The headlines about inflation have, once again, been awful. Consumer prices are rising more rapidly than at any time since 1981, and producer prices are soaring as well.
Stocks and bonds have been shaky since the start of the year, and the tragedies of the larger world are profound and proliferating. A lingering pandemic has taken more than 3 million lives around the world; Russia’s assaults on Ukraine have killed hundreds of civilians and uprooted more than 10 million people; and geopolitical tremors have raised the risks of a nuclear conflict to Cold War levels.
This is all terrible. Yet precisely because so much awful news has already been incorporated in stock, bond and commodity prices, there is reason for suspecting that market conditions may not get much worse and may even get better before long. When the consensus is this glum, it may be time for cautious optimism.
Down so long
“Been Down So Long It Looks Like Up to Me”: That’s the title of a 1966 counterculture novel by Richard Fariña, a songwriter and folk singer, about his student years at Cornell. While it doesn’t discuss bonds or commodity prices, it nicely captures the current situation in financial markets.
Fariña asked a question that has resonated with Cornell students for decades. How is it possible to survive spring in Ithaca, N.Y., when the cold, gray weather just keeps coming? The answer: Embrace misery. Once sleet and snow become your baseline, a hint of sunshine is cause for exhilaration. (Fariña’s personal story had a tragic ending. He died in a motorcycle crash soon after his book was published.)
Consider the state of financial markets now. Misery is the baseline assumption. Further declines will surely come, but it will take new, unexpected shocks to unmoor stocks, bonds and commodities in a fundamental way. Those shocks could come from Russia’s war, or from a source we can’t yet anticipate.
Yet even so, better times will arrive eventually — if not this month, then soon enough, for those willing and able to hang in until the season changes. In the current environment, this modestly optimistic thought is contrarian — a sign, in itself, of how bleak things have become.
Finding encouragement in the middle of misery isn’t popular. If anything, most “investors clearly shifted back to a ‘glass half empty’ mind-set” after the barrage of inflation headlines, Mark Hackett, chief of investment research at Nationwide, an insurance and financial services company, wrote on Thursday. He acknowledged, however, that despite the gloom, “there are hopeful signs that inflation could slow down in the coming months.”
So I won’t go too far in claiming that the glass is half full. This is not a prediction of a revival of the galloping bull market of last year — or a denial of the possibility of a recession next year. I have no idea what’s coming next. Nor does anyone else.
Rather than make fruitless forecasts, we can plan for a broad range of outcomes. But doing so requires dispassionate thinking — and the ability to see past the current news. Just as too much optimism can induce you to make foolish bets, excessive gloom can lead to panic — which, in this case, could mean fleeing investments in both stocks and bonds, because both major asset classes have performed poorly.
Instead, at cheerless times like these, it’s worth appreciating the potential for profit embedded in dreadfully low prices. First, always make sure you have enough ready cash to meet your emergency needs. But after that, if you invest steadily in diversified, low-cost index funds that track the entire stock and bond market, those low prices can be a boon, assuming the markets eventually recover. History suggests that they will.
Roaring inflation
It would be easy to give up on the markets.
Bad tidings about red-hot inflation have been hard to miss. Prices of a broad range of goods and services have been rising swiftly, but lately, the situation has gotten much worse. The most recent government report on the Consumer Price Index showed that overall inflation in the United States rose at an 8.5 percent annual rate in March, the highest pace since December 1981. A variety of other inflation measures have also been troubling, in the United States and around the world.
John Butters, senior research analyst for FactSet, a research company, wrote in a report on April 12 that 65 percent of S&P 500 companies that have reported earnings for the first quarter of this year cited inflation as their biggest problem. He cited this comment on an earnings call from Lawrence Kurzius, the chief executive of McCormick, the global food company: “Cost inflation has remained persistent with recent escalation in some areas such as transportation costs. And as such, we have raised our cost inflation guidance. It is now a mid- to high-teen increase.”
The three main causes of the current inflation burst are well-chronicled and include:
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A combination of stimulative fiscal and monetary policy taken to support the economy’s recovery from the coronavirus recession of 2020.
