07 Mar Capital 19 Catch-Up
“Don’t blindly follow someone, follow the market and try to hear what it is telling you.” – Jaymin Shah
You better get yourself a cup of tea and settle in for a long read this week as we have a lot to cover.
Before we get on to the impacts of Sanctions on Ukraine and the opportunities it gives us, we need to look at what is going on in the US economy, particularly with inflation and interest rates.
Fed Chairman Powell gave a congressional testimony last week and showed he is intent on hiking rates near term – starting at the FOMC meeting next week.
“I am inclined to propose and support a 25 basis point rate hike”
A little bit of certainty goes a long way. US Stocks staged a 2% rally on this announcement.
Interestingly, 30 days ago, Fed Fund Futures were pricing in an 81 percent chance of 5-7 rate hikes this year. They were also pricing in a 40% chance of a 50bps move in March.
Today, the 50bps chance is zero, but the chance of 5-7 hikes this year is still 82%.
Takeaway: even with everything going on this week, this market has not changed its view on the US economy and inflation. Powell gave traders certainty of the path which seems to be set at a steady trickle of 25bps raises at each meeting this year. Knowing this gives traders confidence and they are back to buying risk assets.
The other point of note here is – most of the time, it takes a recession to break the inflation cycle. But traders do not think that will be the case this time. If they did, you would see it getting priced into credit markets and it just isn’t happening. Markets still think the Fed can slowly cool inflation and reduce it in an orderly fashion.
It is really only recessions that end bull markets in stocks. No recession = the bull market continues.
Powell also said he is “attentive to the risks of potential further upward pressure on inflation expectations and inflation itself”. Clearly, both are not receding anytime soon, but even still, Powell expects inflation to fall “over the course of the year as supply constraints ease and demand moderates”. Why? Because of “the waning effects of fiscal support and the removal of monetary policy accommodation”.
This clear testimony was just what the markets wanted, the ambiguity of past statements is gone. Powell is definite on what needs to be done and stocks will act accordingly.
Let’s move on to the sanctions against Russia as what is happening here is unprecedented.
Last week I highlighted the value offered by Russian equities because they were being priced like they had gone bankrupt.
“This idea is certainly not for the faint-hearted, but we can’t ignore the value represented in Russian companies right now. The risk is sanctions do something horrible to any Russian investment. It might mean you don’t get a dividend paid because Russian banks cannot send Roubles out of the country, or it might mean investors are not allowed to hold investments in Russian companies and positions are liquidated in a fire sale.”
Well, the sanctions got worse. Or, more accurately, individual companies decided to take action themselves. I’ve never seen such a co-ordinated move by companies worldwide. It gives me faith in humanity to see everyone working together to punish Putin. But I do feel sorry for how the lives of all those innocent Russians who don’t agree with the war will change.
The exchanges responsible for listing Russian equities took it upon themselves to pause trading in the names I mentioned on Thursday last week.
If you bought them, you still own them, and you bought them at ridiculously low prices. It’s just that you can’t trade them at the moment. When this changes is anyone’s guess. But if one day they decide to allow trading again, then you can bet the prices will be significantly higher than when they ceased trading.
Personally, I don’t mind the pause in trading. Except it stops me buying more, which is annoying. This was always going to take years to resolve so trading or not, the plan has not changed. Warren Buffet once said:
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
That is pretty much exactly what they have done here on Russian equities. So let’s come back to this in five years and see where we stand. My bet is with massive profits.
The actions taken by companies are going to cause a lot of inconvenience to Russian citizens. Hopefully so much so that they revolt and remove Putin, end the war and become friends with the world again.
But what happens in the short term is worth considering. Consider this fact for example:
Rosneft, Lukoil and Gazprom supply about 36% of Europe’s oil needs.
What about Natural Gas?
In fact, Russia accounts for a good chunk of a lot of raw materials
Now, what do you think happens to prices if Russia can no longer supply these goods to the world because companies refuse to trade with them?
That’s right, we are going to see some fairly spectacular increases in the price of these goods. The demand for them is the same. But supply will be drastically reduced. That demand will chase prices higher.
