“There never was a good war or a bad peace”. (Benjamin Franklin, 1783)
Outlook: Reducing Demand in a period of Tight Commodity Supply
Are we heading to a global recession? I think that the consensus view that the Global Economy is heading for a recession is not necessarily wrong. Higher policy rates could bring economic demand to a suboptimal level while making only modest progress in inflation. Inflation is likely to remain elevated because the war in Ukraine and related sanctions will restrain supply of many tradable commodities. The situation can only get worse if Russia decides to retaliate by reducing their exports to the West. It would probably be a good idea for Central Banks to encourage a quick resolution of the war in Ukraine, but unfortunately Central Banks have no tools for that. All they can do is set rates, create money, and buy or sell bonds. Chair Powell has recently suggested that “additional 50 basis points increase will be on the table at the next couple of meetings”, leaving the possibility it can be done a few times, not just twice. During the press conference Powell has repeated this a couple of times, namely three times.
How high can the rates go? Assuming inflation expectations of 3%, real rates of 0.5%, and 2s/10s of 1%, all seen in not-so-distant past, we get 4.5% yield on 10yr Treasuries, rather than 3% expected by many analysts. A further 100 bps increase in Treasury yields will bring more losses to bond investors: negative 5% one-year total return from 10-yr Treasuries, and negative 14% total return from 30-yr Treasuries. The impact on long-duration highly valued equities will also be negative. I am therefore, focused on relatively inexpensive stocks, well-placed for transition from globalization, deflation, monetary stimulation, and security of supplies to re-shoring, inflation, monetary tightening, and shortages.
How long will the war last? It looks to me that the Ukrainian Government is not in any hurry to negotiate a peace accord on today’s terms. It is quite possible that the Ukrainian army, armed and supplied by the West will be able to push Russian forces back to the borders of Russian Federation. It is also quite possible that Ukrainian Government, supplied and encouraged by the West, may attempt to retake Crimea, which could make this war into a multi-year confrontation. The Iran-Iraq war, where the US was on the side of Iraq, lasted for eight years. I would not expect any clarity over the next few months, given that the flow of heavy armaments to Ukraine is slow, and new NATO armaments require additional training.
Inexpensive stocks.
Given high stock market volatility, I am reluctant to add a lot of new names.
Mosaic (MOS NYSE). Mosaic is the largest producer of phosphates and the second largest producer of potash. The stock appreciated quickly after the war in Ukraine was announced, as investors understood that the conflict will restrict the flow of fertilizers from Russia and Belarus (the two countries accounting for 40% of global potash production). I like MOS better than a comparable stock of Nutrien, because of a simpler business mix. The picture is particularly bullish for potash, which both companies produce. Management of Mosaic is taking advantage of the situation in a prudent manner, by increasing production via debottlenecking and development of brownfield projects. At today’s fertilizer prices the stock is “cheap” on any metric. If today’s fertilizer prices were to last, the company will be generating “windfall” cash equal to approximately 15% of the current market cap per year.