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Geopolitical Conflict, Not Fed, is the Main Concern for Stocks
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Wall Street is feeling the tremors of record-high inflation and its aftershock in the form of an extremely hawkish Fed. Market participants across the globe are keenly watching the Fed, its tighter-than-expected monetary stances and their implications on the global financial setup. Major central banks are following the Fed in their fight to combat inflation.
As of now, policy prescriptions of the Fed and each and every comment from Fed officials are creating a ruckus in the markets. Wall Street is melting steadily as the central bank is tightening its policies further in each FOMC meeting.
However, a closer look into the current economic condition clearly indicates that it is not the Fed, but the geopolitical conflict caused by the Russia-Ukraine war that is the reason for the gloomy scenario. This four-month-old war has turned into the primary source of inflation.
Supply-Side Driven Inflation
The seeds of inflation were visible from March 2021. Robust pent-up demand supported by the astonishing savings of Americans (buoyed by unprecedented fiscal and monetary stimuli provided during the pandemic era), shifted the aggregate demand curve upward as the U.S. economy has reopened faster-than-expected driven by nationwide COVID-19 vaccinations.
However, supply failed to catch-up with demand measurably due to coronavirus-led complete destruction of the global supply-chain system. Production costs climbed because of higher input costs and higher wages owing to the shortage of labor.
Businesses did not find it problematic to shift higher costs of production to consumers as demand remained extremely strong. This resulted in the gradual increase of the price level, which is currently at a 40-year high.
The global supply-chain system had shown initial recovery once the spread of the Omicron variant of coronavirus dwindled. Unfortunately, Russia’s invasion of Ukraine on Feb 24, significantly pushed up inflation.
Commodity prices, especially the prices of crude oil and natural gas jumped, as Russia is the major supplier of these products in Europe. The NATO has imposed a sanction on Russian crude oil and its major financial institutions. Moreover, Russia is a major producer of important metals like platinum, palladium, copper, zinc etc. that are used as industrial inputs.
Together, Russia and Ukraine are the major suppliers of wheat globally. Thus, food prices jumped immediately. Sensing a global food crisis, at least 23 countries from Asia and the Middle East stopped exporting major agricultural and poultry products. This resulted in a high level of food inflation.
Since late last month, Russia has started restricting exports of inert or "noble" gases, such as neon, argon and helium to "unfriendly" countries. Russia is the largest producer of these products extensively used to manufacture high-end semiconductors worldwide.
Demand-Side Therapies by The Fed
Central Banks have no power to solve the global supply-chain system. They can adjust policy variables to cool the economy. Perhaps the Fed has considered inflation as “transitory” for too long. Several measures of inflation have elevated alarmingly since May 2021. Yet, in December, the central bank realized that inflation has turned into a genuine threat that needs to be tackled with harsher measures.
The Fed raised the Fed Fund rate by 25 basis points in March, 50 basis points in May and 75 basis points in June. Fed Chairman Jerome Powell indicated a possible 75 basis point hike in July too. The central bank terminated the $120 billion per month quantitative easing program in March and started to systematically reduce the size of its $9 trillion balance sheet since June 2022. Yet, inflation is showing no signs of abatement.
The Fed Chairman has reiterated his commitment to fighting inflation aggressively and bringing it down near the central bank’s targeted 2% without forcing the economy to go into recession. It remains to be seen how effective these policies are in containing inflation by hiking interest rate, squeezing liquidity and reducing demand.
A large section of economists and financial experts are skeptical about a soft landing of the economy. They think that a recession is imminent in the U.S. economy, which otherwise has strong fundamentals despite the pandemic.
Politics Dominates Economics - Unfortunately
At present, the lingering war between Russia and Ukraine is the biggest threat to the global economy. As long as this war continues, chances are bleak that we will get rid of the elevated inflation. Consequently, central banks will continue to adopt tougher monetary stances, resulting in an economic slowdown. The stock markets will react accordingly.
Unfortunately, economists cannot solve this problem and a broad-based political will and accommodative thinking are needed to stop the war. However, no one knows when this political wisdom will become a reality, and an amicable solution will be found.
Despite the free fall, Wall Street tried to rebound intermittently but failed to sustain the rallies in the absence of a genuine trigger. At present, that trigger can only be an end to the Russia and Ukraine war.
How to Invest
Markets may remain volatile in the near future. However, we expect a good recovery once Fed’s policy changes are adjusted fully in the market’s valuation. At this stage, it will be better to stay with quality stocks. Invest in U.S. corporate bigwigs (market capital > $50 billion) with a favorable Zacks Rank.
These companies have a robust business model and globally acclaimed brand value. They have a strong balance sheet and generate solid free cash flow. Five of these are — CSX Corp. (CSX - Free Report) , Lockheed Martin Corp. (LMT - Free Report) , FedEx Corp. (FDX - Free Report) , Broadcom Inc. (AVGO - Free Report) and Enterprise Products Partners L.P. (EPD - Free Report) .
