Stagflation Fears Rise as Oil Spikes - What Markets Are Pricing In

Hello and welcome back to the Market Maker podcast. We are recording this on Thursday, the 2nd of April. So happy Easter to anyone who's listening. Hope you're getting a well-deserved break. But in this episode, we're just going to go back and look at what has been another rollercoaster week in global markets, starting with the euphoric rally, Piers, that we've had described in US equities. I think this was on Tuesday where the S&P 500 rose nearly 3%. One of the biggest moves we've seen in the last year. In fact, one of the biggest updates we've seen since the truce. Is there, has there been a truce between US and China on the trade front? So perhaps we could talk about that move first, look at how the different sectors within equities perform in that scenario. Yeah. And then we can talk about the public address that Trump gave, which really blew up some of the positivity that was emerging earlier in the week.

Yeah. I mean, feel like a little bit of a fraud talking about the big euphoric rally yet when half of it has been dumped back just over the last few hours. But such is the nature of the beast, the beast being the volatility that we've been seeing as this situation's been unfolding. I'm going to start with oil and then we'll just drill into stocks because obviously oil's the key litmus test, the key market when you're trying to monitor how this situation is unfolding. And I was actually just looking back. So remember, you go back like pre-US invasion of Iran, or not invasion, but attack. I don't know what the right word is, but we'll leave that there. But oil was trading around about, well, $70-odd, right? And then it rose a little bit as we thought, hang on, the US are amassing military presence in the Gulf. Something's going on here. So it kind of went from $70. This is Brent crude. Up to about, yeah, we'll just call it 80 to 85, right? And then bang, it kicked off and oil spiked to 120. Then there was big volatility and it actually dropped back. And that's, hang on, let's get some dates here 'cause this thing's been moving on, right? That was the 9th of March where oil hit what is actually officially still the highest point traded in this whole situation on the 9th of March. I'm just going to round it to $120, right? It was just a little bit below there anyway. Full reverse. And by the 10th of March, we were back down to $83. And then actually it kind of trended up and right. I would say ever since we, once we got back over $100, which was on the 13th of March, right? We were recording this on the 2nd of April, basically ever since the 13th of March, it's been in a range $100 to $120 and it's been pinging up and down and up and down and up and down. And we've done the full range several times in both directions. Over the last few weeks as you've gone through the seesaw of positive news, Trump saying, "Bye, we're almost done. Yeah, we're about to wrap up. We've completed 90-odd percent of our objectives. I can pull out this war whenever I want," all that kind of stuff. Fine. Then you think, "Ah, situation's not going to last. Don't worry about this long-lasting inflation problem. This is a short thing." And so oil prices drop. And then obviously we'll talk about maybe briefly overnight, Trump's reversed the whole thing and now he's going to smash it around up again. And so oil prices spike. But look, it's up, down, up, down, up, down. Obviously midweek this week we had oil dropping again, retesting the $100 level. Really, really key, this price point, huge technical level. This was tested yesterday. It was tested overnight again, actually just before Trump started speaking. It's holding firm, right? $100 on Brent crude. It did slip below it briefly, but not for very long. So $100 is key. And that floor's still in place. Now, when you get oil prices dropping off positive news that the conflict's going to come to an end, obviously you're getting then spillover impacts across the asset classes. So stock markets rally when oil prices are dropping. And so S&P up 2.9%, but that's the whole index, right? So when you delve underneath the bonnet of that, you're obviously going to get a kind of range of performance and the best performers will be the ones that are most sensitive to the conflict. So there's something called the fuel trade, which is companies that are very, you know, one of their cost, you know, line items in their accounts, one of their biggest overheads is fuel. So airlines, so Delta Air and American Airlines up 5%, for example. You then got all your cyclicals. That's your companies whose revenues are correlated to economic growth. So like tech stocks, for example. So once you're getting oil down, you know, crisis over, don't worry about inflation, you know, the economy's going to come back. Then obviously your cyclical stocks rally. So tech stocks were up, some of the smaller ones, like some of the micro, well, some like not small, Arm is not a small business, was up about 6%, for example. So yeah, that's what's going on. Lots and lots of volatility off variable soundbites, which Trump is just the king of. And so, but the situation I would describe, it's the same as it's been for the last few weeks when we've been talking about it on this podcast. Nothing's changed. It's still ongoing.

