Commodities are soaring. Interest rates are falling. Stocks can't get out of their own way. All of this is occurring, while the first war in decades continues to rage in Ukraine. Seems to me that any gains in the market averages next week will remain dead cat bounces in this bear market.

 

Yes, I hate to be a squeaky wheel, but I've got to call it like I see it. We have a much greater chance of sliding lower from here than higher. Here's why.

 

Investors received a new lease on life this week when Fed Chairman Jerome Powell, testifying before the Senate banking Committee, triggered a market rise in the averages.  All he did was relieve a little market angst by stating that a 25 rather than a 50-basis point move should be expected later this month at the FOMC meeting. In that context, I would label the resulting short market bounce as simply a relief rally.

 

Initially, the markets rallied because the Fed is not raising rates as high as expected. That usually means higher stock prices, so the bounce was understandable. But the reason the Fed plans to raise rates in the first place is due to soaring inflation. What did investors do?

 

Prices of basic and precious metals, like aluminum, nickel, copper, gold, silver, and food commodities like wheat, corn, fertilizer, and of course, oil and gas were bid up leading the market gains.  The combination of these Russian fear trades, plus inflation plays, continued to lead gains throughout the week. Technology and speculative areas were largely left in the dust.

 

This action has only pushed up commodity prices even higher. Now what will that do to the inflation rate?  Push it even higher, and possibly make the Fed reconsider its plans. Those bond traders who were betting on a "one and done" interest rate hike have changed their forecast. The betting is that there will be at least two more hikes coming before June.

 

On Thursday night, March 4, the Russians attacked Ukraine's largest nuclear facility, which provides 20 percent of European electricity. Fortunately, there did not appear to be any leakage of radioactivity but that could have occurred. The U.S. dollar jumped more than 1 percent, an extraordinary event, indicating a "run for the hills" mentality overwhelming investors.

 

 Unfortunately, this is the kind of market where most market participants are headline driven. Given the circumstances, that is understandable. Algo traders are careening from buys to sells as news pops up on the terminals. Whether it is testimony from Powell, Russian cease fire rumors, oil embargo news, or new atrocities in Ukraine, stock prices either crater or explode hour to hour.

 

Few of these traders know or care about things like price/earnings ratios, balance sheets, corporate earnings or even macro data like the positive gains in employment we saw last month. Remember, most market participants have little to no experience in a higher interest rate environment nor how to invest in equities when inflation is rising. As for maneuvering world markets on a war footing, few have any experience at all.

 

It is obvious that just about everyone is focused on the oil price. The higher oil climbs, the greater the probability that inflation will continue higher, and the greater the chance that global economic growth slows.  Analysts at Bank of America, for example, have raised their forecast for oil to $120 per barrel by the middle of 2022.

 

At the present price of oil, the U. K's National Institute for Economic and Social Research estimates that the Russian-Ukraine conflict could hack $1 trillion off the value of the world economy. It could also add another 3% to the world's overall inflation rate. Predictably, Eastern Europe would get hurt the most. Those numbers worsen as the oil price rises.

 

There are all sorts of worst-case estimates as to where oil prices could go depending on whether there is an embargo on Russian oil, a reduction in exports due to war damage, or if Russia curtails energy supplies to Europe in response to sanctions.

 

It appears to me that the markets have settled on a worst-case price of between $120-$130-barrel oil at this time. If that were to happen, and remain at that level over several months, the impact on the U.S. economy would be to slow growth and bring on the specter of stagflation. I believe it is way too early to predict that outcome.  I did forecast back in December 2021, however, that this scenario would begin to make the rounds on Wall Street about now. In my opinion, the onset of stagflation would be a stretch, given the present robust growth rate of U.S. GDP and the Fed's intention of tightening monetary policy beginning in mid-March.

 

As for the future of the markets, I am sticking to my guns. Stocks will remain in a box until after the March 2022 meeting of the FOMC. That means we could easily test the lows of January 2022 again, either before or after the Fed hikes interest rates. 

 

Crude oil hit $110 a barrel this week. The price of natural gas rose in sympathy. In addition to the already announced economic sanctions, demands to add an embargo on Russian energy exports are increasing. Be careful what you wish for.