Image: Bigstock
Geopolitical Conflict, Not Fed, is the Main Concern for Stocks
Wall Street is feeling the tremors of record-high inflation and its aftershock in the form of an extremely hawkish Fed. Market participants across the globe are keenly watching the Fed, its tighter-than-expected monetary stances and their implications on the global financial setup. Major central banks are following the Fed in their fight to combat inflation.
As of now, policy prescriptions of the Fed and each and every comment from Fed officials are creating a ruckus in the markets. Wall Street is melting steadily as the central bank is tightening its policies further in each FOMC meeting.
However, a closer look into the current economic condition clearly indicates that it is not the Fed, but the geopolitical conflict caused by the Russia-Ukraine war that is the reason for the gloomy scenario. This four-month-old war has turned into the primary source of inflation.
Supply-Side Driven Inflation
The seeds of inflation were visible from March 2021. Robust pent-up demand supported by the astonishing savings of Americans (buoyed by unprecedented fiscal and monetary stimuli provided during the pandemic era), shifted the aggregate demand curve upward as the U.S. economy has reopened faster-than-expected driven by nationwide COVID-19 vaccinations.
However, supply failed to catch-up with demand measurably due to coronavirus-led complete destruction of the global supply-chain system. Production costs climbed because of higher input costs and higher wages owing to the shortage of labor.
Businesses did not find it problematic to shift higher costs of production to consumers as demand remained extremely strong. This resulted in the gradual increase of the price level, which is currently at a 40-year high.
The global supply-chain system had shown initial recovery once the spread of the Omicron variant of coronavirus dwindled. Unfortunately, Russia’s invasion of Ukraine on Feb 24, significantly pushed up inflation.
Commodity prices, especially the prices of crude oil and natural gas jumped, as Russia is the major supplier of these products in Europe. The NATO has imposed a sanction on Russian crude oil and its major financial institutions. Moreover, Russia is a major producer of important metals like platinum, palladium, copper, zinc etc. that are used as industrial inputs.
Together, Russia and Ukraine are the major suppliers of wheat globally. Thus, food prices jumped immediately. Sensing a global food crisis, at least 23 countries from Asia and the Middle East stopped exporting major agricultural and poultry products. This resulted in a high level of food inflation.
Since late last month, Russia has started restricting exports of inert or "noble" gases, such as neon, argon and helium to "unfriendly" countries. Russia is the largest producer of these products extensively used to manufacture high-end semiconductors worldwide.
Demand-Side Therapies by The Fed
Central Banks have no power to solve the global supply-chain system. They can adjust policy variables to cool the economy. Perhaps the Fed has considered inflation as “transitory” for too long. Several measures of inflation have elevated alarmingly since May 2021. Yet, in December, the central bank realized that inflation has turned into a genuine threat that needs to be tackled with harsher measures.
The Fed raised the Fed Fund rate by 25 basis points in March, 50 basis points in May and 75 basis points in June. Fed Chairman Jerome Powell indicated a possible 75 basis point hike in July too. The central bank terminated the $120 billion per month quantitative easing program in March and started to systematically reduce the size of its $9 trillion balance sheet since June 2022. Yet, inflation is showing no signs of abatement.
The Fed Chairman has reiterated his commitment to fighting inflation aggressively and bringing it down near the central bank’s targeted 2% without forcing the economy to go into recession. It remains to be seen how effective these policies are in containing inflation by hiking interest rate, squeezing liquidity and reducing demand.
A large section of economists and financial experts are skeptical about a soft landing of the economy. They think that a recession is imminent in the U.S. economy, which otherwise has strong fundamentals despite the pandemic.
Politics Dominates Economics - Unfortunately
At present, the lingering war between Russia and Ukraine is the biggest threat to the global economy. As long as this war continues, chances are bleak that we will get rid of the elevated inflation. Consequently, central banks will continue to adopt tougher monetary stances, resulting in an economic slowdown. The stock markets will react accordingly.
Unfortunately, economists cannot solve this problem and a broad-based political will and accommodative thinking are needed to stop the war. However, no one knows when this political wisdom will become a reality, and an amicable solution will be found.
Despite the free fall, Wall Street tried to rebound intermittently but failed to sustain the rallies in the absence of a genuine trigger. At present, that trigger can only be an end to the Russia and Ukraine war.
How to Invest
Markets may remain volatile in the near future. However, we expect a good recovery once Fed’s policy changes are adjusted fully in the market’s valuation. At this stage, it will be better to stay with quality stocks. Invest in U.S. corporate bigwigs (market capital > $50 billion) with a favorable Zacks Rank.
These companies have a robust business model and globally acclaimed brand value. They have a strong balance sheet and generate solid free cash flow. Five of these are — CSX Corp. (CSX - Free Report) , Lockheed Martin Corp. (LMT - Free Report) , FedEx Corp. (FDX - Free Report) , Broadcom Inc. (AVGO - Free Report) and Enterprise Products Partners L.P. (EPD - Free Report) .
These stocks have strong potential for the rest of 2022 and have seen positive earnings estimate revisions in the last 30 days. Each of our picks carries a Zacks Rank # 2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The chart below shows the price performance of our five picks in the past three months.
Image Source: Zacks Investment Research