Yeah. Maybe I could just have a quick comment as well about the dissemination of news. What I found quite interesting, thinking my mind back to the job I used to do when I was watching the news flow and you were trading, was that this was a Wall Street Journal leak. So this is very common from a central bank strategy where you want to drip feed a message to the market without it being official policy line. And so what that can often mean is if there's a big disconnect between market pricing and what a central bank is actually wanting to do in the future with policy, they can just pick up the phone and a source at Bloomberg, The Journal, whatever it might be, can drop an exclusive kind of comment. Sources say, which is everyone knows in the market, that's the central bank saying that, but the central bank isn't then held accountable and they've got flexibility. Trump very much knowing what he is doing here, seeing the situation happening. Someone's thought, okay, yeah, let's use The Journal in this case. 'Cause it was a leak in The Journal. So it wasn't official comment at the time revealing that Trump is willing to exit the conflict even if the Hormuz remained closed. So that was how, and this is what traders would look at, right? When you were trading intraday and you were trying to get in, you were holding very short price movements. Yeah. So the absolute microscope of intraday trading, this would be the type of edge that you'd be looking at. But yeah, I just thought that was, interesting because that he already would've been planning well in advance the public address that we can talk about now, but you drip that in. So you play basically as a hedge, you say, right, we are going to, as he said in his public address, televised of course from the White House, that the US will hit Iran, quote, extremely hard. But then And then you also, the spokesperson, the Israeli military responding saying of incoming crushing, broader and destructive attacks. So Trump's kind of, this is negotiation, right? You say, right, we're going to send more troops in physically, which they've been doing this week, more military presence. We're going to hit you hard, but at the same time I drip feed in, I'm not willing to broker a deal at any point if you're up for it. Nothing too surprising, but just, yeah, interesting to see. But yeah, so what's happened since then? I mean, he's obviously come out with the more public line that's a bit more holding their feet to the fire, so to speak. So how have the market taken it?

