Macro Outlook: Will there be peace for our time?
It would be logical to expect that negative shocks from spiking commodity prices, higher interest rates and war-related headlines should slow the post-COVID rebound in the US and in the EU. A recently published study by the Dallas Fed The Russian Oil Supply Shock of 2022 came to this conclusion. The authors did not quantify the expected effect on the economies.
At the same time, the West is making plans to diversify their energy supply away from Russia. I would not be surprised if Russia, known for their tendency to respond in kind, will restrict supplies of piped gas to Europe, under the pretext of optimizing their cash flows over the next five years. This of course will make European gas prices much higher for much longer, making me think that the Russian Gas Supply Shock is coming to Europe in 2023.
Higher price of piped gas will drive up the price of LNG, where Russia is a major player. Just like crude oil, LNG is a tradable commodity and demand for LNG is relatively inelastic in the short run. If cargoes of American LNG are diverted to the EU from other markets, as promised by President Biden, those other markets will have to be supplied by other producers, possibly by Russia.
The US economy is less vulnerable to supply shocks from energy and materials, being self-sufficient in many areas, but could suffer from higher interest rates. The Fed is fighting inflation and will continue to jack-up rates for some time. Jay Powell apparently believes in The Near-Term Forward Yield Spread as a Leading Indicator. Without commenting on the merits of the argument, I can say that it looks convincing for the six recessions we had since 1975. What is more important is that the Fed is looking at many economic indicators, including this one, and acts accordingly. Based on this indicator the market is not expecting monetary easing over the next 18 months, and therefore we can expect the Fed to continue to increase rates as planned.
Back to war in Ukraine. From the headlines, it looks like Russia has declared that the campaign destroyed enough of Ukrainian military infrastructure and shifted to building a new administration in the “liberated” areas of Eastern Ukraine. I would very much like to believe that this will lead to a ceasefire in the very near future, but I am fearful that another victory may be sought by Russia to justify the invasion domestically. Capture of a large city like Kharkov or an encirclement of a sizable Ukrainian contingent may be their next goal.
The peace negotiations continue with little apparent progress: the Russian side is complaining that the Ukrainian side is very slow because every decision needs to be approved in Washington, and the Ukrainian side is saying that they are ready to agree to a non-NATO status, and in the meantime openly pleading with the West for more tanks and rockets.
I continue to believe that a ceasefire will be negotiated by May 9th. Russia is big on symbolism, and a victory (over alleged Nazis) in Ukraine by the V-Day will be a big feather in Putin’s hat. The actual peace treaty may take years to negotiate, because agreeing to Putin’s terms as we understand them today will most likely trigger domestic discontent, and drive Zelensky’s government from power.
A couple of stocks for consideration
Nike (NKE NYSE). Nike is a global athletic attire market leader. After a material decline over the past couple of months the stock is not as expensive as it used to be. Nike is a growth company with a superior brand and a solid business strategy. I like Nike better than competitors Adidas and Puma because I think that Nike is more aggressive with their Direct-To-Consumer strategy. Selling Direct will bring higher margins and easier “consumer engagement”, among many other benefits. Short-term, Nike will benefit from a post-COVID opening in China and globally.
Daimler Truck Holdings (DTG). The company is global manufacturer of commercial vehicles, a recent spin-off from the Daimler group. Truck manufacturing stocks usually offer good returns if purchased relatively early in the economic cycle. Due to shortages of chips and parts, truck makers are operating with higher-than-normal backlogs and lower-than-normal margins. After a period of shortages and constrained supply the truck making industry should see a period of elevated demand, better profitability, and higher margins. DTG is particularly attractive due to high market shares in attractive markets and inexpensive valuation (7.5x forward P/E). Successful internal restructuring and development of electric models could provide additional upside to the shares. The downside scenario can come about if the European economy slows down materially causing a fall in demand for trucks.