ALEX BRUMMER – Uncertainty surrounding Ukraine, interest rates, and exaggerated pandemic valuations are weighing on equity markets

  • The Nasdaq in the US has dropped 10% since the beginning of the year 
  • The European exchanges suffered large pre-weekend drops
  • Due to the strong energy component, the FTSE 100 is more vulnerable than other indices.

There is no way to know how Russia’s military buildup in Ukraine will end. 

Nato chief Jens Stoltenberg has given a loud and clear response. Joe Biden’s less persuasive intervention was muddled. Diplomatic channels are still open. 

Britain is now sending anti-tank weapons to Kiev. For BAE, and other UK aerospace and defense leaders, conflict is always a win-win situation. The strategic standoff is crucial for a struggling global economy with its supply chain issues. 

Uncertainty: There were big pre-weekend falls on Europe's exchanges with the FTSE 100 less vulnerable than others as a result of its strong energy component

Uncertainty: There were big pre-weekend falls on Europe’s exchanges with the FTSE 100 less vulnerable than others as a result of its strong energy component

The main concern for advanced nations, both after 1973’s Yom Kippur and 1990’s first Iraq war, was oil embargoes in the Gulf of Hormuz. Europe is less dependent upon the Middle East to provide its energy, so the point of greatest security has moved from the Urals towards Russia with its control over pipelines and the Urals. 

Germany was too dependent on Moscow because of Angela Merkel’s leadership. When Japan’s Fukushima nuclear plant erupted in 2011, Merkel suspended nuclear output and investment making the country more dependent on imported gas. 

Recent decisions to reduce coal use to achieve carbon emission targets have increased Russian dependence. 

With the threat of being engulfed in Ukraine’s crisis and swinging Western sanctions against President Putin’s Russia, Nord Stream, a new pipeline that was designed to alleviate capacity limitations on existing connectors is at risk. 

These factors are creating huge uncertainty regarding the future of energy prices, and quickly changing the outlook for inflation. 

As recently as October 2021, the Office for Budget Responsibility forecast that consumer price inflation would be 2.3 per cent in 2021 and 4 per cent this year. According to the latest data, annual consumer price inflation was 5.4% in December. It could rise to 7.1% in spring. 

It is difficult to predict wholesale prices for oil and natural gas. The prospects for the Ukraine are grim, regardless of the outcome. Brent crude futures rose 50% in 2021. Since the beginning of 2022 they have risen a further 14%, reaching a high of $89/barrel seven years ago. 

Goldman Sachs and other investment banks are projecting that oil will be $100 per barrel by the middle of next year, at a time when inventory is low and geopolitics are affecting production across many parts of the globe. The inflation shock that will affect natural gas prices is expected to cause natural gas prices to track oil.

Some signs are beginning to show that supply shortages, which were a major factor in the surge in inflation are starting to recede. 

RSM UK’s supply chain index did show some improvement in December but it is not clear that this is the end of the adjustment process to the post-pandemic period. 

New factories and ports are closing due to the Omicron virus in China. This is where coronavirus was first discovered two years back. This is likely to increase prices. Finally, central banks are waking up to the idea that the current bout of inflation is anything but temporary. 

The Bank of England led all advanced central banks in raising the rate of bank lending when it did so by increasing its December interest rates from 0.1% to 0.25 %. 

Market analysts now predict that inflation will peak at 7.5% in spring. There is a 0.25 percent increase in rates expected in February, and a prediction of 1.5% by the year’s end. 

The Old Lady is no longer left to her own devices. Norway raised its rates already, and this week the Federal Reserve hinted that they might be tightening their policies. Finally, the European Central Bank seems to have listened to Isabel Schnabel, a German member of its council. She has warned for weeks about rising energy prices and suggested that a response might be needed.

The uncertainty surrounding Ukraine, the interest rates and pandemic valuations have cast a shadow over equity markets. 

The Nasdaq in the US has dropped 10 percent since the beginning of this year. Former New Yorkers Netflix and Peloton are now being penalized. The FTSE 100 was more vulnerable to losses than other European exchanges due to its energy component. There were large pre-weekend drops on Europe’s stock exchanges. Due to its underperformance after Brexit, the FTSE 100 has less room for fall. 

Although we live in difficult times, there is no reason to panic.