Yeah, well, so oil is back up. It's trading 108. I'm just going to round the numbers. It's 108.50 at the moment. So from an oil price perspective, we're kind of this aggressive set of headlines out of Trump overnight. It's just meant that $100 technical floor's held again and we've rebounded sharply up to $108.50. We're basically mid-range now of this $100 to $120 thing. And basically I think that is such, from a, you know, you look across all financial markets, that is such a pivotal range. You know, it will break. It's just we don't know in which direction. So is it going to break 120 and smash up to 150 and higher, or is it going to break 100 and drop back in? Obviously will depend on whether this situation escalates or de-escalates. And at the moment it's escalation, de-escalation, like a yo-yo. But ultimately it's still ongoing. There are obviously other markets here. I mean, you know, when you're looking out over the, well, let's talk about, we mentioned these sectors there. So we were talking about the fuel trade. So the airlines are hugely volatile off the back of every single, you know, development here. But when you go and look over the last one week, you look at the heat map, then, you know, you've generally got red, like all the big kind of cyclicals are down, although you've got some, I would Within the tech stocks, you've got a couple of what are almost like defensives, which are Apple and Google, which are actually up on the week. But most of the other tech stocks are kind of tracking down. Healthcare's up. You've got consumer defensives are up. You've got utilities that are up and green. So these names, right? If you're not familiar with equity sectors, well then this is just this concept where we bucket together companies that are similar. And so we kind of break really a whole index normally down into like 10 or 11 different subsectors. And then these sectors typically will be correlated. And so their share prices will generally speaking, you know, move in tandem up or down. And some sectors are inversely correlated to others. And that then just depends on what's happening out there. So at the moment you've got cyclicals moving down because we're worried about the economy, more worried about inflation and interest rates maybe having to go up. And we'll talk about this word stagflation in a minute, but there's economic concerns. So you're getting those companies whose revenues are correlated to the state of the economy. Well, they're going down, right? So you can think about a really obvious one might be what we call consumer discretionary stocks, which is, let's say, luxury goods. So are you going to, is a consumer going to be going out and buying a really high-ticket expensive item when they're worried the economy's declining and they might have concerns around, well, maybe I'm going to lose my job. When you're in that kind of mindset, obviously as a consumer, your behavior is, well, I'm going to save more. I'm going to save up for the rainy day scenario. So I'm not going to be buying my whatever Gucci bracelet, right? And so the companies that are selling that stuff, obviously, will their sales drop? So they're very much cyclical, as we say, right? So they're on the down. But where do investors put their money? This is the problem. Normally when you're running a portfolio, an investment portfolio, then you tend to want to stay in the market, right? So it's not rarely will you get people just selling out 100% cash because the idea over the long, long, long, long, long term is always be invested. And so, right, well, if you can rotate your assets so you can sell some of your vulnerable, you know, airlines or your LVMHs, you can sell those 'cause you're worried that the economy's going to get hit and those stocks are going to drop. But of course, if you're worried about that and you sell them, well, you are generating the downside pressure on those share prices. So those share prices do drop. So of course, this is where markets price in the future, right? We are selling shares today because we're worried about the economic situation in the future. So the share price reaction will always come in advance of that future scenario. Of course, sometimes the future scenario pans out differently, in which case, fine. The market goes back up, right? And that's what we're seeing with this up and down volatility over the last few weeks. But where you're putting your money, if you're selling your American Airlines stock, what are you buying with that cash? And there you're moving into what we call defensive sectors. So as I've said, consumer defensives. So that's still thinking about what do individual consumers spend their money on? So fine, it's your luxury items, but the opposite end of the scale is stuff like food, it's stuff like medicine. It's like toiletries, toothpaste, and all the boring stuff. But actually the companies that sell that, their revenues tend to be super stable. They're not cyclical. And so in times of economic concern, those stable revenues become really attractive relatively. And so, right, you're buying those stocks as a kind of safe haven play. So yeah, consumer defensives, you know, stuff like utilities, you know, you have to light and heat your house. Obviously, you know, it doesn't necessarily matter what what the economy's doing, fine, you can try and cut back and save here or there, but ultimately, again, fairly stable revenues. Similarly for healthcare, obviously you need your healthcare irrespective of what the economy's doing. So there's some examples of some of the sectors that are actually performing really well.

I thought I could jump on something you said there, which was the human behavior. Mm-hmm. And there was a really cool article in the FT. The FT have a really great data visualization guy. I can't remember his name. He's pretty well followed. So if you're on things like X, things like that, he shares loads of cool infographics, but they put one together and it's talking primarily about oil imports.

Yeah.

But this was an interesting layer and I think an extension of a lot of our conversations in recent weeks, which is we've talked before about the pain that Western Europe might feel as opposed to America and different geographies depending on their dependency on oil and where it comes from. So I thought perhaps we could extend on that conversation a bit more details because one of the things I clocked last night is, look, you still live in London. I don't live in London anymore. I moved out during COVID And so now I'm part of like the village people. What you tend to see is you get part of these like Facebook community groups and the general vibe is like, oh, there's a pothole here, sort of thing. Be careful when you come out of Sainsbury's, stuff like that. Useful intel for day-to-day life. But one thing I saw last night was the first kind of posts that people were making. And it was like, where can I get petrol? And then someone else said, what is the pump And then someone else comments, oh there, they've just stopped the pumps on BP on 3 of the 5. And all of a sudden someone's saying, oh my God, then another person. And then all of a sudden the emojis are flying off and you're like, have I missed something here? Like, as far as I knew, and like we are watching this stuff, you know, we're fairly well engaged and informed about tracking it, but just this human behavioral element. And I actually went out, took my daughter out last night for a club. And one of the, there was a queue coming out of one of the forecourts.

Right.

And I was like, hang about, it's just, and it's just happened now. You said the peak price was 4 weeks ago.

And this is before Trump spoke last night.

Oh yeah.

Right. Yeah.

Yeah. So yeah, it just all of a sudden the tipping point. Happened.

Yeah. Right.

And people freaked for last night. I don't know why.

