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Portfolio > Investment VIPs

5 Themes Spawning Winners, Losers in the New Global Economy

By Gary Shilling

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My column yesterday outlined six categories of winners and losers spawned by the current disruptive global economic environment as it transfers incomes and assets. Here are five more that result from the repricing of goods and assets.

1. Slowing global growth and disruptions from Russia’s invasion of Ukraine, along with additional drags on the U.S. economy.

Importers and U.S. retailers built inventories late last year in anticipation of exuberant retail sales. In the third quarter, 2.2 percentage points of the 2.3% real GDP growth was from inventory-building and 5.4 percentage points of the fourth quarter’s 6.9% annual rate rise. But real retail sales have been falling and consumers are pushing back against rising prices by shifting to lower-cost house brands and cutting back on nonessentials. Liquidating excess inventories this year could well have mirror-image effects on the economy, resulting in several quarters of negative real GDP growth.

The greatest economic declines will be in Russia and Ukraine, according to the Organization for Economic Cooperation and Development, with Russian domestic demand falling 15% in 2022 from last year and demand in Ukraine down 40%. Russia and Ukraine account for 30% of global wheat exports and 15% of corn exports. Wheat prices have almost doubled since the start of the war, fertilizer prices are up by more than 75% and corn prices by over 40%. But Ukrainian agriculture exports are expected to drop by at least 20% this year due to Western sanctions against Russia and shippers’ worldwide unwillingness to move cargo.

Slower global economic growth and the Russian invasion of Ukraine has spawned many losers. These include Russian and Ukrainian food producers who can’t sell their food nor all their energy, and consumers who can’t buy these commodities, especially developing economies where food and energy account for big shares of household spending. Commodity producers in the West are big winners. Resource-rich Canada also stands to gain from increased exports of crude oil, uranium, nickel and wheat. North American fertilizer producers are winners and have advantages over European rivals due to access to cheap natural gas.

Food prices in the U.S. are also leaping. In response, consumers are shifting from national brands to lower-priced private labels that have wider profit margins for major grocers. American farmers will no doubt plant fence-row to fence-row this year to take advantage of soaring crop prices. And as their incomes jump, so will their spending on fertilizers and farm equipment.

The war in Ukraine has amplified the jump in energy prices that was already under way as a result of Covid-19 disruptions of supply chains and the reluctance of OPEC and Russia to step up petroleum output. U.S. oil and natural gas production has risen in recent years, so with Russia supplying about 40% of Europe’s gas, replacement demand from the U.S. and other sources is jumping.

The elections in November may force President Joe Biden to encourage domestic oil and gas producers to increase their production, as surging gasoline prices threaten the economy and infuriate motorists. While major oil companies are emphasizing their green credentials, 62% of the 734 active U.S. oil and gas drilling rigs are operated by private companies, compared with 49% of the rigs at the start of 2019, according to The Wall Street Journal.

Oil refiners may also do well with margins, the difference between the costs of crude oil and the selling prices of refined products. Railroads win over truckers since they moved freight 492 miles on one gallon of fuel versus 134 miles for large trucks in 2018, according to The Wall Street Journal. With the jump in fossil fuel prices has come renewed interest in uranium production and nuclear reactors.

2. The persistence of COVID-19 is good news for vaccine producers, especially since older vaccines will need to be replaced by newer formulations before their patent protection expires.

Also benefiting are all the medical services involved in delivering the jabs. At the same time, earlier-than-normal deaths cuts spending on day trips to casinos.

With the lockdowns caused by COVID-19 and working from home, office buildings in big cities remain less than 50% occupied and landlords continue to feel intense pain. Midtown Manhattan is especially hard hit, with offices housing barely one-third of their pre-pandemic workforces, according to Kastle Systems. Spending by office workers has nosedived. So has work for employees who service office buildings.

3. Many homebuilders were wiped out by the 2008 subprime-mortgage collapse and the survivors turned cautious.

The supply of single-family abodes had failed to keep up with exuberant demand and prices leaped. But homebuilders have regained their confidence. Government data show more housing under construction than any time since the early 1970s.

Meanwhile, existing home sales fell 7.2% in February from January and 2.4% from a year earlier. Rising mortgage rates and higher prices are taking their toll. In February, the share of first-time homebuyers fell to 29% from 31% a year earlier.

The recent single-family housing bubble is not as extreme as the subprime mortgage bonanza of the mid-2000s, but its bursting will generate many losers including overleveraged homeowners, residential real estate brokers, mortgage bankers, home furnishing stores and movers. Renters will probably be better off than homeowners, and landlords of rental apartments and single-family houses will also be winners.

With average house price declines of 10% to 15% likely, state and local governments that depend heavily on real estate taxes will be strained, the reversal of now when robust revenues are inducing some to cut taxes. Prospective first-time homebuyers and renters will have the advantages.

4. The Federal Reserve’s aggressive credit-tightening campaign will likely precipitate a recession, with equities suffering 30% to 40% declines from their early 2022 peak.

In view of all the zeal for cryptocurrencies and other speculations, declines in prices of financial assets may be widespread. The recent high volatility in major stock indexes is an ominous sign, as is the inverted yield curve. Growth stocks’ current share prices, many believe, are the discounting value of future earnings, so with rising interest rates, their present values fall.

The major bear market, which appears to be underway, will result in many losers, especially holders of speculative equities and those with high financial leverage. Institutions that manage equity portfolios will also suffer as their management fees fall and investors flee to cash. Short sellers will prosper. Defensive stocks such as consumer staples and utilities will probably hold up better than average, but still are likely to decline in price.

5. U.S. government securities have suffered substantial price declines this year as interest rates have risen in anticipation of tighter monetary policy.

Still, the rate increases since December may have discounted the Fed’s entire credit-tightening binge. The jump in the 10-year Treasury note yield from 1.34% in December to a recent 2.8% implies a rise in the target federal funds rate to 4% from the current 0.25% to 0.5% range. Getting to that level would require about seven 50-basis-point hikes in the Fed’s policy rate, and credit-tightening of that magnitude would no doubt precipitate a major recession.

Once the Fed realizes that it has caused a recession, it will reverse gears and ease credit, probably even before the peak in business activity as it did in the last four cycles. Treasury notes and bonds would then rally as credit demand and inflation rates drop, and investors once again flock to the haven of government obligations.

Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, a Registered Investment Advisor and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” Some portfolios he manages invest in currencies and commodities.

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