It’d be difficult to imagine a more inauspicious mix of headlines than those investors confronted on Tuesday.
A “major” recession call from a major Wall Street bank fought for space above the fold with news that Moscow cut gas flows to Poland and Bulgaria, while Sergei Lavrov warned on a “serious, real” threat of nuclear war.
Last month, Vladimir Putin demanded payments for Russian fuel be made in rubles, a condition Europe generally refused to countenance, even as Moscow developed what some initially suggested was a workable mechanism. The decision to cut Poland and Bulgaria off was described by many as a watershed moment. Both countries have moved to reduce their reliance on Russian energy, but the Kremlin broadside underscored the urgency of a debate that’s divided Europe since the onset of hostilities in late February. Italy said it’s concerned, but as of Tuesday, Rome didn’t perceive an imminent supply threat. All eyes turned to Berlin.
The figures (below, from Goldman) are a snapshot of what’s at stake.
There’s also speculation that the West may attempt to sabotage Russia’s capacity to export energy — even to friendly locales — by crippling its logistics. “By sanctioning key firms and oil-carrying vessels for two months, Russian oil flows would back up to the point where its wells would have to be capped and restarting them would be incredibly difficult, if possible at all,” Rabobank’s Michael Every wrote, summarizing the social media cacophony. “That would prevent Russia from redirecting oil to Asia, while depriving it of a major slice of its export earnings,” he added, noting that “meanwhile, Russian gas to Asia would take years to come online on a scale (and price) to match what Europe buys now.”
Those are the types of strategies with the potential to cripple a nation over the long-term, and as such run the risk of reprisals from the Kremlin, which seems increasingly prone to nuclear saber-rattling. Lavrov’s unsettling remarks came in response to LLoyd Austin’s contention that Washington now aims to see Russia “weakened to the degree that it can’t do the kinds of things that it has done in invading Ukraine.”
Although it’s true that cutting off gas supplies to Europe would rob Brussels of a sanctions weapon, it would also go a long way towards exhausting whatever’s left of Moscow’s leverage. Once Putin cuts off the gas, there’s not much left except nuclear blackmail.
All of that, combined with the specter of more lockdowns in China and everything that entails for a global economy trying desperately to skirt the stagflationary event horizon, undercut risk sentiment materially on Wall Street. US tech shares fell 4% Tuesday, in one of the worst sessions of a bad year. The Nasdaq 100 hit a new YTD low (simple figure below).
Tesla didn’t help matters. The stock fell double-digits following Elon Musk’s successful Twitter acquisition, as investors pondered a possible share sale by Musk and the prospect of a distracted CEO. Tuesday’s rout erased $126 billion in market cap or, if you like, three Twitters.
After the bell, Alphabet disappointed, sending shares sharply lower, even as the company announced a $70 billion buyback. “Beyond [the Russia impact], there was a bit of a pullback on ad spend in Europe,” CFO Ruth Porat told Bloomberg, in an interview. “There’s a lot of uncertainty in the macro environment,” she added.
Indeed there is. And that means playing for tactical upside in equities after dips requires a skilled hand and nerves of steel. “It’s not a straight line and there will be more pullbacks for sure,” Nomura’s Charlie McElligott said.
On the bright side, Microsoft beat on the top and bottom lines as cloud revenue rose more than 30%. Texas Instruments, on the other hand, sank in late trading after the company delivered extremely disappointing guidance citing “reduced demand from COVID-19 restrictions in China.”
Geopolitical tensions, economic concerns and earnings disappointments are set against a very challenging policy outlook. The fiscal impulse in the US is all but dead and the Fed has no choice but to stick to a plan that may entail tightening the world’s largest economy into recession — just as the world’s second largest economy engineers a downturn of its own in the name of “zero COVID.”
“The Nasdaq down over 3% and the S&P falling more than -11% YTD have not yet tightened financial conditions to a sufficient degree to call into question the Fed’s commitment to hike aggressively,” BMO’s Ben Jeffery and Ian Lyngen wrote. “However, with the VIX back above 30 and the FCI back to the tightest levels since September 2020, the case against a 75bps hike at some point is mounting,” they added, highlighting non-dealer bidding of 87.4% versus a 76.6% average at Tuesday’s strong two-year sale.
“Whether [it’s the] risk of EPS disasters from mega-cap tech or more China growth scares, stay tactical with tight stops,” McElligott suggested.
Now for the bright side…uhh….mmm…..
I’m buying tech at this point. The inflation and tightening narrative seems overdone now–demand destruction that is taking effect now should ease wage and price growth. The supply chain issues that we all know about are baked in. I bet we get 100bps of tightening (2 50s), a little recession going into the election, and then the easing starts anew.
Waiting a bit longer till core inflation shows clearer signs of exhaustion but I am with you.
It seems like momentum is growing for a European ban on Russian oil, with Germany saying it could tolerate such an action. Russia’s oil infrastructure is designed for export to Europe, and lacks capacity to send an equivalent volume of oil to other markets, e.g. China. Thus Russia’s oil production would be largely shut-in, greatly reducing Russia’s revenue as well as, before too long, degrading Russia’s wells. This would drive significantly higher oil prices and thus inflationary pressure, and potentially even more pressure on the Fed. A Fed under greater pressure is not good for duration.