Global Macro Dynamics: An Overview

Last 12 months have been a dangerous rollercoaster ride for all global economies with us at the most dangerous curve of the ride right now. Pre-Covid we were already grappling with tense geopolitical environment with countries trying to prove their oil dominance. Covid saw worsening supply chain issues and with quantitative easing across many countries, geopolitical problems were pushed aside. But post-covid, it seemed glorious. Dry powder being invested like crazy, SPACs gaining momentum giving a good first impression, however deceiving it may be, and Russia once again going aggressively towards becoming a superpower. But in the last few months, especially last two quarters, it has all got disrupted. SPACs lost their lustre as quickly as they gained it. Quantitative easing was stretched for way too long. And geopolitics is now back to even higher tensions with the Ukraine war. So where do we stand today? Well, we’re in a middle of some really complex problems squeezed all at one point and the best thing to do is brace. Below, I try to analyse key events in the past few months / years that have shaped the global economy to what it is today. I also try to analyse where we may be headed in the hope of finding some soft landing from an individual’s perspective.

The Supply Chain Crisis

The initial Covid lockdowns halted almost all the commercial vehicles supplying essentials leading to a huge supply chain crisis in the world. The crisis did not really surface during the halt but surfaced real quick as economies started to recover and demand increased not just for essentials but also for non-essentials. Especially in 2021, there was a massive mis-match between demand and the ability of the supply chain agents to supply on time leading to massive delays. We are aware how important supply chain is for any business, particularly those that used to bank on JIT (Just In Time) delivery system. With lack of drivers in countries like the UK or just delay in imports because one country is in lockdown but anther is not, JIT was certainly impossible. There may be amazing technology to track the vehicles and eliminate the time wasted. But, if the vehicles do not move because the product is not ready or the assembly is slow or just roads are blocked because of a war or a lockdown, the problem persists. It is a classic case where there has to be smooth running on the ground and tech cannot help much (the help is restricted). However, when we had some hope in February that maybe supply chain crisis will subside gradually, we had a war! A war a location that essentially connects two sides of the world for many things and a location that served as a main resource for food supply in an entire continent – Europe. With this disruption, the recovery in supply chain now seems a matter of a year or two at least.

Subtle Perseverance of Gaining Oil Dominance

Oil and Gas have been key economic drivers for the entire global economy for decades. A change in global economy leads to a change in oil and gas prices and vice versa. With the war, we all know Oil and Gas has become a big issue because of the rising prices. Banning Russian oil means low supply but demand is still intact. This supply-demand mismatch causes oil price to rise. Now, let us go back a few years and look at how the oil market evolved. Middle East had prominent market share. Then came Russia in cut-throat competition. And then entered US with its shell. The three fighting for dominance in subtle ways (and sometimes not so subtle ways as we have seen in smaller Middle Eastern countries). Eventually, these complications led to over-production (oversupply) and hence, we saw oil prices plummet with futures going negative in the covid year. But now, it is reaching record highs. Quick jump! All this time the world economies were compelling OECD countries to reduce their production and now suddenly we want more because we do not want Russian oil. Well, this story is quite simple and clear to every one of us. Going forward, we have inflation, stagflation / recession fear and the outcome of this war at some point. Oil and Gas which dominates GDP of so many countries in the world has supremacy. Whether it is US or Middle East or even an adoption of Russian Oil / Gas, we know oil prices have a very high change to still go higher up. If not it is certainly not levelling down simply because of inflation which drives the price up.

