Some here may have noticed that stocks and bonds have dipped a bit over the past couple of months and have started studying the arts of reading tea leaves, coffee grounds and goat’s entrails to forecast the future.
The market deals with risk rather well but is driven to distraction by uncertainty – and we are facing a perfect storm of that.
Some of the risks are obvious and some “not so much”.
Geopolitics is playing a major role in the financial condition of the US:
Russia’s ambitions in Ukraine (assuming they are not prepared to gobble up the entire country) include, not only consolidating their holding of the eastern Ukrainian provinces (protecting their possession of Crimea), but also the southern tier of the country along the Black Sea from Odessa to the Russian sympathetic breakaway Moldova province of Transnistria. In the absence of direct US or EU or NATO intervention, despite cheerleading and propaganda, it’s pretty clear that Russia has the ability to take the territory. It is also likely they will ignore any requests to give it back or pay restitution to Ukraine as they are now implication that it was “always” Russian territory.
There is an assumption that, in order to prevent a world war, the West will not risk a significant escalation of the conflict and that it will have to look for a face-saving way to cool it down to a stalemate.
So, the uncertainties include:
Whether or not increased Western involvement will cause an expanded military conflict
Whether Russia will continue its expansion beyond their current borders,
Whether assorted Western sanctions against Russia will cause increased shortages and inflation in the West – and how long they will last (including apparent Saudi support of Russian oil pricing by not increasing production)
Whether the war will disrupt Ukrainian food shipments which are required globally and whether it will affect the price of global food commodities
Equity and gold market (US market and global) manipulation by Russia as retaliation for financial sanctions imposed
There is also the potential for increased stress as it appears that Finland former Russian territory) and Sweden will join NATO – bringing it to Russia’s border.
The West is linked to Chinese supply lines by a huge cable. Both because of increased demand spurred by COVID largess, new higher-waged jobs among the newly employed and shortages of supply, the supply/demand curve is dictating higher prices, thus higher inflation.
Possibly due to increased fuel costs linked to the Russia/Ukraine war, China has today reported 8% inflation
The biggest risk to the world’s supply chain is linked to China’s COVID mitigation policy. The Chinese vaccines have not proved as effective as the mRNA ones developed in the US and Germany and they have elected not to head down that road. That means they are very concerned that an unaddressed COVID outbreak will spread like wildfire through a country with a quarter of the world’s population. From the West’s standpoint, the supply chain disruptions caused by the occasional shutdowns of a handful of Chinese cities is a drop in the ocean compared to a nation-wide outbreak.
There are also concerns that China is watching the reluctance of the West to directly engage with Russia over Ukraine and, considering the longer military supply chains by sea for the US compared to the easier land-based European ones, might be tempted to take a swing at Taiwan.
In addition there is a concern that China and Russia will create a bank transfer system which bypasses the SWIFT system and is valuated in their own currencies which, if opened to China’s trading partners, could weaken the stranglehold that the US has on international trade.
The US is experiencing an accelerating inflation rate, due in part to the above factors and in part to the overheating of the economy as a response to COVID and the sudden return to work causing an increase in labor costs. With wages going up but prices going up faster, inflation is the result.
So the Federal Reserve Bank has tightened up the money supply through cessation of asset purchasing as well as the increase in base interest rate. How quickly these strategies will progress as well as how tight the noose will become is contributing to the feeling of uncertainty.
The US economy has a history of ups and downs, but this has been frozen in an upwards trajectory for far longer than usual so the expected reversion to the mean is further down than usual. The concern about how far down constitutes a rational level is also contributing to the uncertainty.
An increase in the value of the US dollar, while biasing non-oil imports lower, will not reduce inflation sufficiently to compensate for the decrease in the valuation of international business (in terms of USD) by US firms. An increase in the USD will likely coincide with a reduction in stock market prices.
Last, but not least, in a country where a primary news source is owned by the same Australian media company which was instrumental in cheerleading for Brexit and where there is ample evidence that other nations provide social media content designed to increase intra-US tension, upcoming political trials are likely to become ever more divisive.
The problem is that, while all of the above are (IMHO) objective, evaluating the risk of each on a quantitative basis is highly subjective and constructing a composite numerical risk factor (at least for me) is currently impossible. What is highly likely is that the decline in both bonds and equities is not nearly over.