Defense stocks have soared since the outset of the Ukraine-Russian conflict. That is a typical reaction to geopolitical strife. Frequently, investors bid up the sector only to sell these stocks once peace returns. This time may be different.

 

Vladimir Putin has put the world, and specifically Europe, on notice that he is bound and determined to resurrect the formal might of the USSR, no matter how long it takes. His actions have caused a sea of change in Europe's decades-long freeze on defense spending. Germany is a prime example of what analysts believe will be the beginning of a new era of inflated European defense budgets.

 

In February 2022, Chancellor Olaf Scholz argued before the German Parliament that the invasion "was a turning point in the continent's history." In order to prepare his country for this new reality, he immediately doubled Germany's defense budget from 47 billion euros to 100 billion. Several European Union (EU) members are planning the same thing. Finland, Sweden, the Netherlands and the UK have been first to declare their intent to beef up defense spending and more countries are expected to follow. The intent is to raise defense spending by NATO members to more than 2 percent of GDP.

 

And while the Ukraine War is serious enough to goose spending for planes, tanks, drone, rockets and such, the shooting war simply adds to a long list of mounting hostilities in an increasingly dangerous world. The threat of China and its ambitions to annex Taiwan, North Korean missiles, incessant warfare in the Middle East, rebel movements in Africa, and regular instances of cyberwarfare have kept defense spending high throughout the last several years, at least in the U.S.

 

The U.S. defense budget has been stable and rising given the quantity of perceived threats. As a result, the defense and aerospace sector have been quietly outperforming the market's returns for the past eight years or more. Thanks to the pandemic, and resulting supply chain issues last year, the industry experienced reduced production, but with the down swing in coronavirus cases (at least in the U.S.) production is getting back to normal. Most Wall Street analysts are expecting government defense expenditures to rise from about 2.8 percent to a range of 3.5-4 percent in the next few years.

 

From an investment point of view, the defense stocks move in cycles; roughly gaining for 7-8 years, underperforming for 2-3 years, and then growing again for another eight years or so. From 2020 to 2022, the industry underperformed, thus setting investors up for what could be a spate of outsized gains.

 

If we look back during the last 20 years of U.S. involvement in the Middle East, defense stocks such as L3Harris Technologies, Northrop, Lockheed Martin and Raytheon gained respectively 1,399 percent, 866 percent, 800 percent and 509 percent compared to the S&P 500 Index advance of 297 percent from 2001 to August 2021. I am not cherry-picking results either; most defense stocks have had similar returns.

 

Obviously, government spending is the largest customer of defense companies. At least 19 members of Congress (or their families) are personally invested in defense contractors, and some of them sit on congressional committees that regulate defense policies. I will avoid the obvious conflict of interest issues that this might raise and just remind readers that politicians on both sides of the aisle have good track records in investing in stocks that they can influence.

 

All indications are that the war in Ukraine is moving to another phase. Military experts expect the war will continue and may evolve into a protracted war of attrition. The China threat is not going away, and now that most western nations are rethinking their defense spending, it appears that we may be starting on a new multi-year cycle for defense stocks.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The red-hot housing markets is cooling off. A combination of higher interest rates and supply chain shortages are squeezing homebuyers. If these trends continue, the spring selling season may find buyers between a rock and a hard place.

 

The total value of the private residential real estate in the U.S. increased by a record $6.9 trillion to $43.4 trillion in 2021. Since the lows of the post-recession market, the value of housing has more than doubled. By this time in 2023, Zillow expects the typical U.S. home will be worth more than $400,000.

 

This year, demand for housing will remain tight and continuing to outstrip supply. But there are headwinds for homebuyers as well. One of the larger casualties of the Fed's intention to raise interest rates is the mortgage market.

 

Home mortgage interest rates have spiked over the last few months. At the beginning of 2022, the rate for qualified buyers was around 3 percent for 30-year fixed rate mortgages. Today, that same mortgage would cost 4.95 percent, according to Mortgage News Daily. During the past three weeks alone, according to Freddie Mac, we have seen the largest rise in mortgage interest rates since 1987.

 

In practical terms, a family that could manage $2,000 a month in mortgage payments could have afforded the purchase of $424,000 at the beginning of the month. This week, thanks to the rise in interest rates, the home they can afford dropped to $375,000. You might ask how rates could have backed up so much when the central bank has only raised interest rates by 25 basis points in March.

 

The answer is that the Fed focuses on the short end of the interest rate curve. Mortgage interest rates, however, are determined by the long end of the curve. A 20- or 30-year mortgage rate is based on what investors believe the Fed, the economy and inflation will be in the future. Given that inflation is expected to continue higher in the months ahead, and that the economy is expected to slow, lenders see more risk ahead for home buyers. Add in the Fed's stated intention to continue to raise interest rates several times this year (and maybe next year), there is no wonder that long-term interest rates for home mortgages are spiking higher.

 

For the last several years, demand for homes have outpaced supply. As such, home builders are having a hard time providing enough homes to the market. The present supply side problems besetting the construction industry, which were caused by the coronavirus pandemic, have just added insult to injury.

 

A huge shortage of materials is plaguing companies' ability to complete new homes. Lumber shortages have been well-publicized, but everything from siding, glass windows, large appliances and even garage doors have stretched delivery times from week to months. Those product shortages are acute and seem to be getting worse.

