When Is This Going To End?

I will admit it: the last several days have been especially trying, as a sharp spike in oil, and other commodity, prices has caused global equity investors to reach for the door. Ordinarily, the bond market tends to rally when stocks hit the skids like this. However, this hasn’t been the case. The prevailing logic seems to be these price increases will eventually find their way to the consumer and interest rates will rise as a result.

We shall see about that. After all, if businesses could pass all of their expenses onto the consumer, no one would ever go bankrupt. Think about it. Also, regardless what the West does, the Russians still have an outlet for their energy through China. From there, the Chinese can effectively ‘launder’ Putin’s oil onto the global marketplace, at least that which they don’t consume themselves (about 14 million barrels per day).

Even so, longer-term pragmatism is seldom a salve for short-term panic, and that is exactly what we have seen in the markets over the last couple of weeks. So much so, the price/earnings multiple on the S&P 500 has fallen from 24.57x at the end of 2021 to roughly 18.78x, as I type at 3:25 pm CST on 3/7/2022. That is quite a drop in a pretty short period of time. It is even more impressive when you consider the yield to maturity on the 10-Year US Treasury Note is currently 1.78%.

So, when does it all stop? There is no shortage of theories and predictions about when the market will turn around, but turn around it will. I have no doubt of that.

Normally, during a “black swan” event, investors will sell their risky assets and buy seemingly safer ones in a so-called ‘flight to quality.’ Historically, US Treasury securities with a final maturity of 2-years or less have been the preferred place to land. This hasn’t really been the case this time, even if yields have dropped a little. In essence, it is hard to eyeball a significant ‘flight to quality’ during this sell-off. But why?

The kneejerk reaction is because investors don’t want to line up to buy debt securities when the Federal Reserve is poised to raise the overnight lending target. After all, bond prices go down when interest rates go up. However, this explanation doesn’t really explain everything, since short-term securities are less sensitive to interest rate risk. Essentially, the 1-Month Bill will barely budge in absolute dollars no matter what the Fed does on March 16th.

Intuitively, if investors aren’t plowing their proceeds into US Treasuries, they must be putting much of it in cash. To be sure, commodities prices have increased, but this, alone, would not be enough to absorb the massive amount of liquidity investors have raised since February 24th. But why cash, particularly when it isn’t paying anything?

The emotional side of me would argue cash makes people feel good. No matter what happens, you still have your cash. Am I right? However, the pragmatic side of me thinks people want to be liquid when this thing turns around, which it could in a hurry.

The Russians have given the Ukrainians four key demands to stop the bloodshed. Obviously, no one can completely trust Moscow or Putin at this point, if they ever have. However, some of the Kremlin’s beefs have been pretty consistent:

  • Acknowledge Crimea as Russian territory
  • Recognize the separatist republics of Donetsk and Lugansk as independent states
  • Change its constitution to “enshrine neutrality.” In other words, don’t join the EU or, more importantly, NATO.
  • Quit fighting back.

The last one would be a pretty bitter pill at this point for Zelenskyy, et al. However, Moscow has wanted the other three since well prior to February 24th. Frankly, the first two are essentially fait accomplish, even if it would seem like a slap in the face to admit the obvious. The third one is a long-standing Russia demand, not completely without merit, and would require some soul searching in Kiev. Finally, absent NATO’s actual involvement, which doesn’t appear likely at this point, the outcome isn’t in serious doubt. Ukraine is prolonging the inevitable at a great cost to itself and the global markets.

Regardless of what happens here, even if Kiev agrees to these demands, Ukraine has more than elevated its standing in the world and has scored a major strategic victory. On the flipside, the Russians want to ‘save face,’ as this has been an embarrassment for them. I will go a step further and say they HAVE to save face. As a result, it will continue pounding on the Ukrainians until they eventually agree to those terms above. In Putin’s mind, there simply isn’t another option.

Therefore, when will this end? When will the markets turnaround? The answer is simple: when Ukraine blinks. Is this fair? No, it isn’t. In fact, it stinks. However, that doesn’t mean it isn’t true. With that said, with each passing trade and with each investor who panics, the market looks even more attractive than it did.

Thank you for your continued support. As always, I hope this newsletter finds you and your family well; may your blessings outweigh your sorrows not only on this day but on every day, and may the conflict and bloodshed in Ukraine end quickly.

John Norris
Chief Economist


Please not, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.