 

Most of the world governments have already instituted several hard-hitting sanctions against Russia. Financially, the harshest step so far has been barring Russia's central bank and several large Russian banks from using the Society for Worldwide Interbank Financial Telecommunications (SWIFT) system. SWIFT is a messaging network used by almost all financial institutions to quickly and accurately receive information such as money transfer instructions. As such, the entire Russian financial system has been cut off from the international financial system. It was considered a "financial nuclear weapon" by most credit analysts.

 

Most bystanders neither understand, nor care about this action. That indifference may be a mistake. No one really knows the ramifications of such a move on the global financial system. While the financial isolation cripples Russia, it may also have unpredictable consequences for other financial institutions.

 

How many of our U.S. or European banks are exposed to Russian debt, for example? How will they receive payments from Russian debtors? Are there assets, holdings, or obligations that are now in jeopardy because of these sanctions? Could the blowback take down parts of our global financial system along with Russia? Global investors are not waiting around to find out. Prices of banks and other financial institutions in world markets have been a free fall.

 

As for the energy market, only Canada has said it was banning Russian oil imports. So far, no other nation has targeted Russia's energy complex directly. Several global oil companies have announced they will be pulling out of activities in Russia. In the private energy markets, there is a clear preference to avoid buying Russian crude, which constitutes a semi-embargo situation right now. But most of the nations opposed to Russia's aggression have kept silent on energy embargos.

 

The problem with an energy embargo is that, even before Russia's evasion of the Ukraine, oil supplies have been tight with supply constraints swamped by increasing global demand. Any additional reduction in supply could not only send the inflation rate much higher but might also plunge the world and the U.S. into a recession.  That said, could the worsening situation in Ukraine precipitate a Russian embargo despite the economic risks?

 

It could, which is why the International Energy Agency decided to hold an "emergency" meeting on Tuesday, March 1. They discussed what IEA members can do to stabilize energy markets and announced a 60-million barrel release from strategic reserves. The U.S. is providing half of that amount. Naturally, several other nations are planning to release energy supplies from their strategic stockpiles. That would amount to a drop in the bucket, however, since those emergency supplies would only cover energy demand for a week at most. A reduction in government taxes on gasoline might help, but not by much.

 

There are two other avenues that the world could use to limit the rise in energy prices. One would be a breakthrough in the Iran/U.S. nuclear negotiations. The 10-month talks have been difficult, since under the last administration, former president Donald Trump arbitrarily quit the negotiation process. The Biden administration revived the talks, but the wall of Iranian distrust has been difficult to climb.

 

The talks are dragging on over resolving questions over uranium traces found at several old but undeclared sites in Iran. "Significant differences" keep both sides from signing a pact. But as energy prices climb higher, the one million barrels of oil that Iran could sell on the open markets become increasingly attractive for a country suffering the impact of economic sanctions. From the U.S. side, those extra barrels could go a long way to corral rising oil prices, at least in the short term.

 

OPEC is also another wild card that could help increase supply somewhat. The oil producer's cartel met on Wednesday, March 2, but made no move to increase supply beyond their already announced program. Both Saudi Arabia and the UAE could increase production, but that would put them at odds with Russia, a member in good standing in OPEC-plus.

 

All of the above, I am afraid, might knock the price of oil down by $5 or so in the very short-term, but I suspect that given the ongoing risks of a war in Ukraine, oil will make higher highs in the weeks ahead.

 

It turns out that the president was correct in his warnings. Russia did invade Ukraine. Financial markets predictably crashed, but then rebounded. That's old news. What happens next?

 

In my last column, I wrote that the fate of the markets was in the hands of two big "ifs." One was an invasion of Ukraine by Russia. That has now occurred. That event broke the range the market was struggling to maintain on Thursday, Feb. 24. But by the end of the day Thursday the markets bounced back up big time. It was a classic investor behavior pattern of "sell the rumor, buy the news." Stocks fought to continue that bounce on Friday.

 

There is an old saying, attributed to Baron Rothschild, an 18th-century British nobleman, that "the time to buy is when there is blood in the streets." That famed member of the Rothschild banking family made a fortune buying into the panic that followed the Battle of Waterloo against Napoleon. But buying becomes a bit more difficult if the blood spilled happens to be yours.

 

I have tried to steer investors to safety over the last two months. Whether you listened or not, my target level has been 4,060 on the S&P 500 Index. This week we hit a low of 4,114. I guess you can say that was close enough for government work. As such, I would begin to add back equities into my portfolio, if you haven't already. But that does not mean that this pullback is over.