The Side-Lined problem of Climate Change

IPCC’s latest report on climate change says that climate is not a thing that is going to come in the future. It is here and now! While we do focus on prevention, there are many things we must cure now. With the pandemic, climate change was gaining importance because of the ESG requirements and awareness among the investing community. But then came the war which again deprioritized climate change. Must rising Oil and Gas prices not drive a transition to renewable energy? I understand there are many work-upon to make renewable energy as efficient as oil and gas. However, it is now the best time to force a transition to renewable energy if we really want to handicap Russia. But, investors want results and companies need money to show these results. What is wise to do in this case? It is not as simple as this. Investors are responsible to answer their fund-providers. And investing in renewable energy would not be as beneficial as holding oil and gas especially when oil prices are rising. So it comes down to every one of us to show that this is what we want and we must be willing to let go some of the higher returns we would otherwise have received. But we are struggling with inflation. Who would want this? Very few. And that would not be sufficient. And transition in itself is costly. We all understand that dealing with climate change is not an option anymore, it is a compulsion for the survival of our species in the centuries to come. But are we truly ready for this investment in the transition? I believe not. But I know we must be ready really soon despite the difficulties.

Read IPCC Reports here if you are curious.

Cryptocurrency – The Hot and Most Debated Topic of the decade

The recent Terra fiasco has once again triggered challenges with cryptocurrency and blockchain technology. For some, let us simplify what happened here. Terra provided two cryptocurrencies – TerraUSD (called UST) and Luna. These were designed to be Stablecoins providing a stable value (well, not as volatile as traditional coins such as Bitcoin) by pegging it up with another currency (in this case, the US dollar) which is backed by a physical asset. Terra was slightly different than other Stablecoins such that its algorithm altered supply to maintain a stable value. The following table from Bloomberg gives a good distinction between Terra-type coins (Algorithmic Stablecoins) and other type of coins (called Asset-backed Stablecoins):

One key characteristic of Terra was that its UST and Luna were connected. Every investor who invested $1 in UST would always be able to get / redeem $1 at all times while Luna’s price was set by the market. Note, 1 UST was hence, always equal to $1 worth of Luna. Luna would fluctuate. But swapping Luna for UST always meant that you would swap $1 worth of Luna for UST keeping the price of UST constant at $1 (because you paid $1 worth of Luna for UST). Because of this robustness of UST, Anchor (a platform built for lending on Terra’s blockchain) offered interest rates as high as 20% for UST deposits. This was attractive enough to drive and maintain demand for the two Stablecoins. Now, in the start of May, the interest rates for UST deposits fell to 18%, major investors such as Terraform Labs started selling off their UST and overall the stock markets were falling. There were large withdrawals from UST. Because the algorithm was designed to adjust the supply, the system added more number of Luna coins to be able to facilitate the link between UST and Luna mentioned above. So, the number of Luna coins in the market a higher (supply is high) while there are withdrawals and panic selling (less demand). This supply-demand mismatch plummeted Luna’s price (which was based solely on supply-demand dynamics and not regulated like normal stock market) to cents. The price of Luna touched as low as 2 cents! Now, to correct this, the Terra team sold Bitcoin. And because cryptocurrencies are all very volatile and sensitive to such fluctuations of peers, Bitcoin and other currencies also took a hit. Surprisingly, Bitcoin and Ethereum stabilised at some point (e.g.: Bitcoin stabilised around 30,000). This may be because Bitcoin is too big to fail or many large institutions have exposure to Bitcoin and hence, they have maintained its value. But the debate here is that if these cryptocurrencies are all based on consistent demand and adjusting supply, will it work long-term? Will the demand remain consistent long-term? There claims that this is proof that cryptocurrencies are never meant to last long. But others claim that not all coins are the same. Who is right? Nobody knows yet. What can be done? We can wait and watch while the tech and finance guys find a way to make the market robust. For once, we know that regardless of such Terra stories, cryptos are here to stay (since Bitcoin and Ethereum were somewhat stable when they actually had to be volatile). However, this long debate on cryptos and stories like Terra just bring out opportunities to make this space more robust and bring in more innovative solutions.

