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German Economy Fears, Commodities Fall

MARKET INSIGHTS
11 Jul 2022

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

In the article published last Monday, it was reported that the S&P 500 lost 1.9% over the course of the preceding week. After adjustments, this number now stands at negative 2.21%. By no means was this type of winding down limited to the U.S. equities. A similar picture is emerging from European Union powerhouse Germany.

When comparing the benchmark DAX Performance Index (GDAXI) versus the S&P 500 (SPX), there is a general trend of correlation seen in the Western Hemisphere’s two major economies:

Over the course of the past week, it seems that, when not accounting for corrections at the moment, both benchmarks are up. This is, however, a false positive, as the daily price trajectory indicates:

While the S&P 500 was largely flat, the DAX was trending downwards throughout the week – until the last trading two days when both benchmarks rose. As discussed in the article published at the end of last month and confirmed in the following week, this was due to oversold positions being covered. Over the course of the past week, Germany officially no longer has any company in the Top 100 companies by market capitalization. The country’s most valuable company – SAP Labs – now ranks No. 112.

There are a number of factors for this: first, the post-pandemic recovery has seen Germany lagging behind other top Eurozone economies. Second, the fall of the Euro versus the U.S. $dollar has impacted valuations, Third, Germany’s balance of trade is precarious even within the Eurozone and finally, inflation is sky-high in the Eurozone.

Over the course of the year, expectations on 10-Year inflation in Germany have rapidly increased:

Another problem for the German economy is the availability of electricity. After closing down its nuclear plants and mothballing its coal-fired plants, successive German administrations bet heavily on renewable energy – which doesn’t neatly meet all of the country’s needs. The only alternative was increasing dependence on gas-fired plants across the Eurozone as well as Ukraine while gas was piped in from Russia.

After a series of measures adopted by the European Union against the Russian Federation due to the Ukraine conflict and retaliatory measures (both actual and threatened) from the latter in recent months, electricity prices for 2023 delivery, i.e. the year that NATO intelligence estimates as seeing the war in Ukraine ending one way or the other, have skyrocketed in most parts of Europe:

While U.S.-European measures were enacted to limit revenue flow into Russian companies for energy exports, the natural countermeasure from the Russian side would be to limit energy flows to these countries. Starting today, Gazprom’s Nord Stream 1 pipeline into the Eurozone is being shut down for 10 days for maintenance. There are expectations that the Russian government might either either prolong the shutdown or limit the gas flow after this period.

With regard to gas imports, European countries have two key problems: firstly, there aren’t nearly enough sites open for natural gas extraction within their sphere. Secondly, given the pipeline from Russia, there aren’t nearly enough terminals for receiving imported gas from outside of Russia. As a result, the spread between gas priced in Europe and gas priced in the U.S. (which has a number of sites within its territory) is growing steadily wider:

Unsurprisingly, Germany’s economy minister Robert Habeck warned that the country faces a Lehman Brothers-style collapse in the next year. Rationing of energy in Germany has already begun.

Given rising inflation (both current and prospective), economists’ consensus on GDP/economic growth in 2023 for both U.S. and Europe have dramatically changed over the past one month:

There are two points to note here. First, forward-looking estimates for Western economies lately tend to be more optimistic than what is measured after the fact. Second, July’s consensus estimates aren’t out yet but it’s an even bet that the estimates will continue to carry on with recent trends.

Speaking of the U.S., there is an interesting trend in U.S. equity markets: volatility is vanishing:

This is bad news for investors holding U.S equities; over the last 8-10 years, large traded volumes lent to volatility which, in turn, led to high intraday spreads and a general exuberance in equity prices. This is now gone, thus leading a steady decline in stock prices.

As last week’s article indicated, its likely that the recession part of the inflation/recessionary cycle has begun. This has had a number of effects. For instance, as per data from realtor.com, it has been reported that the number of U.S. homeowners reducing the asking price for their properties has doubled year-on-year:

Also, there is an interesting effect on commodities due to the fading outlook on growth: the Bloomberg Commodity Index – which tracks energy, grains, industrial metals, precious metals, softs (coffee, sugar and cotton) and livestock – has reportedly been falling in recent times while showing a steady uptrend:

In U.S. agricultural markets, spot contracts for U.S. wheat, corn and soy have also been plummeting:

Now, the interesting aspect of this is that these are spot prices for the spring season’s harvest. In the U.S., winter wheat production, i.e. crops planted in the fall season, represents approximately 70% of total U.S. production The U.S. Department of Agriculture has already indicated in April that 30% of total wheat planted can be expected to be in good health – with estimates varying by a couple of percentage points in subsequent estimates. Overall, a large portion of global wheat supply comes from Ukraine and Russia.

Unsurprisingly, given the circumstances, India – the world’s second-largest grain producer – has banned all wheat exports until the foreseeable future. In the face of rising inflation, it can be expected that most major food producing/exporting nations will enact similar bans to contain inflationary pressures on their citizens.

In Conclusion

The facts presented drive home the points made in the past two Mondays: on a global basis (at least when the lens is centered on the U.S. and the Eurozone), the scale is steadily tilting towards the latter phase of the inflationary/recessionary cycle. While little can be done about the food supply situation beyond a «wait and see» approach, there are alternatives available for tactically capitalizing on broad markets.

For example, Exchange-Traded Products (ETPs) are available that deliver daily-rebalanced 3X leverage on the downside on both the S&P 500 and the DAX indexes. Similar products for high-conviction tech stocks, clean energy stocks, semiconductors, et cetera, i.e. stocks that will be acutely affected as the S&P 500 continues to deflate, are also available. Sophisticated investors with a disciplined and pragmatic approach have a lot to gain in these times.

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

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Elaborado por

Sandeep Rao

julio 11, 2022

Category: MARKET INSIGHTS

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