by Franklin J. Parker, CFA
The Summary
- Lots of big news swirling around. First, tensions at the Russia-Ukraine border have intensified, with US officials warning today that military action may begin within the next few days. This has created significant jitters in markets, as a Russian invasion of Ukraine generates significant uncertainty around a US response. Though a military option is not on the table, the Biden administration has repeatedly said that targeted and painful sanctions are. As we have discussed here before, however, sanctions are painful to everyone, not just the target. Investors, at any rate, are in a wait-and-see mode.
- Inflation posted last week at the highest level in 40 years, a startling 7.5% (though economists were expecting a 7% rise). This has pushed investors to reevaluate the path of Fed rate hikes and monetary policy. St. Louis Federal Reserve president Bullard threw gasoline on that fire with his comments that he sees the Fed raising rates by half a percent in March, with a full percentage point increase by summer. This was a shock to markets as it represents a significantly more aggressive stance than previously expected. I see the Fed as unlikely to follow such a path, though recent inflation figures suggest that it is warranted.
- Earnings season continues to be fairly good, of the 72% of S&P 500 companies that have reported, over three-quarters of those have beaten expectations. Revenue growth has been quite good, but inflation is a hot topic on earnings calls. Inflation can be expected to erode profit margins over time: as companies begin losing pricing power in the marketplace, they are forced to eat their higher costs, which hurts profits over time. Investors will be watching closely in coming quarters to see how bad inflation is compressing margins—to date, companies have been able to increase prices to keep margins steady.
- My investment outlook has not shifted. It is still my view that we have a bit more downside to go, though I will readily admit that judging short-term swings is very very difficult. Inflation and the Fed are likely to keep volatility elevated over the coming six months. As I have said before, I do not yet see this as a recession and this downswing is likely to be short-lived, in my view. In the end, exactly how you position your portfolio is dependent on your goals, time horizon, and willingness to watch your statement value move.
The Details
I listened to a very interesting interview with Ryan Peterson, CEO of Flexport, last week on the All In podcast. There were several eye-opening points made about the current and future state of our supply chains, two of which were particularly concerning.
First, and most concerning: ports along the entire west coast of the US, Mexico, and Canada are operated by a single union, the International Longshore and Warehouse Union. As it turns out, their contract expires in July of 2022, and the last time their contract expired, there were severe disruptions to shipping. With ports already overloaded, disruptions this year could be catastrophic. The Wall Street Journal reported back in November that the union appears to be ready to dig in.
Second, the international maritime regulatory body (which sits under the United Nations umbrella) will require every fossil-fueled ship to reduce emissions by 13%, starting in January 2023. Of course, most ships cannot simply flip a switch to make that happen, and many of the technological innovations to reduce emissions have already been brought to bear. The only real way to immediately accomplish this objective is to reduce the speed of the ship, which, in turn, reduces emissions but also reduces the number of trips available within the same period of time.
Both of these points are enough to generate concern that our supply-chain woes have not yet peaked. Investors should keep a close eye on both developments and make provisions accordingly.
Chart of the Week
This week we look at an interesting graphic produced by Reuters detailing current Russian military positions, and possible paths of invasion into Ukraine. I must admit my amateurishness in this area, so I will refrain from commenting on possible motives and objectives of the Russian Federation. In the end, I am left to watch the events unfold along with everyone else, though some risk control here is warranted. War is an unpredictable thing, and with US/NATO troops all around Ukraine the risk of a wider conflict is not zero.
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