The Options-Quant team is home to former economists, traders, and statisticians. With over 30 years of combined experience, we have developed the ability to accurately assess and interpret various market regimes and environments. What follows is the team's perspective on global markets for the second quarter of 2022.
Geopolitical Risk Factors
As of April 2022, the current war in Ukraine seems to not have an end in sight. While the military combat may be confined to the Eastern European landmass, the spillover effects may be wide-reaching and devastating.
The main risk to European markets primarily stems from the energy market. On April 26th, Gazprom announced that gas deliveries to Poland and Bulgaria would be suspended. Poland relies on Gazprom for nearly 45% of its natural gas. Natural gas is used for heating, refrigeration, cooking, outdoor lighting, and a plethora of other key industries. This, paired with Poland’s intake of nearly 3 million refugees is likely to spell a disaster.
It is plausible to assume that the ever-increasing scarcity of goods in Poland will exacerbate internal strife between refugees and native Poles. It would not be the first time that Russia has strategically weakened the internal relations of a foreign nation.
Middle East & Africa:
While this may not immediately have a direct effect on mainstream markets, the risk of human casualty is grave.
In East African countries like Somalia and Kenya, more than 50% of the wheat and fertilizer used to feed the population comes from Russia or Ukraine . Analysts currently estimate that Ukraine’s 2022 wheat harvest may shrink by as much as 45%, due to the disruption from the war . Unbeknownst to many, some East African nations are in the midst of a severe drought not seen in 40 years. According to the United Nations, an estimated 13 million people are facing severe hunger as a result.
Wheat and fertilizer prices in the region are already rapidly on the rise, in line with global inflation, so it is likely that the number of those experiencing famine will increase. Surely, this lays precedence for a jump in geopolitical tension. Around 450 million people live in this region, so while mainstream equity markets may not immediately feel the brunt, the entropy will surely reverberate globally.
With inflation on the move globally, the Federal Reserve has transitioned to a rather hawkish policy approach. The consensus among analysts is that the Fed will raise rates by 0.5% in May and that the market currently implies a fed funds rate of 2.5% by year’s end.
Without sufficient inflation targeting, consumer confidence is likely to shed further. If consumer confidence continues to shred in an environment of increasing rates, this only increases the probability of a US recession. A US recession would be monetarily catastrophic as the Federal Reserve has already greatly exhausted its powers with regards to ‘printing’ and low-interest rates.
However, it appears that the Fed is aware of this and is becoming proportionally hawkish. The most optimistic scenario is that the increased rates in mortgages, loans, and savings will have the desired effect of cooling down spending and that inflation will peak. This may lead to an increase in consumer confidence, and ultimately consumer demand, due to the feeling of security derived from falling inflation. The probability of an increase in US GDP must not be discounted.
A rarely discussed outperformer of the current market regime is that of Norweigan energy stocks. Norway currently supplies about 22% of the EU’s gas demand and only about 33% of the country’s natural gas resources have been accessed. Norway, an active NATO member, is uniquely positioned to increase its market share on the basis of European diversification. It is an EU-friendly democratic country, with a strong geographical edge and has been a major player in Europe’s energy markets for decades.
To narrow this down, one can look at Equinor (NYSE: EQNR). Equinor is a Norweigan state-owned multinational energy producer and currently has about 20,000 employees. To give a quick glance at the company’s fundamentals:
Break-even barrel cost is $28 a barrel (oil)
Production Volume grew 3.2% in 2021
$3 Billion Net Cash
$96 Billion Market Cap
Increasing special dividend by $0.20 and buying back $5 billion of stock
With Russia creating the need to diversify, we can expect to see not only an increase in purchasing volume but also an increase in infrastructure investment as they must optimize their pipelines and processes to meet this newfound demand.
The market seems to agree with this thesis, and as of April 26th, 2022, the stock is up 35% YTD, while the S&P 500 is down 12% YTD.
The world is an uncertain place, unequivocally. While there are numerous factors that could push things over the edge, there are also factors that signal great upside for all. In times of uncertainty, traders and investors alike flock to quantitative strategies meant to weather the volatility. With tools like Options-Quant, you are able to access a host of alpha-generative strategies that hold no correlation to the markets.
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