I write this to you from a cool and overcast Lisbon, Portugal as I head back to the U.S. following a visit with my 97-year-old mother. Over the past several years we have built a very strong support team at Alpha Beta Gamma Wealth, and I want to thank all the ABG team members who helped me keep the firm running in my physical absence.
One of the benefits of this kind of travel is that I am able to catch up with friends along the way and dip a toe into their waters to better understand their perspectives on the economy and markets. Here is a short synopsis of my interpretation of their observations: Europe is very nervous. The Russian threat to European nations now extends well beyond Ukraine. Putin is not “crazy” but he is very calculating, and the Western leaders are weak and have repeatedly allowed him to get away with murder, literally. There is great concern that Western leadership is not up to the task of slowing Russian aggression down. Were it not for the US supplying increasingly sophisticated weaponry to the Ukrainians, this war would be over.
The consensus among my European professional peers is that this market decline is not finished, in spite of a great week on Wall Street. Their concerns really emanate from the belief that there will continue to be significant global disruptions in the supply chain which will cause commodities in particular, to remain volatile and have the potential to morph the global economy into something more than a moderate recession.
As we know, countries starved for energy continue to purchase Russian oil and gas. While some western countries have and others threaten to cut off the energy purchases, countries like India and China continue to purchase Russian oil. If a global boycott were to restrict Russian oil and gas sales, the 7 million barrels per day lost from supply would be challenging to make up. As shortages of oil increase due to such a boycott, one might expect commodity prices for oil and gas to move significantly higher and volatility would certainly increase. Of course, demand for oil and gas is not wholly elastic and there comes a point where demand destruction occurs because of price increases. We opine that there is better than a 50/50 chance that higher energy prices, coupled with higher interest rates will slow US economic growth, materially. We do not believe that this is “baked in the markets.”
We also believe that transportation is under pressure and will continue under pressure. For example, the bulk of the global shipping fleets are owned by China and then Northern Europeans and Southern Europeans. The US has virtually no ocean-going oil or gas carriers. As well, there are still concerns about whether the NATO nations will provide protection for western bound carriers coming out of the Middle East through the choke points in the Straits of Hormuz or the Bosporus Straits into the Black Sea. Looking back, Putin’s taking of Crimea was an important strategic step in his longer-term plans. If ships and cargoes cannot be insured, those ships will not sail. If a commodity is not moving and there is demand, prices will continue to remain volatile and increase.
Finally, we believe that there are supply shortages that will have a material impact on certain economic sectors and companies over the coming several months. For example, neon gas is used heavily in the production of semiconductors. It is used to regulate the bandwidth of the lasers that are used to print the chip circuitry. The largest industrial producers of neon are steel mills and the largest steel mills in the world were in Ukraine and are now in Russian hands. There is, at present, no replacement capacity for this loss of neon production which amounts to roughly 75% of global production. In short, according to a recent piece from Credit Suisse, no neon, no chips. In a world where everything from the most sophisticated weaponry to your home thermostat is controlled by a chip, this has the potential for creating havoc in company supply chains.
I think that where there was once speculation that “Putin is crazy,” perhaps the analysis should shift to his having understood commodity chokepoints in the modern technological world and has worked to level the playing field through the destruction or takeover of steel plants in Ukraine where the bulk of the world’s neon production occurred as by-product of oxygenated steel production.
While the market this past week provided some good relief, until the Ukraine/Russian war is over, we think that it is going to be a long and volatile summer as companies find themselves unable to produce their products due to increasing chip shortages.
As always, give me a call if you have any questions or comments.
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