Russia’s Grip On The Economy

Reflecting on our 2021 year-end Market Perspectives, our thesis held that 2022 could look quite a bit like 2021 — with some key differences. We noted the positives such as the economy reopening should continue, and global economic and corporate earnings growth should be above trend. The negatives: Inflationary pressures were increasing, interest rates rising, and fiscal and monetary support waning. In short, the economy was slowing, but still moving at a pretty good clip. The landscape was looking reasonably good.

Looking back to December, we provided risks to our outlook: headwinds and geopolitical risks were in the viewfinder, but no one imagined a Russia led full scale attack on Ukraine.  The implications are already being felt and we believe conditions will further deteriorate, at least in the short-term. Add this unfortunate outcome to persistent inflation and we have a very unstable system.

Russia’s invasion of Ukraine brought new challenges for financial markets just as they were beginning to digest rising inflation and rising interest rates.  The picture is much more complicated with wide-ranging sanctions against Russia, something President Biden may have underestimated. Consequences are unlikely to be transitory.

The situation has changed our outlook for 2022 and 2023— higher economic and market volatility and longer-term inflation. Long before the great recession, America became conditioned to low inflation and historically low interest rates. All signs are signaling a rough patch for the foreseeable future and increased volatility that could persist well into 2023.  We are still optimistic about stocks, but from a thematic perspective, commodities will likely be part of our strategies for the remainder of 2022.

How Russia effects the global economy:

Russian exports typically amount to less than $500 billion a year. In the context of total global trade of around $30 trillion, that appears inconsequential. Of course, there is more to the story, and it has everything to do with supply and demand.

Russia is a major supplier of raw materials, nearly 40% of its exports. With that knowledge, it is easier to understand ongoing controversy around the Nord Stream 2 pipeline. You may recall the Biden administration waiving sanctions (in early 2021) on the company behind Russia’s Nord Stream 2 gas pipeline to Germany. That move was decried by many congressmen, but Secretary of State Anthony Blinken fully supported the move. Much of Europe is dependent on Russia for oil but that is only part of the problem. The United States has also become a major importer of Russian oil despite the abundant resources at home. The same resources that President Biden squashed by executive order just after being sworn in as our 46th President.

Russia is also a large supplier of the world’s aluminum, which is already in short supply, as well as significant shares of global palladium, platinum, nickel and copper. Both Russia and Ukraine are major suppliers of wheat. Sanctions and disruption could limit supply of these commodities over the coming months.

Returning to our thematic perspective, commodities have tended to perform especially well when inflation was high but economic growth was low or slowing. Much like we are experiencing today at the same time central banks find themselves in the unusual position of tightening policy while growth is declining. We don’t want to start throwing around the “R” word, but Russia’s invasion of Ukraine is already exacerbating the slowing growth story and, to a greater extent, inflation.

Moving through the current year, we see commodities as a necessary diversifier as well as a longer-term theme of the transition to a net-zero, electrified economy—a prominent long-term inflationary pressure. Many supporters of “going green” disagree with our thesis, but we are confident that traditional energy commodities will remain high. That is not to say we don’t support a greener planet, rather we don’t believe alternative power can be scaled fast enough to keep up with demand.

In summary, Russia’s importance in the world’s energy, aluminum, palladium, platinum, nickel and copper markets means that sanctions are likely to exacerbate already growing shortages in these raw materials.

The Bottom Line: The first few months of 2022 were filled with volatility, interest rates fears, another variant of Covid, and the underestimated Russian attack on Ukraine. Investors have experienced extreme volatility amid inflation that is uneven and rising. Headwinds are part of life, but our government has created a series of unforced errors in recent years. For example, we are purchasing 203,000 barrels of crude oil from Russia, every day and another 500,000 barrels per day of other petroleum products. That is approximately eight percent of our total crude oil imports. At the same time, we are sending much needed supplies and weapons to Ukraine. In other words, we are spending big dollars with Russia (helping them fund an attack on Ukraine) when we have the same resources right here at home. In fact, in 2020, we were net exporters of oil since 1949. Relying on other countries for resources such as crude oil is counterproductive and very costly to American citizens.

Our thesis about a robust economy remains optimistic but the likelihood of longer-term inflation has prompted some allocation changes that include commodities and tighter option strategies. What we know for sure is equities are clearly in a down trend. From a technical perspective, nearly all sectors are making lower highs and lower lows. A recession cannot be ruled out, but for now, that is not our primary concern. However, we are cognizant of growing risks and remain vigilant in our quest to control risk and improve reward. If you have questions about your portfolio or want to explore alternative strategies, don’t hesitate to contact our team today.

If you want to learn more about growing and protecting your wealth, contact us today.

In observance of Good Friday, OmniStar will be closed Friday, March 29th. Happy Easter!
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