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Supply shortages caused by the pandemic, ranging from a scarcity of parts needed for automobiles to bottlenecks in factories in China, to an insufficient number of workers willing and able to take jobs at prevailing wages.
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Russia’s war in Ukraine and the Western sanctions on Russia, which, together, have increased the prices of energy, food and a range of other commodities, and contributed to supply shortages.
Turning a corner
Yet the problem of raging inflation is hardly a new discovery. A year ago, it was evident that prices were rising rapidly enough that they needed to be taken seriously. I pointed that out then and so did many others.
Russia’s war complicates matters considerably. Nonetheless, it is at least possible that inflation is about to ebb. James Paulsen thinks so. He is chief investment strategist for the Leuthold Group, an independent stock research firm in Minneapolis.
The Russia-Ukraine War and the Global Economy
Rising concerns. Russia’s invasion on Ukraine has had a ripple effect across the globe, adding to the stock market’s woes. The conflict has already caused dizzying spikes in energy prices and is causing Europe to raise its military spending.
The cost of energy. Oil prices already were the highest since 2014, and they have continued to rise since the invasion. Russia is the third-largest producer of oil, so more price increases are inevitable.
Gas supplies. Europe gets nearly 40 percent of its natural gas from Russia, and it is likely to be walloped with higher heating bills. Natural gas reserves are running low, and European leaders worry that Moscow could cut flows in response to the region’s support of Ukraine.
Food prices. Russia is the world’s largest supplier of wheat; together, it and Ukraine account for nearly a quarter of total global exports. Countries like Egypt, which relies heavily on Russian wheat imports, are already looking for alternative suppliers.
Shortages of essential metals. The price of palladium, used in automotive exhaust systems and mobile phones, has been soaring amid fears that Russia, the world’s largest exporter of the metal, could be cut off from global markets. The price of nickel, another key Russian export, has also been rising.
Financial turmoil. Global banks are bracing for the effects of sanctions intended to restrict Russia’s access to foreign capital and limit its ability to process payments in dollars, euros and other currencies crucial for trade. Banks are also on alert for retaliatory cyberattacks by Russia.
“I think we may be at a turning point,” he said in an interview. “There’s a good chance that inflation has peaked or is very near its peak.”
Because inflation began to surge 12 months ago, the year-over-year comparisons will be more favorable this spring. Furthermore, two of the causes of current inflation — expansive financial conditions and coronavirus-induced supply problems — are already shifting substantially and may soon bring down the rate of inflation, Mr. Paulsen said.
“The biggest supply problem, by far, is labor,” Mr. Paulsen said. “A lot of people couldn’t work earlier in the pandemic, and a lot were reluctant to work at the wages then being offered. That’s all changing now.” As the labor bottleneck eases — thanks, in part, to higher wages — he said that the supply of goods and services will begin to meet the demand for them, reducing pressure on prices.
Andrew Slimmon, a managing director at Morgan Stanley Investment Management, said in an interview that freight costs and shipping backlogs have been dropping, which may predict that the C.P.I. will be substantially lower six months from now and that, “maybe, the Fed won’t need to raise interest rates quite as much as the markets are expecting.” Corporate earnings continue to be strong despite the world’s problems. So he expects a rocky year, but one that will include stock market gains before it’s over.
Pessimism as a baseline
Russia’s assault on Ukraine — and the course of the pandemic in China and elsewhere — are wild cards. On Thursday, the Conference Board, a business research organization, projected an extremely wide range of possible outcomes for oil prices, inflation, economic growth and interest rates. Clarity is impossible now.
The critical question for short-term traders is whether financial markets have already baked in sufficient pessimism. Energy price shocks have caused recessions in the past. That could happen this time, too, deepening the gloom around the planet.
So it’s no time for casual bets. Only investors with an appetite for financial adventure will want to take on much fresh risk now. Still, the fog will lift at some point. With a little luck, those with the fortitude to have hung on when the outlook looked grim will find they have prospered.