 

I do not expect a V-shaped recovery in these markets. We have yet to see a "capitulation" day where 90 percent of all stocks are sold. Rarely, if ever, is a market decline over without at least one capitulation day. In addition, geopolitical events like this Ukraine debacle usually lasts several months, not several days. If the fear index, called the VIX, remains above 20 (and it is right now above 29), we could still see 100-point swings or more in the index averages daily.

 

And as usual, Wall Street strategists, who were so bullish a month ago, are now predicting confidently that we could see the S&P 500 fall to 3,750. It is therefore not the atmosphere where stocks can soar into a new bull market. There is still a boat load of headline risk, so purchases should be done slowly and not all at once. Average in as the professionals usually do. And any adds you may decide to make should be in the more defensive sectors of the market at first.

 

Of course, the markets can go lower, or bottom a little higher than my predictions. In markets like these where geopolitical uncertainty can move markets wildly, don't expect precise measurements. Suffice it to say that most of the decline is over in my books. 

 

The face-ripping rally we experienced this week is normal in bear markets. From the lows to the highs, the S&P 500 Index swung 180 points in a single day. We could easily see the reverse happen next week.

 

In this type of a downtrend, I believe we will need to test the lows and possibly go lower one, two, or even three times before this correction is over. That should take us close to the mid-March FOMC meeting. Even then, I am not expecting the overall market to come out of the doldrums before mid-year. Why?

 

My second big "if" of last week was the Fed. I am sure that the bond market will be wondering if their present expectations for seven interest rate hikes by the Fed this year remains a possibility. Could the Fed change its monetary tightening policy because of the invasion of Ukraine and resulting U.S. sanctions? My short answer is no.

 

Soaring oil and gas prices, and dislocations in the supply chain due to this geopolitical conflict, will only add upward pressure on the inflation rate. The Fed will continue to tighten, because they must, if we don't want to see hyperinflation. But I am not in the camp that seven rate hikes are being contemplated by the Fed membership. That premise is simply noise from a crowd of neophytes who have never worked in a rising interest rate environment. If the Fed raises interest rates even three times this year, I would be surprised.

 

That said, the Fed's monetary policy change will continue to pressure stocks through the first half of the year. That should cap any real upside we see going forward over the next three to four months. Still, flatlining by the stock market is better than going down I guess.

 

 

The war drums are beating. Oil and gas prices are soaring. Inflation is at a decades-long high. Bearish sentiment is exploding. And the stock market is giving investors angina. What to do?

 

Take a deep breath and remember that whatever the circumstances, this too shall pass. I know that is easy to say, but a longer-term perspective might prevent you from doing something foolish like selling into this downturn.

 

Let's address the present fear that today's geopolitical tension will somehow escalate into possibly WWIII. Sure, anything can happen, but is war the most probable outcome? The present reaction by the U.S. and its allies regarding Vladimir Putin's aggression toward Ukraine has been confined to economic sanctions. No one in the administration is contemplating a military response.

 

Make no mistake, the economic sanctions that we implement against Russia could have a certain amount of blowback for the U.S. and European nations. We already see higher prices for energy (oil is above $100 a barrel as I write this. Other commodities have also shot up in price. This could mean that further increases are ahead and for a longer period of time than we expected, which would make fighting the present rate of inflation more difficult, but not impossible.

 

From a historical perspective, the specter of a new cold war shouldn't have a debilitating impact on the world economy. Economies, including our own, have thrived despite decades-long cold wars in the past. Could we see further hacking attacks directed against our companies or financial system? We could, but I suspect they would be more of an inconvenience than a real body blow. If anything, it may change the investment prospects for certain sectors (such as defense or IT security) in the future.

 

As for how the markets are handling this event, one must understand that for many this kind of correction is brand new. There are 25 million investors new to the stock market that have only seen markets go higher in the last year or so that have been investing. And there is an entire generation of investors who have never seen an environment of rising interest rates and higher inflation.  

 

In addition, there are now armies of short-term traders with software programs set to react instantly to news based on certain key words. You can guess that words like "war," "invasion," and "sanctions," in connection with "Ukraine" or "Russia" are triggering buy or sell programs with millions (if not billions) of dollars at risk. The fact that the world media is broadcasting every accusation, every rumor, every quote concerning this crisis simply heightens this type of trading.