Price of Luna in the last 3 months
Price of UST in the last 3 months

The Rise and Fall of SPACs

Post covid in 2020 and 2021, SPACs (Special Purpose Acquisition Companies) gained prominence in the global market with millions raised in SPACs and many companies entered public markets through SPACs. However, as I have mentioned in my previous articles (SPACs: A Mystery Unfolding and SPACs: Meaning and Recent Developments) on SPACs, we know that investors are entitled to withdraw from these whenever they want. And that SPACs are obliged to invest in companies that return well to the investors. By the end of 2021 and start of 2022, large withdrawals were witnessed in SPACs. SPAC sponsors tried attracting investors or retaining them by providing additional return opportunities but to no avail. A section of the article from Financial Times succinctly describes what led to these withdrawals. Before taking a look at that, understand that the money SPACs receive from investors are to be invested in good deals but there is always a mismatch. In March 2022, US SEC gave out a rule that SPACs must disclose the possible magnitude of this mismatch. This would be detrimental as it discloses the uncertainty that drives SPACs (classic high risk-high return dynamic). There is another reason that has surfaced. Every $10 an investor invests in a SPAC, the sponsor received $2.5 worth of those shares of the SPAC for this apparent fund-raise and fun-management. If the deals return well, this $2.5 does not really matter. But if the SPACs do not, it is an issue as the investor will not receive all the $10 he or she invested. Third problem, some SPACs can be bad schemes. So, although SPACs had a boom last year and some were and are genuinely good SPACs returning good to their investors, many are failing partially because they are really not good structured SPACs and majorly because they do not have sufficient funds (as their fund-raising power has diminished drastically due to the current dynamics).

Bond Yields, Interest Rates and Inflation

Last few months have been a crucial times for bonds. It started when everyone saw the bond curve reversing (2 year bond yield going above the 10 year bond yield). Then we saw inflation numbers going high but also wages going high with unemployment being at all-time lows. This was followed by the Federal Reserve, Bank of England and other central banks in the world considering rate hikes. The entire dynamic has made the markets sensitive to any news regarding bonds, rates and/or inflation. In a nutshell, post the 2008 financial crisis, central banks around the world engaged in monetary easing. But that was stretched too far with too little tightening. In 2018, briefly a tightening was considered but the huge market reaction subsided the decision (as far as I understand that event). With the Covid pandemic, more easing was put in place. But in 2021, when the economies were doing great and rebounding, tightening did not come in place. Now, we are at a tipping point where tightening is required to control inflation but that will certainly lead to a recession (in a good case, a stagflation which also not that great). But there is no point mourning and cribbing about this now. This has to come and we must prepare for resiliency. If the rates hike do not come, inflation is there to eat our money up. If rate hikes are put in place (e.g.: if the Federal Reserve increases rates truly by 0.5%) then brace for impact which would be stagflation or recession. And I say this is certainly coming because Powell has indicated that the rates will be hiked to control inflation despite any consequences. This is good for bonds as it corrects the yields and increases them. But, not so good for the short-term equity market.

10-2 Treasury Yield Spread (10Y bond yield – 2Y bond yield)

Find an overview of interest rates and inflation by region here.

