting countries. But for such a cartel to work properly, it would have to include the world’s second and third largest oil consumers, China and India. And right now, these two countries’ positions toward Russia reveal a notable strategic misalignment. It would therefore be very surprising to see them allied in this area. On the contrary, sea freight tracking reports that several cargo ships are collecting barrels of Russian oil in Europe to divert them to Asia. After the US, UK and Europe announced they would stop buying Russian oil, it is finding buyers elsewhere.
Chinese and Indian refiners are buying Russian production at a price well below the market price; there is even talk of a discount of 35 dollars per barrel! An alignment of Chinese, Indian and Western interests is difficult to imagine in this situation, even if in reality everyone would benefit in the long term from a real buyers’ cartel. In agricultural commodities, the price of wheat, popular due to the risks to global supplies posed by the war in Ukraine, rose +52% (after a +93% peak in early March). These risks are increasing, as in the case of large countries such as India, which are now banning all wheat exports for fear of shortages.
In this context, you need to reconsider your portfolio in terms of sector allocation. In fact, performances vary greatly from one sector to another: corporate actions in consumer staples are stable, while markets are falling and energy sector actions are up +45%. Priority should be given to the least affected sectors, characterized by inelastic demand. It is also necessary to prioritize stock picking, taking advantage of the opportunity to invest in value. PER ratios vary widely in the same market, ranging from 7x profit to 45x profit in the Casablanca market, for example. It’s wise to pick promising stocks and use current prices to invest in them for the long term.
: Omar Fassal working on the strategy of a local bank. He is the author of three finance books and a professor at a business school. To be found at: www.fassal.net.