War, Inflation and The Federal Reserve
The War in Ukraine is now entering its third week. The impact of this war is exacerbating the global inflation challenge. As the Federal Reserve Open Market Committee meets tomorrow, March 16, it will be faced with treading a very narrow line of removing excess liquidity from the U.S. economic system while not chilling economic growth. The geopolitical challenges from Russia’s invasion of Ukraine make the Federal Reserve’s job that much trickier.
In response to these uncertainties, the market has sold off. If the market likes what it hears from the Federal Reserve tomorrow, you may get a relief rally. Conversely, if the market believes the Federal Reserve will err on tightening monetary policy too fast, that could trigger another leg down in the market. Our indicators are signaling that we are close to a near-term bottom so that any market sell-off may be the capitulation leading to a mid-year rally. As you know, we have increased our cash reserves over the last few months. This will give us some dry powder to buy into the market during the next rally phase.
Inflation is elevated and sticky. Anyone who has gone to the gas pump, or bought food, or looked at housing can see the signs of inflation throughout our economy. The war between two resource-rich nations such as Russia and Ukraine will further complicate the unfolding inflation story. We see a few broad themes that will benefit this economic and geopolitical environment.
- Agriculture
- Metals and Mining
- Energy
- Defense
“Horror” may be the best word to describe the West’s reaction to the largest invasion in Europe since World War II. The war has served as a wake-up call, especially for Eastern European countries, whose borders likely do not have the level of safety needed to stop an aggressive Russia. As NATO countries look to increase military spending dramatically over the next few years, U.S. defense firms and cybersecurity defense firms may benefit.
While energy has had a strong run, we believe it will be a multi-year opportunity for investors. Russia is the second-largest exporter of crude oil and the third-largest exporter of coal in the world. While Russia is only ranked seventh in natural gas, most of its exported gas is to European countries. China, Netherlands, Germany, North Korea, Japan, and Poland are top Russian petroleum/energy products recipients.
As the largest oil producer globally, the U.S. should be one of the top nations Europe calls on to lessen their dependence on Russian oil and gas. While it will take time for European countries to adjust refineries to U.S. oil and build LNG terminals, long-term demand drivers are in place, on top of increased post-pandemic demand. All of this is bullish for U.S. companies that need to get more oil out of the ground and ship it.
With tight supply globally, energy was on track to be a strong performer before the invasion. The supply disruption caused by this war will amplify this investment opportunity.
Russia’s invasion has also disrupted the supply of other natural resources. Russia is a top-10 contributor to global nickel, iron/steel, gold, platinum, palladium, aluminum, and copper. European automakers are in for some bad news as frames, catalytic converters, motors, and batteries all rely on these metals. Additionally, Russia and Ukraine were among the top-10 exporters of cereals/grains, cooking oils, ash, and fertilizers in 2020.
What stands out most is that Russia and Ukraine combined represent the largest grain exporter globally, exporting nearly $19 billion or 17.2% of global grain exports in 2020. Turkey, Egypt, and Bangladesh are among the top four importers of Russian/Ukrainian grains. If these countries do not impose sanctions on Russia, it could cushion the impact on Russia and grain prices. The U.S. is the world’s leading exporter of grains, so there could be some attempt to help other countries shun Russian grains. At a minimum, U.S. farmers should benefit from higher prices.
With rising interest rates and the potential for a commodity shock to the system, we are in waters not chartered since the late 1970s and early 1980s. Many investors have not experienced this environment. We are fortunate to have folks on our investment team who have experienced a similar climate to today. We have adjusted our strategy to align with what we see play out globally. Over the last several months to a year, we began adding positions around these themes, and you will see us deploy more capital to these areas as we see a bottom firm up. Investors will need to be nimble as the year continues, but we expect that the year will provide some very good investment opportunities. Your patience with cash on the sidelines will be rewarded.
The Riggs’ Report is written and published by Riggs Asset Management Company, Inc. The information contained in this Report is for informational purposes only and should not be construed as investment advice.
IMPORTANT DISCLOSURES
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Riggs Asset Management Company, Inc. (“Riggs”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Riggs. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Riggs is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Riggs’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a Riggs client, please remember to contact Riggs, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Riggs shall continue to rely on the accuracy of information that you have provided.