Tracking analyst earnings estimate revisions activity (i.e., are estimates rising or falling, and by how much?) is a key feature of our research. With earnings season underway, we can check in on how revisions activity looks across the 11 US sectors, where we find, among other things, a big divergence between the commodity-related sectors of Energy and Materials.
Last month we commented that while the CPI readings remain very high, there are signs of moderation in commodity prices. With commodity prices remaining center stage as a macro driver, we continue to closely watch the various commodity indices, including the S&P GSCI index and its subcomponents.
There now seems to be a greater divergence between energy prices and other commodities.
The chart below shows the S&P GSCI Commodity Index (top section) along with its component indices over the last three years.
The latest CPI report yesterday showed prices in April still rising at a worrisome rate, led by recovery in service-related spending like airline fares. The monthly increases in the headline CPI and the core (excluding food and energy) rate were both above consensus expectations.
Notably, the core rate (+0.6%) rose substantially more than the headline rate (+0.3%), as the impact of food and energy was negative in April. However, the year-on-year increase in the headline CPI, which eased slightly to 8.3%, is still substantially higher than the core rate of 6.2%.
Inflation remains a big topic among investors, and the charts below clearly show some of the reasons why, but there are also reasons to suspect inflation pressure could ease later this year.
Inflation is high . . .
A barrage of recent headlines has made it hard not to notice that reported inflation is very high (e.g. US CPI year-on-year change at 8.5%). More importantly for markets, inflation has continued to come in above expectations. The Citigroup Inflation Surprise indices (chart below) measure the degree to which inflation reports come in above or below consensus expectations. The indices for the US, Europe, Emerging Markets, and the global aggregate are all still extremely high relative to historical norms. Europe is by far the most extreme, as it is affected most directly by the war in Ukraine and the resulting impacts on energy prices and many other commodities.
Commodity markets have become the center of global economic and financial market attention recently, showing unprecedented volatility. Russia’s invasion of Ukraine, coming on top of the volatility caused by COVID and the subsequent policy responses, has highlighted the supply constraints now facing a wide variety of commodities.
The S&P GSCI commodity price index is a widely-watched benchmark for global commodity prices, with history back to 1970. As shown in the chart below, the rolling 3-month percent change in the GSCI index has just hit its highest reading in its 52-year history. This exceeds the moves following the OPEC oil embargo of 1973-74, the 1979 oil shock, the invasion of Kuwait in 1990, the rebound in prices in 2009 after the 2008 collapse, and the rebound in 2020 from the initial COVID-driven collapse.
While we hesitate to comment too much on the situation in Russia/Ukraine given how fast conditions are changing, many investors are naturally interested in the market impacts of the recent invasion and the resulting sanctions.
The first order impact is clearly volatility, in many different markets. Stocks, bonds, currencies, and commodities are all seeing increased volatility recently amid extreme uncertainty surrounding the unprecedented global response to Russia’s invasion of Ukraine. And of course, Russian assets of all kinds have seen their prices plunge, if they are still being traded at all — the Russian stock market has remained closed since February 25th.
Volatility in the crude oil and natural gas markets has been a big topic among investors and policy makers recently. Limited supplies and higher demand are pushing prices higher, and stock prices in the Energy sector are responding.
The chart below helps put recent movements in perspective, seen in the context of the last five years. Crude oil prices (second section, in red) have just recently topped their 2018 peak, completing a full recovery from the COVID-related drop and weakness that preceded COVID. But the five-year average for crude oil has been about $55/bbl, with a low of $25 (on this measure, which uses an average of the next 12 months of crude oil futures contracts to avoid near-contract distortions) and a current high of $76. So crude is elevated but not at an extraordinary level given it was at about the same price in October 2018. And it reached much higher levels above $100/bbl. back in 2008, 2011, and 2012.
One of the themes in our sector research for clients recently has been to focus on relative preferences within broader style or macro categories, rather than making big macro bets on Growth versus Value or Cyclical versus Defensive areas. We find that in a more range-bound market with conflicting macro trends, a more granular view is often more effective.
One stance we have held for some time has been within the Value-oriented commodity space. While in many cases historically the Energy and Materials sectors have moved together, this year has seen a dramatic divergence between the two commodity-related sectors. We have favored Materials over Energy this year, and still do, and below are some of the drivers of that view.
In financial markets, it seems like “everything” is going up recently. Stocks, bonds, precious metals, even Bitcoin. Perhaps that should not be surprising given the huge amount of liquidity being produced by global central banks in addition to the fiscal stimulus earlier this year. That tends to have the effect of pushing asset prices up generally.
But when we look at relative returns of some key assets, it looks more like the “risk on” trend has not really gone anywhere since early June. That is, owning the riskier option within various asset classes has not generated excess returns to compensate for that extra risk since the recent peak in risk about June 8th.