Oil Price Temporarily Returns To Pre-war Levels

Chart of the Week

The chart shows the development of oil prices over the past 12 months. After a very strong rise at the beginning of the crisis in Ukraine, the price declined again. At 22.3%, it was the largest weekly drop since oil prices have been recorded.

Why This Is Important

The biggest impact of the war in Ukraine on the global economy has been the sharp rise in energy prices. This price movement has the potential to push the entire world economy into a recession. A decline in oil prices helps calm markets and reduces the risk of a recession.

However, there are increasing calls to extend sanctions against Russia to the energy sector. It is indeed difficult to understand why the European Union imposes tough sanctions on Russia while, since the beginning of the war, it has been transferring USD 660 million per day to Russia for oil and gas deliveries. Estimates suggest that the war costs Russia about USD 1 billion per day, with more than half effectively financed through direct payments from the EU.

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Is a recession coming, or are we seeing exaggerated fear?

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The chart shows the forecasts by JPMorgan Chase for inflation (CPI) and gross domestic product (GDP) over the next two quarters. What stands out is the change compared with the previous month, highlighted in the red rectangle. The inflation forecast was revised sharply upward, while the growth outlook was revised downward.

According to the official definition, two quarters of negative growth constitute a recession. One of the largest banks in the United States is therefore expecting a recession as early as this year.

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The chart shows how U.S. stock markets have developed on average since 1950 after a 10% correction when a recession followed (grey) and when no recession occurred (black). The current performance of U.S. markets is shown in blue. It is clearly visible that the markets have reacted too strongly, even in scenarios where no recession occurred.

For this reason, last week we used the excessive downward reaction in the markets as an opportunity to enter at favorable prices. However, we are not only seeing exaggerated negative price movements in equities, but also in bonds.

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When the economy is performing well, short-term interest rates are lower than long-term interest rates. This is known as a positive yield curve. In a recession, short-term interest rates are often higher than long-term rates. This is referred to as a negative yield curve. As the economy moves from a boom toward a recession, the yield curve shifts from a positive to a negative structure. The first step in this process is known as a flattening of the yield curve.

The chart above illustrates exactly this process. It shows how much the yield curve has typically flattened since 100 days before the first interest rate hike (green line) and how the current market movement (purple line) compares. The current flattening of the yield curve goes far beyond the normal behavior of the bond markets. This is another indication that it may make sense to start buying bonds again.

Despite the enthusiasm about entering the market at favorable prices, one should remember the well-known market saying: "Never catch a falling knife." A falling knife should not be caught in midair. Instead, it is better to wait until it has hit the ground and can be picked up safely.

The knife is probably still in the air and falling. A first tranche can already be invested now, but it is likely still a bit too early to go all in.

The following chart supports this assumption:

The chart shows the results of a survey conducted by Bank of America among major institutional investors. The negative economic outlook (light blue line) is even more pessimistic than after the COVID shock and almost as negative as after the collapse of Lehman Brothers, which triggered the global financial crisis.

At the same time, it is also clear that the overweight positioning in equities remains high (dark blue line) and does not align with the negative view of economic developments. This discrepancy is likely to adjust in the coming weeks. Expectations may become somewhat less negative, but after an initial recovery, further stock sales by large institutional investors cannot be ruled out.

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Disclaimer:

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The content in these blog posts is intended solely for general information and to help potential clients gain an understanding of our approach. It does not constitute recommendations to buy or sell assets and should not be considered investment advice. Marmot.Finance cannot assess whether or how the statements made align with your investment objectives or your risk profile. If you make investment decisions based on this blog post, you do so entirely at your own risk and responsibility. Marmot.Finance cannot be held liable for any losses that may arise from the information contained in this blog post.

The products mentioned are not recommendations but are used to illustrate how Marmot.Finance works and selects such products. Marmot.Finance is also completely independent and does not earn any form of compensation from product providers.

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