 

Don't mistake these computer-generated day trades as indicative of what the market thinks will or will not happen. The professional institutional investors are not panicking. Dark pool buying, which is a better indication of what the pros are doing, has seen consistent buying for the last few weeks. Of course, what they are buying (and selling) could be significant.

 

In this age of higher inflation, materials, financials, commodities, and defensive sectors like REITS, telecommunications, and utilities are in demand. Technology and speculative areas, such as cryptos and the "Kathy Wood" stocks, are being liquidated and will continue to be a source of funds, in my opinion.

 

Will the overall market continue to decline? If the Federal Reserve Bank continues its monetary tightening program, the odds are that we have more downside ahead of us. If things get out of hand (and it appears today that they are),  this decline fall another 6-7 percent in the S&P 500 Index. That would bring the total decline to almost 20 percent overall between now and the end of March.  Given the market's outstanding performance over the last few years, it seems to me a small price to pay for those gains.

 

Yes, a loss like that in less than six months would be painful, but not the end of the world. And losses you might incur now could easily be recouped by the end of the year. If you hold through this downturn, they would only be paper losses. If you sell in a panic however, they will become real losses. Selling the "news" is a bad strategy, but selling when the news cannot even be verified is a real sucker's game. We are in that kind of investment atmosphere today.

 

Take it from me, it is too late to sell. Hang in there, ignore the news, and take a deep breath.

 

Over the next three weeks, equities will likely trade in a wide range. The caveat to that forecast: if the Fed suddenly changes policy, or if a shooting war erupts in Ukraine. Those are two big ifs. Unfortunately, I can neither forecast when or what the next Fed head will say, nor predict Vladimir Putin's next move.

 

The next Federal Open Market Committee meeting occurs in mid-March. The latest CPI and PPI inflation data shows inflation accelerating at a rate much higher than economists and the Fed expected. It is all but certain, according to the bond market vigilantes, that the Federal Reserve Bank will raise interest rates at that time. As such, it is only a question of whether the rate increase will be a 25 or 50 basis point hike.

 

That will be only part of the equation. Investors will be expecting Chairman Jerome Powell to give them more insight as to how many rate hikes they can expect going forward, and what other monetary tightening the Fed will be planning as well. The risk will be that the equity market could swoon and test the lows if the Fed is perceived as more hawkish on tightening than expected.

 

That in the meantime, we have plenty to occupy our attention. This week the market's interest rate worries have been superseded by Russia's intentions toward Ukraine. Thus far, the conflict has been played out in the media in a "he said, she said" war of charges and counter charges.

 

War is never a good thing, suffice it to say. But besides the human costs of such a conflict, there would also be an economic price to pay. The sanctions that the U.S. and its allies are prepared to inflict on Russia in response to perceived aggression would inflict damage on the global economy and on the U.S. as well.

 

Russia supplies a great deal of the commodities that the rest of the world consumes. Sanctions could immediately cause substantial price spikes in commodities such as oil, gas, and coal. Russia is also a major exporter of rare earth minerals and heavy metals. One third of the world's supply of palladium (used in catalytic converters), for example, and titanium (think aircraft) is also mined and exported by Russia.

 

Ukraine is also a major source of neon, an essential input in the manufacturing of semiconductors. The Ukraine is one of the world's largest producers of wheat, as well as fertilizers (as is Russia). Hostilities could damage their ability to export or even harvest the nation's wheat supply.

 

I would expect price spikes in several food commodities as a result. That would add fuel to the inflation fire and could force the Fed to become even more aggressive in raising interest rates. It would not be a pretty picture for stock market investors.  

 

To be honest, no one knows whether Russia is bluffing or serious about invasion as a next step.  For me, a telltale sign of their intent would be any movement of medical facilities and supplies forward to the troop staging areas and border with Ukraine. This week, I have seen just that.

 

The risk is obvious. A shooting war would probably see the S&P 500 Index re-test the lows (4,222) of Jan. 24. Geopolitical events usually have a limited impact on the stock market, unless the hostilities are protracted and far-reaching.  If, on the other hand, a negotiated settlement was to occur, markets would likely fly higher. That "if" word is going to keep investors jumpy and prices in a box with every headline capable of moving markets 1-2 percent up or down.