Wall Street has been treated to intense volatility in the period since Moscow launched its invasion of Ukraine, with tough sanctions on Russia — a major producer of critical commodities — sending the market into turmoil. Higher prices have stoked inflationary fears and raised the risk of widespread economic disruption, including a recession in Europe.
Some of the moves across stocks and commodities are mind-boggling. Markets are evidently in turmoil — but are they broken?
At a high level, thankfully, the answer appears to be no.
Based on independent measures of market functioning, there is little evidence of a broken market, Kiran Ganesh, a multiasset strategist at UBS, told Barron’s. The Swiss bank has looked at key indicators of financial system stress, including US Treasury spreads and liquidity in credit markets. These metrics have so far signaled some stress, but not near the levels seen during the stark selloff at the end of 2018, let alone the Covid-19 meltdown of March 2020.
“Of course, you’ve got very big moves,” Ganesh added. “But I think that’s really a reflection of the fact that you’ve got three or four major factors for global markets which are all in flux.”
A complex calculus over shifting sands has wreaked havoc on stocks in particular, as investors attempt to price in multiple unknowns across the short, medium, and long term. This may manifest in apparent chaos, but can be explained.
The behavior of the market right now is really a symptom of the fact that moves are being driven by headlines in a rapidly-evolving situation, Craig Erlam, a market analyst at broker Oanda, told Barron’s. “This is a sign that the market works. This is an extraordinary situation, and therefore the reaction in the market is extraordinary. ”
Traders are attempting to adjust to multiple factors that are all influenced by the same, unpredictable force: war. Some of the most important considerations are the risk of wider escalation by Moscow, the bond market struggling to react to an inflationary shock, and how corporate earnings could be hit by higher commodity prices.
“How would you price in a situation where the outlook six months from now, 12 months from now, 24 months from now can vary to such an enormous degree?” Erlam asked.
Said Ganesh: “It’s really volatile because it’s uncertain rather than broken.”
But cracks have appeared, especially in commodities.
The London Metal Exchange suspended trading in nickel and canceled affected contracts on Tuesday after prices spiked above $ 100,000 a ton. “The current events are unprecedented,” the exchange said in a statement, blaming the situation on the war in Ukraine. This is the closest we’ve seen to a market actually being broken.
Both Russia and Ukraine are commodity powerhouses, between them supplying a significant amount of the world’s oil, natural gas, coal, wheat, corn, and a range of industrial and rare metals, like nickel, steel, and palladium. Conflict and sanctions have rocked supply chains and caused breakneck price increases.
“Commodity markets can be brutal,” Giovanni Staunovo, a commodity strategist at UBS, told Barron’s. Commodities aren’t priced into the future, like equities, but rather priced in the here and now.
“If there is some mismatch between supply and demand, then prices need to rise to bring both sides to similar levels,” Staunovo said. Prices explode until you trigger demand destruction. This is partially what we are seeing now. ”
It is understood that a short squeeze and perhaps a quirk in London’s metal market structure were the main factors behind the spike in nickel, but it is not beyond the realm of possibility that something similar happens with another commodity.
After all, “currently what’s going on is really crazy,” Staunovo said. And it could get even crazier, especially in the oil market, according to the commodity strategist — though a further surge in crude prices could also mean market clarity.
Currently, the supply and demand dynamics are reacting to sanctions on Moscow, but material restrictions on Russian crude have yet to take widespread effect. Oil that has been delivered in recent days is linked to contracts signed before the war broke out, Staunovo said; from tender to delivery takes about two weeks, so the real drying up in supply will come two weeks after the sanctions were implemented.
“We should see some larger disruption coming” in the spot market, Staunovo said. “We should get more clarity over the coming days.”
Where does that leave investors?
“Markets are resilient,” Christopher Rossbach, the chief investment officer at Anglo-Swiss asset manager J. Stern & Co., told Barron’s.
“The US and European [stock] markets have shown that they have resilience, they have liquidity — and if you’ve seen the market moves, I think they’ve actually been moderate compared to some of the moves in commodities, ”he added.
In fact, the impact of commodity prices is likely the main concern for equity investors, Rossbach said, but long-term investors can analyze this to understand what the enduring challenges will be, and how individual stocks are impacted.
Rossbach’s perspective, shared by others, is optimistic: While the war in Ukraine remains, in no uncertain terms, a devastating human tragedy that must come to an end, it is unlikely to cause widespread economic disruption.
Entering 2022, the global economy was in a robust position, the asset manager said, with a strong recovery from the pandemic led by corporate earnings and steady consumer demand. Little, ultimately, has changed the macro picture.
“If there is an impact on the economy, on GDP, on spending, on inflation — it will be an impact that will be overcome, as previous impacts have been overcome,” Rossbach said. “Governments, central banks, and regulators are very aware of these risks, and I think are going to act rationally and proactively to offset them.”
Write to Jack Denton at firstname.lastname@example.org