Ukraine war will continue to affect markets – investor Peter Hermannrod also thinks an additional painful kind of inflation is on the way

The war in Ukraine led to huge volatility in the financial and commodity markets last week. Oil and gas prices plummeted, the Moscow Stock Exchange plunged nearly 40 percent in one day, and the Russian ruble weakened sharply. From Thursday evening through Friday, markets took a breath, after Western sanctions proved not as severe as expected.

But a lot has happened since the stock market closed on Friday.

The fighting continued in full force, and on Saturday night the European Union, the United States, the United Kingdom and Canada committed to imposing sanctions that could cripple large parts of Russia’s financial infrastructure.

The parties will close many Russian banks outside the Swift international payment system, freeze the funds of the Russian Central Bank, and close Russian oligarchs outside European financial markets. For now, the energy market appears to be on the safe side.

We have not seen any indications that the sanctions seriously threaten the energy supply of Europe, then there will be an economic crisis of a completely different dimension. Russia should sell gas, and we should buy. In this sense, I don’t think there will be a sudden stop in the power supply, and then this is not very important for the market. Russia is strong militarily, but not economically, says investor Peter Hermannrod.

Bad inflation

Stock markets have had a slow start to the year, with the S&P 500 leading index down about eight percent so far this year. In addition to the Ukraine crisis, investors are also struggling to account for the effects of a supply crunch, commodity shortages, high inflation and monetary policy normalization on the way out of the pandemic.

As a stock market player, Hermannrod is now more interested in what he calls “bad inflation.”

– I am very concerned about inflation. People talk about higher oil prices and that it will increase inflation, but I’m not afraid of that inflation at all. Serious inflation is that caused by the shortage of goods and the rise in the prices of all kinds of goods and, most importantly, the shortage of labor and the increase in labor costs. When wage inflation stabilizes, Hermannrod says, it’s dangerous.

He fears a so-called wage-price spiral, where inflation raises wages – and higher wages causes inflation.

Every time I think about how to stop it, I see no other way than to cause a recession. Hermannrod says a recession is the worst thing that can happen to stocks.

In the middle of March, the US Federal Reserve (Fed) will make a new interest rate decision. The Fed is expected to raise its key interest rate to 0.25 percent after two years of zero interest rates and fiscal support purchases. Then the increases are expected, respectively, in 2022 and 2023. The goal is to beat the highest inflation rate in the United States in 40 years.

Hermannrod believes that a rise in interest rates can be so sudden that it causes a recession, that is, an economic contraction.

– Last year, it was believed that you could push the interest rate to zero forever and that it would not cause any problems. Now we have the bottom line: It’s not working, he says.

Higher interest rates lead to more expensive loans and therefore higher financing costs for companies, which are generally negative for stocks. Investors constantly calculate the present value of future cash flows and dividends for the value of shares, and this value will be lower as interest rates rise.

There are many aspects to inflation. One effect is an increase in interest rates and corporate repricing. Another is corporate earnings, which have been doing very well through the pandemic. What companies sell has increased a lot in price, while costs have remained low. We are now entering a world where prices rise less and labor costs increase more, and it’s bad inflation that causes stagnation or a fall in profits, Hermannrod says.

Warn for a long time

Elisabeth Holvik, chief economist at Sparebank 1 Markets, says the sanctions will be painful and financially stressful for Russia, but notes that significant gas revenues will remain.

It is difficult to find sufficiently effective penalties. The most effective is to cut off imports of gas, oil and coal from Russia. It would be devastating for Russia, Holvik says, but would also hit Europe hard.

Europe receives about 40 percent of its gas supplies from Russia. Declining energy stocks and rising electricity prices are the main reason why many countries, especially Germany, are reluctant to lend their support to Russia’s exclusion from Swift.

Communication with the opposite party who has such different values ​​and makes us vulnerable to conflict, is something that many have warned about for many years. Holvik says Europe has been too naive about going green, not taking energy security and defense into account.

different crisis

The stock market rally in the US and Europe came ahead of the weekend after sanctions from the West turned out to be more moderate than expected.

DNB equity strategist Paul Harper thinks it’s actually only a matter of time before Swift’s ban is extended to more companies, but he also thinks Western banks probably won’t now trade with Russian banks anyway.

– We cannot exclude that this week will start somewhat weaker, considering that they are now narrowing down. It is a relatively well-known phenomenon that the stock market often bottoms out right after the outbreak of war, and then rises. Harper says the rally on Thursday and Friday may be related to a combination of technical indicators and knowledge of history.

Holvik at Sparebank 1 Markets notes that stock markets tumbled before the conflicts in Georgia and Crimea, before rallying again when the war began. But this time the starting point is a little different.

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