Yeah. Well, I don't know why either, but it's interesting from a behavioral point of view. And actually it got me thinking about, because look, this has been going on for like 4 weeks now and maybe it's, I don't know, maybe it's just accumulation thing where, okay, this was supposed to be done in a couple of weeks and out and actually it's not. So let's hunker down for the long run. And maybe, yeah, as you say, that behavioral trigger Obviously then leads to the stampede and the stampede can come out of nowhere. I'm not sure if the stampede is nationwide yet, but it's interesting to see how other countries are also behaving. And there's a really cool article, you mentioned it, I'm going to name the title of it. If you've got an FT subscription, the title of the article is The Global Wave of Energy Rationing. Go and have a look. There's some amazing graphics. I'm going to talk through a couple of them now. And it's just talking about how, you know, the vulnerability of different countries to this situation. And as you're starting to get stampedes kick off, well, all right, which economies are going to be impacted the most? And it's actually beginning, you're starting to get an economic impact now. So firstly, there's a really cool graphic looking at all the energy importers fossil fuel energy importers of the world, and it's kind of left to right, you know, from 0% to 100%, right? And so if you look on the right-hand side, you've got countries like Singapore are furthest to the right. In fact, they import 99% of their fossil fuels. You've got Hong Kong at 98%, Malta 96%, Jamaica 93%, Panama 91%, Dominican Republic 91%, Cyprus China, 91%. They are the only countries 90% plus. And fine, then you go back through the order. The biggest large economy is Japan. Japan's the 4th biggest economy in the world. They import 84%. South Korea, another obviously big one, they're top 10, I think they import 80%. And the problem for those two is obviously they import a lot, but they're getting their oil from the Middle East. When you think about the US imports zero of its energy from the Middle East, right? Then you've kind of got Europe in a little band kind of around the sort of 70% area. You got Germany, 67%, Italy, 72%. You got Turkey, 70%. You got Spain, 70%, Netherlands, 70%, Austria, 63%, Portugal, 66%. So kind of those European countries there are all very obviously dependent on their energy imports. And I like some of the bigger ones, like China's the second biggest economy. This surprised me. I thought they imported a lot more, but it's apparently only 24% of their fossil fuel that they import. And then the good old UK, we're actually not bad in amongst this lot. We do produce our own oil up in the North Sea, of course, but UK, we import 37% of our fossil fuels. So yeah, less vulnerable to some of those other European nations.

I guess just looking at the next kind of obvious step here is that how are these countries economically formed? Because on the furthest left of your chart, I'm looking at the likes of Uganda, Ethiopia, Sudan. But when you think about those countries as opposed to say like Singapore, Hong Kong, or in fact China, So how does that layer in to better understand and interpret not just the top-level figure, but how do you compute that with contextualizing it with the actual economy?

Right. So there's how much of your oil or fossil fuels is imported. There's then what's your GDP per capita? Just break that down. Basically, how financially prepared are you to deal with this crisis? Singapore, even though they're the most vulnerable from a, right, they import 99%, they also happen to be one of the richest nations on the planet. Their GDP per capita is like, I think it's $150,000 per head, right? It's literally one of the richest on the planet, meaning they can buy their way out of this. Okay. So really you've got to think about who's the most vulnerable here. It's those countries where you've got the double whammy of both high percentage of imported fossil fuels, but low GDP per capita. And so those countries are right in the crosshairs and I'm going to read some out. Dominican Republic, Morocco, you've got the likes of Georgia and Armenia and Jordan. And then you've got some bigger economies, but they're in the low GDP per capita bracket, but they're now large as they're growing fast, Thailand and the Philippines. So Thailand, 50% imported fuel and Philippines 55%, but GDP per capita and Philippines particularly, they're down around just over $10,000 per capita versus $150,000 from Singapore. So the Philippines are particularly vulnerable here and they're really starting to, you're seeing countries put in place measures to deal with this. So there's Basically, they've declared a national emergency in the Philippines and they're starting to encourage people to work from home where possible, therefore less transport fuel being used. So there's real countrywide curbs and measures now being put in place. But you think back to COVID days, well then you think about your restaurateur, well they're in all sorts of trouble now when obviously everyone's staying at home where they can. And so obviously you have a knock-on effect and knock-on effect and knock-on effect. So It is now happening. You're getting countries put in place like Zambia, their government, there's wins like, okay, we'll stop charging VAT or we'll stop charging excise duty on fuel. So you're seeing that a lot around the world. But now those like Thailand and the Philippines are going much further where they're starting to put in place measures to curb demand and to curb usage by stay at home kind of policy. You know, it's beginning and it's happening. And obviously the longer this Gulf, Persian Gulf situation carries on, obviously the worse this is going to get and the more genuine economic impact is going to be felt with those countries I've mentioned being particularly vulnerable.

