Not investment advice.
Each day, the odds of another big leg up in oil prices increase.
For investors, true north is the flow of oil and gas.
Three weeks in, and the oil and gas is not flowing. The ships that move it are largely frozen. A few are getting through, but mostly not. If you interrupt the flow, you can store it for a while. But now storage is filling up. Wells are being shut in. The supply destruction is permanent. When demand fell by this much during Covid, prices went to zero. The opposite can happen now, supply is down roughly as much as demand was during Covid.
Central banks are on hold. Given how almost unglued inflation expectations became in 2022, central bankers now must contend with the fact that inflation expectations could become unhinged. Inflation prints this summer will be high. I don’t think central banks tighten, but the discounting that they may tighten can get more extreme, driving short-term interest rates yet higher—which is what happened this week.
Short rates (2 years) are rising faster than long rates (10 years and beyond), meaning yield curves are inverting, meaning the bond market is discounting weaker growth ahead and a spike in inflation. In past episodes, like the Iran-Iraq tanker war in the late 1980s, interest rate expectations shifted dramatically higher.
Stocks are cash flows discounted back to today. The higher interest rates go, the less attractive that distant stream of earnings, so stocks fall. The more stocks fall, the bigger the negative wealth effect. We are in a self-reinforcing negative market dynamic, and only the opening of the Strait short-circuits that.
The higher energy prices go, the more the pressure builds for a solution—which is the point, meaning it is in Iran’s interest to get energy prices as high as possible. Stocks are trading at the extreme end of their valuations, and the sharp rise in short-term interest rates and energy prices is unambiguously bearish.
Opportunities for diversification are limited. Long oil and short stocks is a bet that things get worse. Long risk parity is a bet that things get better. The risks are tilted to the downside.
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