Stock Market reaction

Through all these events mentioned above, stock markets have reacted, drastically to some, very less to others. Supply chain crisis has affected maybe a few segments of the stock market – companies reliant on robust supply chain. But the reaction was not as drastic as anticipated since there was toppling growth happening regardless. However, when we see the poor earnings reports of companies like Target and Walmart, we realise that supply chain issue combined with inflation (leading to people not spending as much) is affecting the retail segment which once seemed resilient. Not saying this is the end of retail being a resilient space, but the impact is evident. On the other hand, the war in Ukraine which has affected food supply and oil supply, the sanctions on Russia which has disoriented the financial system and flow of money for many countries, the shift of investment of countries in defence (away from other segments that could have contributed to the GDP), and the inflation and recessionary fears are all contributing to the bearish trend in the current global stock market. Yes, there are some days when there is a relieving news in the market which temporarily brings and upside in the market but that could just be seen as a retracement in the bear market. With the upcoming rate hikes, markets are bound to fall further down and we all know that (regardless of how much we want to believe it is not coming). Well, the best option is to look at the bright opportunity that might be coming in. Take a step back and look at the bigger picture (which I am sure many are able to see as the market has matured since the pandemic). We have a bear market -> there is a rate hike underway -> when the rates are hiked, the market will plummet -> major global indices would be at all time lows -> opportunistic investors will start buying (you can start buying too – one might wonder, when though? My best bet would be to proportionately buy as the market falls with every rate hike) -> the market will renounce but will be sensitive to every news surrounding the above-mentioned topics -> recessionary fear is underway and hence, focus will be on resilient industries such as food and essentials providers, energy, utilities, etc. So, invest in these resilient industries. Also, as we all know through historical data that dividend yielding stocks, value stocks and ignored high-potential growth stocks perform well during such times, we can invest in these kinds of stocks in the resilient industries. Now, dividend yielding stocks are super easy to find – just pick stocks that pay high dividends. Value stocks are relatively easy to identify – go to funds that claim to invest in value stocks, look at their portfolio and try to replicate of pick out of those. Ignored high-potential growth stocks are the most difficult to find as retail investors because this information is first, “ignored” by most funds and second, we do not analyse large amounts of stocks every day because we are not fund managers. So this can be tricky but if you can identify one, great, go for it. If not, try to research on YouTube and Bloomberg on what they thing are good stocks, invest a small fraction first, if it returns decent (somewhat around the lines of dividend yielding stocks), go for a larger investment in those. Even if you ignore these altogether, you will still have a decent portfolio with value and dividend yielding stocks in resilient industries of energy, utilities, food and essentials, etc.

S&P 500 Index 1Y chart – observe how by the end of 2021 the price peaks and falls all through 2022 (Source: Bloomberg)
FTSE 100 Index 1Y chart – observe how it was deeply impacted in March with Ukraine war escalating (source: Bloomberg)
MSCI AC Asia Pacific 1Y chart – from March it has been giving similar downward trend (source: Bloomberg)

Parting Thoughts

With all these discussions, it may sound everything is doom and gloom but that is not true. We have resilient industries to look forward to. There are tougher times coming (purely an opinion) and bracing is never a bad idea. Today, we have a bunch of historical data and infinite knowledge on how to deal with what is coming. The dynamic may be quite complex today more than ever before. However, if we join the learnings from different events in the past – the Great Depression, the dot com bubble and the 2008 financial crisis – we see that we have learnt a lot on how to survive tough times. We know it all rebounds at the end. It is all cyclical. So the best thing to do is not panic, cooperate and make informed, cautious decisions. A word of caution, do not ever go all in into any financial instrument – something like Luna can happen, not targeting cryptos though. If you had great exposure to Russia today, you would be in great trouble. So this work of caution is not restricted to tech or cryptos or new forms of investments. Something like Sri Lanka can happen too! Diversification is the safest option now with exposure to resilient industries. There many questions raised here – are cryptos ever going to be robust enough to become a good mode of payment? if yes, how?, is a recession coming or a safe-landing is possible?, what is the right time to sell or buy in this volatile market?, have we learnt anything from past crises? This phase, from the pandemic to the recession / stagflation / safe-landing whatever is to come is going to be one of the biggest crises the world is facing and is going to become a historical event. Survive it through expert advice (not panic) and learn from this for future cyclical events to come.

Disclaimer: This article is in no way a recommendation to buy or sell any instrument whatsoever for anyone. This is just an opinion and an individual, independent analysis aimed at making the audience think about crucial questions today. Always make your investing decisions through an expert and through your personal research.
MSc Finance graduate from the London School of Economics and Political Science (LSE)
Avatar for Ria Vaghela

Ria V Vaghela is an M&A Executive at RSM UK and an MSc Finance graduate from the London School of Economics and Political Science (LSE). She has worked at Jefferies, Dial Partners and 7i Capital prior to RSM UK gaining an experience of about 1.5 years. She has also worked as an Editor and Content Writer for The Representative Media. Apart from finance, she is interested in reading books on psychology and economics and also likes to paint and play lawn tennis

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