From a trading perspective then, because whether you're on the buy side investing in opportunities or you're on the sell side facilitating the flow of it. When you have scenarios like this where there's some obvious real challenges facing a lot of these more emerging market spaces, is there some sort of opportunities here in terms of certain funds and who, who would be the sort types of players that would be looking at that sort of thing?

Yeah, you're going to get some niche funds who are, I mean, this is where you get a bit of moral hazard coming in because you could be shorting, I don't know, Vietnamese industrial stocks because like Vietnam, very dependent on importing fuel, industrialized nation, low GDP per capita. So less equipped to kind of deal with it from a government and a financing point of view. So you can get, you know, You can short Vietnamese industrial stocks, but then the moral hazard, obviously, well, you are profiting from other people's, well, choose a word, misfortune, misery, I don't know. And so there is that aspect to wrestle with in your mind. But sure, there are funds that are geared up towards this, you might say, event-driven situation where they're looking for certain particular kind of circumstances and trying to build strategies around taking taking advantage of financial asset price swings that are resultant of that.

I guess what I'm trying to say then is it's quite easy to just read and consume and talk about oil prices at a top level. And we often talk about it on the macro kind of chain of events, inflation, growth, therefore rates. But there's also this other third, fourth dimension thinking.

Yeah.

That this is what makes up a large portion of the more sophisticated investors out there who are looking at this sort of things and thinking in that way. So rather than trading this $100 to $120 band, right, which is obviously where your mind gets drawn to, there's actually other, you know, what was good when you were explaining that you're thinking, okay, so maybe I should be looking at Morocco here. Or, you know, it just kind of sends signals.

Yep.

In your mind.

And if you want to avoid the moral hazard, just wait for this thing to end and then buy those, buy that stuff. 'Cause they're the ones that'll have been beaten down the most. You've obviously gotta wait for the conflict to end, which let me just really, you know, make clear has not ended. So don't wade in and buy, you know, Moroccan airline stocks just yet necessarily. If you want to keep it on a top level, maybe we can end with this. It's kind of go back to that sector situation I was talking about, which equity sectors are actually best off here. And it's the defensives, it's your consumer staples, and it's your utilities. And actually, when you are looking across different countries' stock indexes, then Obviously each country's different and they'll have their own kind of idiosyncrasies. But the UK, can I tell you, is one of the best performing places. The FTSE 100 is one of the best performing indexes of the year, and in fact it's up 4.2% as I speak on the year. When you look at like the S&P, the S&P's down 5%. And actually it's only Japan, the Nikkei 225, which is up 4.5%. Those two are basically the only lead, you know, large economy countries whose stock markets are in positive territory. So why, why would the FTSE 100 of all places—

so, so one of the things, so let, let me cue you up here for the breakdown because we were talking last week about bonds and stocks being down in the UK. Certainly there's a lot of mainstream media talking about our rates are going up, rate hikes, and obviously consumers thinking about their mortgage resets and all these sorts of things. And yet the FTSE is not doing that. So how do you marry that up?