Look at what has already happened to the price of Palladium.
Palladium was just an example, but if you like it, go and check out Sibanye Stillwater (SBSW) on the NYSE. It is still only trading on a PE less than 7 and a trailing dividend yield of more than 8%.
There are only two ways this plays out over the medium term.
- The world decides to continue to trade raw commodities with Russia.
- Raw commodities from Russia are cut off from the world markets.
If you believe option 1 is most likely, then you want to own those Russian raw commodity producers because they were priced like option 2 was the only possible outcome. (the annoying exchanges have stopped us buying these at the moment)
If you believe option 2 is most likely, then the producers of these commodities in other areas of the world will be getting a shed load of new orders and you buy them.
There is an interesting side piece to this and that is the impact on Europe. Europe is massively dependent on Russian energy as you saw above. Quite how they can fuel their cars and homes without it is beyond me.
And it isn’t as simple as “oh they will buy it from another place” because it takes a long time to transport it from this other place. For example, suppose Germany started buying oil from the US instead of Russia
Germany consumes 2.4 million barrels of oil per day
The largest oil tankers can hold 2 million barrels of oil.
So that means the US could send one tanker per day to Germany to just about satisfy their needs. Seeing as it takes 10-20 days to do the trip and then they need to travel back to refill, it would take about 40 or 50 tankers continuously en route from the US to Germany to meet Germany’s oil needs.
And that is just Germany. So what about the rest of Europe?
No, the world will not stop buying Russian energy any time soon, simply because it can’t. There is no other way Europe can meet its energy needs. If Russian energy companies are selling oil to Europe they are not going bankrupt and hence the price they were trading at was a steal.
But Europe is likely to transition from such a dependence on one country to diversifying its supply over time.
That will mean the prices of these raw commodities will remain elevated. Demand will remain the same but we have reducing supply and it takes several years of new investment to bring new supply on.
On the topic of Europe. They really are in trouble here. The economy has been weak for a long time and they have exposure to Russia on many fronts.
Take a look at what is happening to the EuroStoxx 600 index.
MSCI Europe is down 15.9% YTD and down 18.5% from highs
MSCI Germany is down 21.1% YTD and down 28.5% from highs
MSCI France is down 17.9% YTD and down 21.1% from highs
MSCI Italy is down 19.0% YTD and down 22.9% from highs
European markets are discounting a strong possibility of a recession in Europe this year. Clearly, fund managers are pulling out of their European positions. But those fund managers still need to put that money to work somewhere and US equities are seen as a relative safe haven. (The S&P500 is only down 10%)
The longer the war goes on and the more entrenched these sanctions become, the more appealing US equities will look compared to others in the world.
So, how do we profit from all this?
The obvious place to start is alternatives to Russian raw commodity suppliers as we mentioned.
For now, let’s focus on Oil. This is the biggest commodity in desperate need by Europe. They could get it from the US. Exxon Mobil (XOM) and Chevron (CVX) are the two biggest existing suppliers.
Both also pay nice dividends.
But the other country likely to step in is Saudi Arabia.
The problem is, due to country rules, foreigners cannot own Saudi company shares.
But there is a country-specific ETF – KSA – the MSCI Saudi Arabia ETF
The top holdings are:
Al Rajhi Bank, Saudi National Bank, Saudi Basic Industries and Saudi Arabian Oil.
Crude Oil prices are up to $124 per barrel at the time of writing. I have seen forecasts of $200 oil. But the real question is not what the price is today, but what the long-term price settles at.
The 5Yr average is around $62. It fell way below during Covid and has now spiked way above due to sanctions.
This spike higher will likely fall back over time. I feel $90 oil is a fair price. The fact is, this market has seen little investment over the last 5 years so supply is reduced. Take Russian oil out and that supply is reduced further.
You better get used to these higher petrol prices. They are here to stay for a long time. But that shouldn’t be too much of an issue for you if you own those very same companies that sell the oil to you.
There are an astounding number of great opportunities out there now for those who can see past the news of this week and focus on where the money will flow in 12 months from now.
Employees of Capital 19 do not presently own any of the securities mentioned except Chevron (CVX)
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.