Investability bulletin 08/03/22: Commodity chaos

Broken commodity markets are racking up the pain for equities

Photo by Rick Rothenberg

Soaring food prices: Greggs shares tumbled 10% this morning as the company warned on cost input inflation. The critical thing about stagflation is how do you defend margins when costs are rising but growth is stalled and people spend less?

Greggs’ CEO Roger Whiteside said (emphasis mine): “Cost pressures are currently more significant than our initial expectations and, as ever, we will work to mitigate the impact of this on customers, however given this dynamic we do not currently expect material profit progression in the year ahead.” The fact is you find it very, very hard to maintain margins in this environment and companies will be cutting costs. The Greggs full-year numbers are actually pretty good: profits up to £145.6m on a 5.3% rise in total revenues vs 2019 levels. But the outlook is poor – expect more retailers to deliver these kinds of warnings when wheat prices are up 50% YTD and there is a squeeze on just about every soft, energy and metal out there. Remember we were heading into 2022 already with huge inflation pressures before the war was even talked about as a risk. 
Crazy commodity moves are becoming the norm. It’s not just oil and gas markets going parabolic; yesterday saw multiple sigma moves in nickel as prices jumped over 70% in a single day. Prices are higher again today at $81k from about $25k a week ago. The LME has suspended trading. Wheat is higher again, too. European nat gas prices are mooning. This commodity squeeze will lead to margin calls and liquidations, we just don’t know many are hedged the wrong way. There is a lot of risk in these markets – producers who are short the futures as a hedge are seeing VaR goes off the charts…their scramble to cover shorts is what’s making these moves get so big…who’s surviving and who’s not? 
Everything hangs on the talks between Russia and Ukraine. What if talks yield results and Putin calls his troops back to end sanctions? A tail risk, for sure, but what if? There would be some considerable volatility as markets repriced. So far, the talks are not getting very far; the shelling continues. As long as Russia keeps up the attack it’s stagflationary.  
After spiking, oil futures have pulled back. Brent rose above $139 before settling at $123.21 per barrel, its highest since July 2008. It’s around $125 this morning, with WTI around $121. Chatter about a Russian fossil fuel ban drove prices higher, but it became evident throughout the session that Germany was not about to get on board. But Russia might start to take their own action – Russia’s deputy PM said “In connection with…the imposition of a ban on Nord Stream 2, we have every right to take a matching decision and impose an embargo on gas pumping through the Nord Stream 1 gas pipeline.” Elsewhere, gold holds $2,000 and that MACD crossover trigger was bang on again.
European stock markets reacted to surging crude by slumping, but closed well off the lows as the crude gap filled and indices are firming up today, led by banks. The FTSE 100 is close to 7,000 this morning, having hit a low of 6,788 yesterday. The DAX trades above 13,000 having been at 12,438 yesterday at the lows. So some recovery here as immediate threat of cutting off all Russian oil and gas seems to be diminished, but the stagflation story remains. German inflation linked bond yields plunged to record lows. An important gauge of the market’s long-term eurozone inflation expectations climbed to 2.2%, this morning, the highest since January 2014. The EU this morning apparently mulling a joint-bond sale to fund energy and defence – EUR up, stocks pushed higher and bunds down on the headline. The spread between Italian and German 10yr paper narrowed about 10bps to 151bps. Let’s see how they wrap up arms manufacturer stocks as ESG…
The S&P closed down almost 3%, its worst day since October 2020, the Nasdaq down 3.6% to enter bear market territory. Spec tech still getting hit hard – ARKK down over 3% to $58, over 50% below its all-time high. “Downside risk remains most acute over the next 6-8 weeks,” Morgan Stanley’s Michael Wilson told clients. “We are firmly in the grasp of a bear market that is incomplete in both time and price … Any relief should be sold … We recommend staying defensively oriented by running less risk than normal and searching for companies with superior operational efficiency and earnings stability.” 
Elsewhere, Bernstein has screened four unprofitable stocks that it thinks are worth a go on the dip. It’s highlighted Australian oil and gas producer Santos, Chinese e-commerce firm Pinduoduo, Indian telecommunications services company Bharti Airtel, and Air China.

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