Stocks have fallen but they have a lot to fall more unless serious measures will be taken by US and EU Governments and I'm not seeing them doing that. Here is my opinion.
This is mostly a supply led inflation, it's very different than other inflation cycles we witnessed in the past because those were demand based and could be addressed by raising interest rates to curb pressure on demand. Stocks would still go up with interest rates rising because the economy was booming.
This inflation cycle is different and only have a precedent during the early '70 oil supply crisis that caused stagflation and a massive stock market crash. How bad was that crash? Well, in the US the market lost 50% of its value, in the UK the stock market lost well over 70% of its value. As can you imagine, we are just at the beginning of the crash and in my opinion the situation today is worse than in the '70 so the stock market crash can be worse.
The point is, we are seeing inflation because commodities prices are rising and those higher prices of production are then transferred to the consumers. How do you fix it? Well, you can only fix it by increasing supply of those commodities. What are we doing instead? We are boycotting all supplies from one of the biggest producer in the world: Russia. And ESG policies are also targeting local companies so their CAPEX is very low. And you can't just increase CAPEX overnight, it takes years. Add to that that the current US Administration has very bad relations (the worst since many decades) with Saudi Arabia and UAE, two of the biggest oil producers in the world. They already said they won't increase oil production.
What the FED can do? Well, not much in reality because the FED is very useful to fix demand led inflation cycles but they can't do much to fix supply led inflation because they don't set commodity prices. It's all about demand and supply and since the supply is low the only thing the FED can do is destroy demand to match the low supply and reach a new equilibrium. But you see where we are going? To lower inflation to 2% the FED will have to destroy demand so much to cause a big recession. Any soft landing talk is bullshit. There can't be any soft landing given the circumstances. The FED will have to raise rates so much because the sensitivity of inflation to interest rates rising (in a supply led crisis) is much lower than in a demand-led crisis. And by raising that much a recession will follow and the demand destruction will match the supply, finally lowering inflation. The stock market will crash massively with a big recession.
This is already very bad, but things get even worse when we consider Europe. They are very dependent on Russian commodities and if they ban russian oil and gas, the price of these commodities will skyrocket to over 150$/barrel. Now, Europe already is experiencing a massive inflationary cycle (same as the US, supply led) but contrary to the US they can't raise interest rates much because the very existence of the euro currency is at stake. Why? Well, because Southern European countries already have such a massive debt (and zero growth) that they wouldn't be able to finance themselves in an open market at rates low enough to keep their economies afloat and not default on their debt. Indeed after the Sovereign debt cycle the ECB one way or another bought massive amount of their debt to keep them from defaulting but that was a band-aid that only postponed their demise.
Now, there is a Covid-related vast debt buying program that the ECB is doing but it's gonna end soon. Keep in mind the ECB, by charter, can't buy debt of Sovereign countries because it's totally independent and this is why a massive crisis will happen in Europe. I try to explain. Until now the ECB kept these countries from failing with different emergency buying programs and there were never inflationary pressures so interest rates were held below zero. Now inflation is above 8%, the ECB (contrary to the FED) has only one goal: to keep the inflation around 2%. So they have to raise interest rates and can't keep find excuses to buy Sovereign debt and expand their massive balance sheet because otherwise inflation will keep go higher and they would not respect their charter (by law they can't do it).
As soon as the ECB stop this debt buying program (they say it's gonna end soon) and raise rates, Southern European countries will experience big problems in financing their debt in the open market. Debt spreads between EU countries will rise and a new big Sovereign debt crisis (much bigger than the one in 2011/2012) will emerge threatening the survivability of the euro itself because Europe would need two different monetary policies (a lax one in the South, and a hawkish one in the North) but they only have one central bank.
Imagine a scenario with stagflation (high inflation+recession) and Sovereign debt crisis at the same time. This duo will create probably the biggest crisis in European stock market in history. Once they crash, the repercussions will be felt in the US as well because the economy is interconnected….imagine all US companies (already with the US crash I explained above) having to deal with demand destruction from a massive crisis in Europe…the recession in the US would get so much worse.
So, how do we get out of this crisis? I don't think there is a way unless the commodity inflation is taken care of and looking at the comments from various US and European politicians I don't see this scenario to happen…actually it's the opposite since they want to ban ever more russian commodities creating the condition for the scenario I explained above. The thing is, in the current interconnected world, already experiencing commodities price pressure, you can't ban the commodities from Russia (after you already did it with Iran and Venezuela) without ruining our economies too. By trying to ruin Russian economy, we'll ruin our economy and crash the stock market. Unfortunately, not many people have understood it and there is so much ignorance in this regard…so many people think they can ban those commodities and feel no effect in their countries. Economic ignorance and emotional based decisions are the biggest threat to our economies.
Why I'm extremely bearish on the stock market? Because the politicians went so far with their words that now can't walk their comments and decisions back. Every person that try to explain that boycotting russian commodities will cause a massive recession and stagflation in Europe and US is thought of as a Putin friend. The average person is just as dumb as a rock and no matter how you try to explain it, they don't get it.
How to position in the current geopolitical and macroeconomic environment? Well, I think going long commodities stocks, shorting the Nasdaq (with many stocks that reached very high valuations after the Covid crisis) and shorting Europeans stock indexes would provide decent results in the next year. As I said I really believe the stock market will crash more than during the '70 and back then it crashed over 50% in the US and over 70% in Europe.
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