Gas price spike shakes bond and equity markets

9 min Read Published: 06 Oct 2021

The 123rd episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about the impact that energy prices are having on stock markets.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 123

Energy prices are what everyone is talking about here in the UK. Whether its consumers bemoaning rising energy bills or investors worried about rising gas prices on capital markets there’s no getting away from it.

The price of natural gas has soared in 2021. For example the price of the front-month futures contract in natural gas (i.e for delivery within the next month) has risen almost 400% since the start of the year. That’s a five-fold increase, and after rising 19% yesterday alone it now sits at an all-time high.

As a UK consumer, you can see the impact of this if you look at the price you were paying for gas last year compared to now, assuming that you haven’t fixed your energy deal. You will probably notice an almost four-fold increase in the price of gas, alongside a smaller increase in the cost of electricity.

According to the Financial Times, the price of gas in the UK and Europe is trading at more than $200 a barrel of oil equivalent which is almost three times the price of crude oil. In the UK we’ve seen a number of energy firms go bust, as a result of the gas price rise and the energy price cap, with only the major energy companies surviving thanks to their ability and strategy to hedge against such price risks. But it means that consumers are not only having to bear the brunt of rising energy prices but ultimately the costs associated with the UK energy regulator ensuring the lights are kept on in the homes of those orphaned customers.

This inflationary pressure on consumers and economies that are reliant on gas for heating and power is being felt. Don’t forget that UK consumers are also facing a petrol crisis at the pumps which I can assure you is still very acute in the South East of England and London, despite supply returning to normal in other parts of the UK.

All of this is symptomatic of the global energy crisis, in gas and oil for example, where a surge in demand as a result of economies reopening after the pandemic and a cold, coupled with a cold winter in the northern hemisphere followed by insufficient supply from green alternatives and political posturing from Russia which has hit gas supplies to Europe the problem is escalating,

Some European governments have already stepped in to try and limit the strain on domestic economies and consumers by providing subsidies to protect households from higher energy costs. Such is the inflationary pressure of rising energy prices that some traders are pricing in that the official UK inflation rate will hit 6% by April next year, which is three times the Bank of England’s official target of 2%. The UK’s official inflation rate currently sits at 3.2%.

All of this doesn’t give investors confidence that the spike in inflation we are experiencing globally is transitory as major central banks (such as the US Federal Reserve, the European Central Bank and the Bank of England) keep trying to convince us.

Last week I mentioned that bond markets seemed to have made up their minds about the future course of inflation and monetary policy and began pricing in higher inflation, higher interest rates and reduced QE measures. After the 10 year UK gilts yield hit 1% (the highest level since March 2020) and the 10 year US treasury yield hit 1.55% (which was a month high) we had a brief respite.

At the time I said that while equity markets had stabilised and even rallied since the Fed meeting as investors ditch bonds in favour of equities, the question was how long can such a trend continue. History shows that at some point the rise in yields (and tumbling bond prices) will start to matter to investors even to reflation trades. Tech stocks were bearing the brunt.
This week equity markets have been on the back foot and bond yields have now surged higher once more (with the 10 year UK gilt yield hitting 1.12% while the US 10 year treasury yield is back at 1.55%) because of rocketing gas prices.

Earlier in 2021 bond yield rallied alongside equity markets, but that is no longer the case. That’s because back then inflation concerns were met with optimism over economic growth. Now investors fear that the economic rebound from the pandemic may have run its course or worse still rising energy prices will cause domestic economies around the world to stall. That is effectively stagflation and equity markets have tumbled in recent days.

The FTSE 100 is back below 7000 despite a weak pound and a 7 year high oil price. That means it’s almost 3% of its September high while the more domestically focussed FTSE 250 is down nearly 8%. Since early September’s highs S&P 500 is down almost 5% while the Nasdaq is down 6% as is the German DAX. The MSCI All Country Asia ex Japan index is down 8%. There are some bright spots however, Indian equities as a broad index are up more than 1% since the start of September, buoyed by energy stocks. In recent days Russia’s stock market has also been a beneficiary of the spike in energy prices.

That isn’t a disaster by any measure as equity markets were stretched following the epic rebound from the March 2020 low, assuming things don’t escalate. The problem has become one of diversification, especially with bond yields continuing to rise. It means that bonds and equities are falling in tandem. UK gilts have come back to earth with a bump after a very strong summer, with the average UK gilt fund having fallen 5% since the start of September. Global bonds funds have fared better (being broadly flat) having benefited from the currency boost provided by the weaker pound versus the dollar. Don’t forget most global bonds have significant US bond and treasury exposure. It means that UK investors that have exposure to certain Targeted absolute return funds, cash, key commodities and even bitcoin have fared the best in recent weeks. It’s times like these when the simple long bond/equity portfolio gets hurt.

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