What should we make of the market trends this week? When the leading indices in the U.S. drop by 2-3% (and roughly double that from their mid-week highs), and Israel sees a 5% decline, the ground starts to shake beneath investors’ feet. In this week’s letter, we’ll try to understand why this is happening, what the market is trying to decipher about the future of the economy, and where this whole story is headed.
While the major indices saw relatively moderate drops, many of us “felt” a much larger hit (for instance, holders of Google and Microsoft who lost about 8%). And don’t even get me started on sectors like Quantum computing stocks, which looked like they jumped off a roof months ago and have only accelerated their fall since.
Simultaneously, Gold stabilized and began to rise again. This reinforces the feeling that previous drops were merely profit-taking by the big winners of the last two years—a move triggered by a combination of factors over the last week or two (if you want to understand why, check out EcoMan’s previous letter).
The general mood is somber. Whether you are an Israeli citizen running to a shelter several times a day, an American citizen at a gas station, or certainly an Iranian citizen, you are suffering. You suffer and look up to your leaders, hoping they will show mercy and end this.
The market, acting as a barometer of mood (in the short term) and economic truth (in the long term), reflects this situation. On one hand, it drops in the short term, following the traders’ sentiment. On the other, it attempts a “price adjustment” - determining what will be worth more in the future and what will be worth less. For example, growth companies that constantly need external cash through loans and capital raises will struggle to secure them in a harsh economic environment. This decreases their chances of success, making them worth less today.
Who else is worth less? Generally, the technology sector is more sensitive to high interest rates. And high interest rates happen when there is inflation. As we discussed last week, inflation absolutely loves high energy prices (oil and gas). Every day that oil prices stay above the previous average, inflation regains momentum, and at the end of that chain, Microsoft, Nvidia, and Google take a hard hit.
What’s happening in our pockets? Not much yet, besides gas for cars or motorcycles. But moving forward, we will feel it in other products that require energy to produce or transport (which is, let’s be honest, most things) and those that “catch” inflation from the first category.
The Concept of “Sticky Inflation”
I’ve noticed many people using this term lately without truly understanding or being able to explain it. Simply put, Sticky Inflation is inflation that migrates from product to product, from service to service, until it becomes a broad phenomenon where everything we pay for becomes more expensive.
How does this mechanism work? Let’s look at an example that seems completely unrelated to energy prices: a private Yoga teacher. She teaches in her home studio and doesn’t spend a dime on gas for work. However, her electricity bill went up (a bit), her mortgage interest increased (a bit), and the candles she buys for the atmosphere are pricier because they are imported. Suddenly, she realizes she’s earning 2% less.
To avoid a pay cut—not out of greed, but out of necessity—she raises her lesson price by a few dollars. Just 2%, to get back to where she was.
Now, a successful lawyer who attends yoga twice a week notices the price hike. Her gas is also pricier, as is her Spotify subscription and the organic eggs at the supermarket. Suddenly, she is also earning 2% less at the end of the month. What can she do? She raises her legal fees.
And just like that, inflation “infects” two services that seemingly have nothing to do with the blockage of the Strait of Hormuz or LNG production issues in the Gulf. This kind of inflation is easy to catch but very hard to “cure.” Policymakers don’t aim for a “remedy” (lowering prices back down), but rather stop the contagion so that prices stop pushing each other up and stabilize at a new level.
Where do we go from here? Two Scenarios
Scenario 1: The Gulf War ends immediately. The reason doesn’t matter (ceasefire, victory, or negotiations); the result does. Opening the straits, lowering gas prices, and stopping emergency war spending would signal to the markets that this was a one-time event. We would return to the trend of the last few years: rising stocks, stable bonds, and gold as a hedge against government debt.
Scenario 2: The “Perfect Storm.” In this scenario, the U.S. and Israel continue to struggle without a clear resolution. This leads to the two things markets hate most: Uncertainty and Long-term profitability hits.
In this case, stock prices will continue to fall. These declines could be worsened by “Deleveraging”—investors who took loans to buy stocks being forced to sell them immediately because their value no longer provides enough collateral for the broker. Additionally, bond prices would likely drop as governments increase debt for military spending while seeing lower tax revenues.
In a “Perfect Storm,” there is no safe harbor—both stocks and bonds drop. The entire portfolio goes down.
Will Gold save us? Maybe. As the value of money drops (purchasing power decreases), Gold—the alternative to fiat currency—should rise. Gold is the ultimate yardstick; you measure the value of the Dollar or Euro against it to see the true worth of money.
The Bottom Line
It could get very good, very fast. Or it could get worse. But I find it hard to believe the situation will remain stagnant. This isn’t an equilibrium; it’s a tipping point.
Personally, I believe the economic data relevant as of late February, and the incredible capabilities of tech and research companies support long-term growth. If the leaders involved don’t ruin everything, the path to growth remains open.
We shall see.
See you in next week’s letter, or during the week—if I can’t restrain myself until then...