The oil price will determine the further course of economic development in the coming months

Chart of the Week

The chart shows the maximum loss over a 9-month period that could be made with stocks (S&P 500) and bonds (Barclay US Aggregate) in the US. The loss during this period was higher with bonds than with stocks.

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Why this is important

Stocks are considered risky investments and bonds are considered safe investments. This correlation has held true for the past 30 years, as interest rates have steadily declined during this time period:

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The chart shows how sharply and, more importantly, steadily long-term interest rates have fallen in the U.S. since 1980. In any long-term calculation, therefore, bonds are shown as a safe asset class.

Now, however, the U.S. Federal Reserve announced last fall that it would switch from an expansionary to a restrictive monetary policy. In mid-March, it then took the first step and raised interest rates by 25 basis points. Most market participants now expect 9 rate hikes by mid-1923, so there is an almost 95% probability that rates will break out of their 30-year trend upward.

In Europe, the loss of bonds has been smaller because the European Central Bank has not yet begun its rate hike cycle. But even it will not be able to escape the trend toward higher interest rates for long. European investors are therefore facing the same losses in bond values in the foreseeable future.

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Bonds are no longer a safe haven

The chart shows again impressively how strong the current interest rate movement was and how it is to be classified historically. The chart shows the maximum losses that could be made with bonds before a counter-correction occurred.

We are currently seeing the third strongest correction since 1992!

In the chart of 10-year interest rates in the U.S., however, it is also apparent that the correction is reaching its limits. A countermovement is therefore to be expected in the medium term. We are taking advantage of this to now fully invest the bond portion of clients' portfolios.

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The oil price will determine the further course of economic development in the coming months

Crude oil prices are currently very strongly influenced by the course of the war in Ukraine. If a ceasefire or peace were to be reached, oil prices would fall sharply. If, on the other hand, there is a further escalation, either in the direct course of the war or that the EU renounces oil and gas supplies from Russia, oil prices can be expected to rise sharply once again.

The chart shows the very strong price movement in oil. After the low of the prices after the first Covid shock, the price of crude oil has more than doubled from USD 50 to USD 130.

Most market participants expect the price to fall back to USD 90 by the end of the year. This is suggested by the currently paid futures prices for December 2022 contracts (light blue line).

However, the respected investment bank Goldman Sachs, which is very often correct with its forecasts, expects prices to rise again (dark blue line).

In the chart are the price increases of the CBR commodity index since 1915 and especially during various crises.

Not only oil, but in general commodity prices have risen sharply in the last 6 months. It is the strongest increase since 1915!

As the chart below points out, this is red hot.

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The chart points out that the probability of the economy falling into recession increases massively when energy prices rise. When oil prices exceed USD 111, the probability increases above 50%. A sharp rise in energy prices has the same effect as an increase in key interest rates. It slows down the economy.

The respected investment bank Morgan Stanley has developed its own leading indicator to predict the earnings performance of companies in the US. As the chart above shows, this indicator (yellow line) is amazingly good at predicting the future since 2001.
We can expect that due to generally rising prices, earnings per share should come under strong pressure in the next two quarters.

Our basic scenario currently assumes stagflation. In other words, low growth with high inflation. If this turns out to be true, the performance of investment styles and asset classes during the last major stagflation from 1974 to 1981 is a good indicator.

The chart shows how the individual asset classes, styles and sectors performed during a prolonged stagflation. In particular, value and small cap stocks outperformed the broad market. In terms of sectors, companies from the real estate sector (REITS) and commodity stocks scored particularly well.

Even if there is no stagflation, but a mild recession, the same styles and sectors are the winners.

We have made a steady shift from growth stocks (Growth) to value stocks (Value) since last fall, and will continue to invest that way. We have not yet started buying small company stocks and real estate stocks. Since these usually only develop their potential in a second phase, after the first 2-3 interest rate increases.