When people talk about market risk, they often reference Nassim Taleb’s book “The Black Swan.” A “black swan” event is one that is extremely rare, hard to measure but exerts a materially negative impact on capital markets. By contrast, Michele Wucker coined the term “Gray Rhino” to describe obvious risks that are being ignored. I think several gray rhinos present unappreciated downside risks for investors as they start looking into 2022. Chief among them are energy prices. In Europe, a prewinter shortage of natural gas has resulted in a sharp spike in energy prices. The UK is so concerned that Prime Minister Boris Johnson has enlisted the aid of the army to help ease the fuel shortage. In China, they are so worried about winter energy supplies that the government has ordered energy companies to increase reserves, at any cost. All this is naturally pressuring energy prices across the globe. Crude oil prices have surged in recent weeks. European natural gas import prices are trading at an equivalent of $190 a barrel – something the oil market has never seen. Even coal, despite shrinking demand over the last several years, saw prices surge to a record.
As economies slowly recover from the pandemic, we find ourselves in an environment characterized by rapidly rising demand and sometimes limited supply. For example, a lack of semiconductor chips has limited the ability of car companies to manufacture enough motor vehicles to meet demand. Despite the supply-demand mismatch, investors have greeted rising aggregate demand as a reason for confidence in future economic growth. Unfortunately, elevated energy costs have a way of destroying demand as it effectively acts as a “tax” on consumption. In the past, this has weighed on stock returns. For example, in 1990 crude oil prices spiked from $16/barrel to $41/barrel (inverted line below) resulting in a multi-month decline in stock prices.
Evidence from global equity markets indicates that momentum is waning even as commodity prices march higher. The proverbial gray rhino of spiking energy costs suggests that 2022 earnings will likely be lower than analysts currently forecast. Despite this, there are few credible alternatives for investors as elevated inflation punishes bondholders by eating away at the spending power of their capital (table below). Even though stock investors may be facing a challenging environment, the asset class is still the “prettiest girl at the dance.”
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