This Is Not Going to be an Easy Week in the Markets

American markets today, viewed several hours before the 9:30 a.m. Eastern time opening appear poised for a strong start as traders juggle two opposing forces: optimism at talks between Russia and Ukraine and pessimism at the prospect that China might come to Russia’s aid as well as bracing for the upcoming Federal Reserve rate decision. The S&P 500, DOW and NASDAQ all look promising in the hours before market opening.

Canadian markets also appear poised for a positive start with the TSX60 and TSX Composite in positive territory.

European markets are already open at time of writing and have been in positive territory since market opening as the FTSE 100, DAX and CAC 40 are all firmly in the green.

Amongst precious metals gold and silver are down.

Amongst currencies, the Canadian dollar is down while the Euro and British pound sterling are up against the American greenback which has lately increased its safe haven status.

This is not going to be an easy week in the markets and these figures follow Friday’s trading in which shares dropped dramatically under the weight of the Russia-Ukraine conflict and expectations that the Federal Reserve Bank will hike interest rates.

Financial markets have reacted wildly since the war in Ukraine began while bracing for tightening monetary policy by central banks including the Federal Reserve Bank.

On a slightly more cheerful note, we get more clues about the impact of Christmas shopping this week. On Thursday Dollar General Corp. reports fourth quarter revenue likely boosted by holiday purchases and discounted groceries. Investors will be hoping for clarity on supply chains, inventory levels and labor levels. Also on Thursday FedEx Corp reports its third-quarter numbers most likely boosted by shipping volumes of holiday packages. Investors and analysts will look for the impact of FedEx’s suspension of activities in Russia, Ukraine and Belarus.

This week we can continue tallying the cost for countries, companies and investors of the war but cannot hope to even estimate the total accurately, nor even on the bottom lines of Western companies. All sanctions declared to date by the West have costs. The damage to Russia’s economy has costs to the West. The refugee crisis in Europe will have costs. Whatever happens in Ukraine, it seems questionable how quickly the country can recover after losing over two million inhabitants. Worse still, Josep Borell, the European Union’s head of foreign policy has stated that the EU could expect five million refugees. That estimate represents approximately 12% of the total Ukraine population. If Borell’s estimate proves correct, it makes recovery in Ukraine even less likely for many years.

And it seems equally questionable how well the countries receiving those refugees can cope. Poland suddenly acquired 1 ½ million refugees and is genuinely attempting to cope with the influx.

All divestments have costs. Shuttering operations temporarily has a cost. McDonald’s has closed its 850 locations in Russia and has generously promised to continue paying its 62,000 Russian employees. McDonald’s input supply chains within the country are going to take a deep hit, adding to the damage to the Russian economy.

And when the war is finally over, McDonald’s and other Western companies face some painful decisions about their Russian operations.

For clues on the damage to Russia watch for whether it makes its US$116 million bond payment due Wednesday. If Russia attempts to pay in very much depreciated rubles, that may not go over very well with its lenders. It is reasonable to believe that Russian President Vladimir Putin did not accurately anticipate the extent of Western sanctions before launching the Ukraine invasion.

And consumers are feeling the cost, right down to the gas pump and the grocery store. The rising price of gas may have some drivers thinking about electric vehicles but the increasing price of nickel, produced by Russia is going to make the production of electric vehicles more expensive. Watch for the impact on EV stocks.

Predicting what could happen next is tricky in a situation in which Russian Foreign Minister Sergey Lavrov stated and re-stated his claim that Russia did not attack Ukraine. (I had to read that story over several times to ensure that I had got it right.) The situation is not going to improve this week and the markets will reflect that with more swings. It is possible that we are approaching the bottom and then we can review what has happened to equities and our portfolios.

And somewhere down the line all of these sanctions have to be unwound and we cannot begin to estimate the fallout from that stage.

Some economists are musing about a stagflationary environment. Stagflation is one of those terms which is confusing and attracts different definitions, further increasing the confusion. “The term stagflation is imbued with subtly different meaning by various protagonists – often to suit their needs,” says James Athey, Investment Director at Abrdn in London.

“The economic theory which dominated prior to the 1970s was that as unemployment rose so inflation fell and vice versa,” he says. “What the United Kingdom, United States and others experienced in the 1970s was a prolonged period of high unemployment alongside high and rising inflation – something theoreticians previously had stated was not possible. Stagflation was the term coined to describe this situation,” he recalls.

Currently it is used as a generic term to describe a period of high inflation and low growth or recession Stagflation cannot be a greater risk than inflation because all of the scenarios that are stagflationary are by definition inflationary while the opposite is not true.

If we do find ourselves stuck in a stagflatonary environment, assets will be under pressure and a diversified portfolio of cheap and defensive equities, long dated government bonds, precious metals and cash make for the best combination, Athey says.

At the same time, investors get some good news. Countries are re-opening as we climb out of the pandemic, though there are still troubled areas. That should go a long way to easing the supply chain issues that have plagued Western economies. Moreover the Russia mess may have headed off another mess: the effectiveness of Western sanctions and Russia’s costs in soldiers, equipment and world disapproval would not be lost on China which has long considered Taiwan a prime target for its Southeast Asia expansion plans.

This line of reported intelligence suggests those costs have meant that the likelihood of a Chinese invasion of Taiwan has decreased for now. And while Western sanctions have not stopped Russia’s invasion, they have done massive damage to the Russian economy and China is well aware of those costs. That might provide a measure of relief to investors in Taiwan Semiconductor Manufacturing Company Ltd. which still has a consensus ‘Buy’ rating on the Street.

This is not going to be an easy week in the markets – but the news isn’t all bad.

Related: There Are Many Fallen Angels in the Market Right Now

Al Emid is a financial journalist, broadcaster and author with two books underway.

The Emid Report on Volatility 2022 – the next in the series -- is scheduled for release in Summer 2022 and his book on foreign investing is scheduled for release in January 2023.