Well, so it's just the components of the FTSE 100 index, which is the key. And it's, you know, I've been a vocal sort of, The word depression would be used when I think about the FTSE 100 over the last 20 years is because it's got no tech. There's no tech stocks in the FTSE 100, which is why it's kind of missed out on the 20-year gangbusters rally that you've seen when you go and look at things like the S&P 500. So there's virtually no tech in the FTSE 100. Bad news when we've got, you know, secular upswings in global economic activity and positive sentiment. However, good news when it comes to the opposite. So when you're getting economic worry and concern, then the FTSE, well, what's the FTSE made up of? Well, it's actually got 16% of that whole index is, it can be considered in the defensive consumer staples sector. 10% of the index is in energy. And that are those, when you think about those two stats, that is more than double of any other major stock index. They've got double the weighting of those two, consumer staples and energy, than any other major stock index. So that's why the FTSE 100's outperforming. 'Cause when you're thinking on a, the geographical stock index chessboard, you know, where are you moving your money? Well, yeah, not only are you thinking sector rotation, you can go, well, I'll sell the S&P and I'll buy the FTSE 100. Cause that in of itself is a defensive move given the differences in the kind of makeup. Cause you think about the S&P, it's over 30% tech, that index. So the FTSE, this is where it's at. Come on down. Good old United Kingdom. Finally, you know, when the rest of the world's suffering, it perks up a little bit.

And maybe to finish then, something, a word you mentioned earlier was stagflation.

Yeah.

And it's something which I think probably warrants being educated upon because it's a word I think probably gets used inappropriately to influence political optics a lot of the time in the media. Yeah. And so stagflation, I think sets alarm bells off for most people in a very negative way. But what does the statistic say about stagflation and its economic performance?

Well, firstly, this is definitely a word you are going to hear a lot about in the weeks ahead. All right. This is going to be, we'll have to do a bit of an analysis on the frequency of the word stagflation in the financial media. It's definitely going to go up. And that's just because the further this conflict continues, well, the bigger the stagflation risk becomes. Well, what is stagflation? It's just a situation where you get lower growth or indeed negative growth, we're talking economic growth, right? So if you could get slower GDP growth or worse negative economies contracting at the same time as inflation moving higher. So the cost of stuff is getting more expensive and we've got a recession at the same time. And this is triggered by that energy supply crisis and how energy costs, it's not just energy, it's then as we've talked about in previous episodes, We won't go into again, but it spills over into stuff like food inflation via fertilizer costs or goods inflation via plastic costs going up and this kind of stuff. But this is the worst case scenario. And the further, the longer this conflict lasts, the bigger the stagflation risk becomes. However, there was an analysis done because everyone thinks stagflation, oh my God, worst possible case scenario. And kind of in some ways it is, but from a market performance perspective, if you look back at stagflation years in recent decades, then actually you've only got, if you think about stock markets, it's actually a 50/50. So 50% of the time in a stagflation year, stocks actually finish up, but then 50% they finish down. And here we're talking about in real terms. So when we talk about real returns, that means What was the appreciation in that financial asset over and above inflation? So actually, for the 50% of times we've seen stocks finish higher in a stagflation year, they've actually finished up on average 16% real return. And bear in mind, so that's, you take the actual return minus inflation, but if you've got inflation moving up, right, then that that inflation negative is bigger, right? So I was quite surprised. That's a huge number, 16% real return, 50% of the time of a stagflation year. However, there's the opposite. On average, the other side, 50% stocks finish down. On average, it's a -14% average real return. So it's a 50/50 toss-up. So here we are right in the middle of the uncertainty. How long's this thing going to last? How big of a stagflation problem will it become? We don't know. And therefore, unfortunately, stocks could finish massively up this year or they could finish massively down.

So the asset managers, what you're saying, should really sponsor the Market Maker podcast. And the point being, stay invested over the long term.

That's right.

Diversification. Just take away from the episode.

Buy the FTSE. Yeah.

This is not investment advice. This is for educational purposes only. Footnote. All right. Well, on that note, we'll wrap it up. Hopefully you found that an interesting discussion. Any questions, of course, just let us know, drop us a comment. You can, of course, on YouTube and also on Spotify. Also, don't forget to subscribe to the channel if you don't already do so. I do know on the statistics there is a portion who don't. We'd love to have you in the community and more episodes coming on a weekly basis, but have yourself a fantastic long weekend, if you have indeed have one. I know that's not for everyone. So yeah, happy Easter everyone. Yep.

Enjoy it.

Thanks.