Hello Friends, welcome to the March Market Outlook. So far, it’s been a difficult start to the year for financial markets. Of course, risk exploded last week after Russia began its invasion of Ukraine, an unfortunate possibility we began discussing last year. In our opinion, the market at that time wasn’t pricing in the risk of conflict occurring on three different continents- Russia/Ukraine, India/Palestine and China/Taiwan. Now that the former has occurred, the remaining question is, how long does it last? We’re not going to pontificate on the situation, as we believe this conflict could go in a number of directions. That said, we have been recommending commodities and inflation sensitive assets for over a year due to inflation and the Federal Reserve falling behind the inflation rate. Of course, the crisis in Europe has exacerbated the situation, really pushing up those assets. The CRB food index closed at a record high for the 8th trading day in the past 9, the price of wheat is up another 6% and higher by 45% over the past 2 weeks to above $12, the highest since the parabolic spike in 2008. Soybeans are near $17 and corn is at $7.5 per bushel. Aluminum is up another 5% to a fresh record high. Zinc is at a 15 year high. Oil continues higher after reaching the highest level since 2008, the peak of the commodity boom. And there’s no end in sight. We believe this cost pressure will be with us in 2023, and potentially beyond. Demand has not yet shown signs of dropping. The only way we get back to normal supply is with some level of demand shock, meaning the price will need to get so high, that eventually, consumers just say “that’s enough.” That conversation is occurring now surrounding the oil market, with many experts predicting $185 a barrel before demand shock will set in. That’s a very scary world when you consider the highest outpost cost for companies after payroll is energy costs. If you thought margins and earnings would be compressed this year due to growth waning and inflationary pressures picking up speed, the environment just got much tougher.
Given the loss of life and the horrific images displayed on the news, our hopes and prayers are with the people of Ukraine and Europe. This is a very dire time for the world. Arguably the darkest geopolitical period since WW2, and how the geopolitical landscape looks following this conflict is anyone’s guess. Given no one knows how this plays, nor how damaging the sanctions will be to global growth, we will sit patiently and wait for further information and market signs. That said, we had transitioned our portfolios prior to the conflict, and will make changes when necessary and appropriate. One last point- Russia looks to be on the brink of collapse. The ruble is talking on water like never before. The last time we had a ruble crisis was after the fall of the Iron Curtain. That slide brought us the Long-term Capital Management fiasco, which ended up bringing Wall Street to its knees. If I had to pick one bright spot though, it’s the strength of NATO. The previous administration called it dead but we just saw a revival like no one imagined. At the same time, after years of internal fighting, Americans finally have one thing they can agree on.
Onto the Federal Reserve, whose decision on a rate hike currently hangs in the balance. After listening to Chairman Powell’s Congressional testimony Wednesday, we disagree with current speculation that the Ukraine crisis will slow the Fed down or cause them to change course. The war will not reduce U.S. demand. The impact on U.S. exports will be minimal. Taste for risk could eventually have such an effect, but it is too early to impact the Fed. The impact on energy prices is clearly the most striking risk factor, but this will compound supply concerns and put upward pressure on inflation. Fed Funds rate futures have backed off on expectations that the Fed will raise rates by 50 bps later this month. But this is a response to the Fed’s own communications. If the February CPI-inflation data, coming next Wednesday, are as horrible as the January data, then a 50 bps rate could be on the table for the May FOMC meeting. Regarding CPI, we’re predicting an 8 handle- which will look and feel ugly. And we believe inflationary pressures get worse before we see any improvement. The war will not determine financial tightening or rate hikes.
We continue to believe the market made an important top in January. Until the charts prove differently, we’re preserving capital and emphasizing value stocks. We recommend keeping higher levels of cash presently. Volatility and daily 1-2% moves continue to be the new norm. Stay safe, pay attention to the news and please reach out with any questions.
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