Red flags fly

Stocks had a rough go of it on Friday after the White House warned of an imminent Russian attack on Ukraine. Consumer sentiment has fallen to lows not seen in a decade.

Red scare, scary. Stocks were trying…trying really hard to overcome the earlier-in-the-week jolt from the Fed. Late to the party Fed bankers, under pressure from lawmakers are ready to put the hammer down on cheap money. The bankers are also probably tired of paying too much at the pump, just like the rest of us. Ok, so we are ready to take our medicine and traders were trying their level best to claw their way back from earlier losses. Still not quite operating on all cylinders, markets got caught with a haymaker punch when government officials in the US and UK warned its citizens to leave Ukraine to avoid the mounting threat of a Russian invasion. The news was enough to send stocks lower into the close in Friday’s session. So, what does a Russian invasion of Ukraine really mean for stocks? Well, the most obvious impact has and will continue to be on energy prices, which were already volatile leading up to the crisis. 

Crude oil has been surging in the past year and a half. It is hard to believe that crude oil futures were actually negative at one point in 2020 as demand disappeared early in the pandemic.  Manufacturers responded to the fall off in demand by cutting production (supply). The move initially stabilized prices, but when demand picked up with the recovery, energy prices began to ascend. By the end of 2020, WTI crude was around $47 / barrel, slightly below the long running $50 – $60 / barrel range prior to the pandemic. By mid-2021, recovery in full swing, crude was bouncing up against $70 and it ultimately closed out the year at around $75 / barrel. In less than 6 weeks, crude has found its way to $93. The EU is highly dependent on Russian energy imports (around 60%), and as geopolitical tensions in the East rise, so does the likelihood of supply disruption. That puts further upward pressure on energy prices.  Did I mention that it is winter in the EU and demand for natural gas for heating is at its peak?  Back to the original question from above. 

Energy prices are already contributing to the nasty inflation being experienced not only here in the US, but around the globe. Further upward pressure caused by a conflict with Russia, can only make things worse. Let’s bring it close to home for a minute. A gallon of gas in the US (on average) is now $3.82 / gallon. That is around +40% higher than a year ago and nearly +50% higher than it was in December of 2020. That can certainly eat into your budget as a consumer.  Diesel fuel, used by trucks and trains to transport goods, is higher by around +37% in the past year, and as we are learning in earnings season, those cost increases are being passed on to us consumers. So, it costs more to drive to the grocery stores and the products at the store will also cost us more due to increases in transportation costs. Energy companies have certainly capitalized on rising prices and increased demand. The S&P500 energy sector has risen by some +56% in the past 12 months. Beyond the energy sector, companies will be able to maintain their margins if they are able to continue to pass their increased costs to consumers. That will only hold up as long as consumers are willing to pay the higher prices. Consumers’ wallets are already under pressure from rising prices and with interest rates about to go higher, that pressure will certainly increase. On Friday, the University of Michigan Sentiment release showed that sentiment was at its lowest in a decade. Fear of recession and soaring inflation are likely causes.  Low sentiment is a prelude to consumers’ cutting back on consumption. Consumption makes up roughly 2/3 of US GDP, so a drop off in it will certainly have a negative impact on economic growth. Can rising energy costs, general price inflation, and rapidly rising interest rates cause a recession? It is too early to tell at this point, but that combination has certainly caused recessions in the past. 

FRIDAY’S MARKETS

Stocks fell on Friday as investors learned of the increased risk of a Russian invasion of Ukraine.  The S&P500 fell by -1.90%, the Dow Jones Industrial Average lost -1.43%, the Nasdaq Composite Index dropped by -2.78%, the Russell 2000 gave up -1.02%, and the S&P500 ESG Index traded lower by -2.02%. Bonds rose and 10-year Treasury Note yields dropped by -9 basis points to 1.93%. Cryptos fell by -5.77% and Bitcoin declined by -2.77%.

NXT UP

• No economic releases today, however Avis Budget Group, Arista Networks, Advanced Auto Parts, and Continental Resources will announce earnings after the closing bell.
• Later this week earnings season continues, and we will get Producer Price Index, Retail Sales, housing numbers, and FOMC meeting minutes from Jan 26. Please refer to the attached earnings and economic calendars for times and details.