From land war to economic war
Chart of the week
The chart shows the deviation of the oil price from the long-term trend and when a recession followed in the U.S. (shaded in gray).
Why this is important
When the oil price exceeds USD 100, the risk of the USA sliding into a recession increases massively. Since the USA is the largest consumer market in the world, this would massively weaken the entire global economy.
A recession in the USA would come at a very bad time. Since interest rates are already very low in the USA, the central bank would have almost no possibility of giving the economy a helping hand and lowering interest rates.
Is the big crash coming now?
Also last week, all eyes were on the war in Ukraine. Ukraine is unimportant in terms of economic policy and is not a factor that should worry the markets. Prices are driven by:
- Profit performance of the companies:
The last published figures were very promising. A large number of companies were able to exceed expectations. However, many companies are still suffering from the fact that the supply chains are not in balance due to the Covid crisis.
Expectations for earnings growth for companies in the US are also moderate and below the long-term trend of 10%. The chart below shows earnings per share growth expectations for US companies. The expectation is 9.9% for 2022 and 8.3% for 2023. With the relatively low expectations, there is a great chance that companies will surprise on the upside.
- Central Bank Policy:
In particular, the U.S. Federal Reserve has announced a change in its expansionary policy to a restrictive one. The market expects up to 9 interest rate hikes by mid-2023. The war in Ukraine could lead the central bank to postpone the rate hikes a bit, which would be a very positive sign for the stock market. However, the next meeting date is not until March 16/17. So it may be some time before a positive sign comes here.
Investor sentiment is poor and stock markets are going down worldwide. Here it is important to classify the correction historically.
The chart shows the performance of the European stock index Euro STOXX 50 since July 2021. Since the beginning of the year, the index has lost 20%.
More money has flowed out of the European stock market in recent weeks than during the Covid crisis:
However, in the long term, there is no cause for concern:
The chart shows the performance of the European stock index Euro STOXX 50 since July 1989. With a long-term perspective, the situation looks much less dramatic. Stock markets fluctuate and are not a one-way street. Corrections of 20-30% are normal and occur again and again without being triggered by a specific crisis.
Moreover, since the lowest point after the first Corona shock, the Euro Stoxx 50 has risen 78% without a significant correction. What we are currently seeing is therefore so far a completely normal correction, which also occurs after periods of overheating.
Since the financial crisis, the markets have actually risen by 145%.
The question that now naturally arises is whether the current crisis has the potential to lead to a major slump of another 20-30%, as occurs about every 10 years.
Long-term effects of the Ukraine crisis
New security policy
The Ukraine crisis is a turning point in history and will lead to a complete change in security policies of many states.
The chart shows the geopolitical risk index of the Federal Reserve. The current situation is comparable to the Gulf War of 1990, the terror attacks of 2011 or the Iraq war.
There has been no war in Europe for decades (except for the Balkan War). A whole generation has grown up without the fear of war.
In recent years, it has been argued that there will be no more conventional wars in Europe, only cyber wars. The military was losing more and more prestige and support among the population.
That is now about to change. There will be a massive rearmament in Europe. Public money will be diverted from other areas and flow into armaments.
Limits of capital and globalization
Covid has already shown how vulnerable the economy is when the supply chains for a product has over 100 components that have to be delivered from different continents. Already there has been a shift in thinking. Previously, capital and investment was welcome everywhere. But there is a new political dimension to this. Companies have to revise their long-term investment plans.
From land war to economic war.
The invasion of Ukraine will be carried out with conventional means of warfare and an exhausting ground battle. This is known from history.
In return, Europe and the USA have declared economic war on Russia. This is the first truly comprehensive economic war since globalization. For Western companies, the risk is growing. in countries that are not friends of the USA. In Europe, this applies to all non-NATO states, but also to China.
The question arises whether globally active companies in strategically important sectors will still exist in the future. Meanwhile, Visa and Mastercard no longer work in Russia. This will lead to Russia and China setting up their own payment systems in the future. Companies will have to decide which markets they want to enter. A concentration on Europe/USA, China or Russia dominated areas will be the result.
The stock market is currently struggling to accurately quantify these new risks. This uncertainty is causing a buyer's strike.
What is clear is that the world will change. There will clearly be losers, but also winners. However, also due to the already very poor investor sentiment, we rate the probability of a further stock market slump of 20-30% as very low.
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