 

As mortgage rates continue to climb, it becomes harder for existing homeowners with low mortgage rates under 3 percent to sell and take on higher mortgage rates in order to buy a new home, which continues to cost more and more. This hesitancy further reduces the existing supply of housing stock available.

 

Home prices in the U.S. increased by 18.8 percent in 2021. That is considered an unsustainable level, but given the reduced level of inventory, most experts expect prices on homes to grow 16.4 percent or more in 2022. For homebuyers looking to purchase homes, the call seems to be do it sooner than later rather than later.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Oil prices are up 70 percent since last year. Prices at the pump were well over $4.25 a gallon recently. Everyone from President Biden on down is scrambling to find a way to reduce energy prices. Why, therefore, aren't we looking at our own domestic oil producers?

 

Unlike Saudi Arabia or the United Arab Emirates, which can increase the global oil supply with a flick of a switch, the shale energy community would need to increase spending in areas such as exploration, drilling and production. That is something they are not willing to do for a variety of reasons.

 

For years, shale drillers have been plagued by regulatory and environmental obstacles. Despite the court cases and lawsuits, shale companies forged ahead. Their stock prices soared as they spent more and more on speculative drilling and expansion. That era ended badly when oil prices collapsed in the early days of the coronavirus pandemic. A wave of bankruptcies swept through the shale industry and left the survivors chastened and extremely cautious.

 

The cowboy of yesterday has become the pinstriped borrower that Wall Street prefers. Rather than wild catting, company managements are buying back stock and instituting dividends.

 

That is not to say that oil production is at a standstill. The U.S. Energy Information Administration expects 2022 production will average 12 million barrels per day and 13 million barrels per day by 2023, which would be a record production year for U.S. producers.

 

The problem is that the same problems that are besetting the rest of the economy are plaguing energy producers as well. Supply chain constraints as well as the scarcity of labor are slowing even those companies willing to produce more. One simple example is the cost and scarcity of sand.

 

A cocktail of chemicals, water and sand are used in the fracturing of shale formations. The price of fracking sand has risen 185 percent during 2021 and now costs $45 per ton — if you can find it. If you throw in other key inputs like diesel fuel and steel, which are also rising in price the costs of drilling have exploded higher. At the same time, labor shortages not only at the well head but also in every link in the labor chain, from truck drivers to drillers, slow down production immensely.

 

Even if there was some policy change or other event that could galvanize another shale oil drilling boom, it would require six to nine months before that oil could reach the market. As such, the U.S. is joining the mad scramble for additional oil supplies. The U.S. is at a disadvantage thanks to President Biden's cool relationship with the heir-apparent to the Saudi Kingdom, Prince Mohammed bin Salman. Biden pledged to make Saudi Arabia a "pariah" due to the killing of Washington Post journalist Jamal Khashoggi in 2018.

 

At the same time, Saudi Arabia has changed their approach towards the U.S., especially under Biden. Russia's membership and importance in the OPEC-plus cartel has resulted in a neutral Saudi stance toward Russia's aggression in Ukraine. Qatar has agreed to work with Germany in increasing their supplies of liquefied natural gas. Japan is also negotiating with the UAE to increase oil supplies as has the U.K., but so far, they have received little satisfaction.

 

About the best the world can hope for is a cease-fire and a reduction in hostilities between Russia and Ukraine to at least dampen the rise in oil prices. I will stick my neck out and predict that we should see such an agreement by the end of the month.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

 

Over the last year, the People's Republic of China has instituted several far-reaching policies that have roiled its economy and stock market. As a result, the Chinese stock market has lost some $2.1 trillion from its high. Are things about to change?

 

In a brief statement on March 15, 2022, China's top financial policy body seems to have relented somewhat, if not completely made a U-turn on policy The governing policy committee promised to ensure stability in capital markets, support overseas stock listings, resolve risks around property developers and complete the crackdown on technology companies. Both the central bank and the banking oversight committee would help implement these policy changes.

 

Some might say that China has been its own worst enemy. An increasing (but late) chorus of Wall Street pundits have deemed the Chinese stock market as "uninvestable." Some might ask where have they been over the last 10 months or so?

 

On July 8, 2021, I warned investors in my column "China's Red Hand of Regulation" https://tinyl.io/5uAP that "there are all the signs that these new regulatory risks are here to stay. In which case, we can expect more of them and as a result, a re-rating of Chinese securities (downward) would certainly be in order."

 

I believed that the efforts of the Chinese Communist Party faithful, led by President Xi Jinping, to clamp down and extend control of its largest companies in the name of "common prosperity" would not only be successful, but also devastating for both local and international investors. The result: a $2.1 trillion hit to China's financial markets. But is it now time to look forward?

 

Until this week, the red hand of this communist government had become even more intrusive and had moved into areas that were thought to be governed by the private capital markets in the name of national security.

 

There were also real concerns that another $1.1 trillion worth of U.S. listed Chinese stocks could be in jeopardy. The fear was that some large mega stocks like Yum China could be de-listed under the Holding Foreign Companies Accountable Act for failing to submit detailed audit documents that support their financial statements.

 

An ongoing auditing dispute between Chinese regulators and the U.S. Securities and Exchange Commission is still not resolved. This issue is also complicated by several other events which need to be resolved between both nations.

 

For example, in February 2022, China and Russia declared a new era in the global order, endorsing their respective territorial ambitions in Ukraine and Taiwan among other things. Since then, Russia invaded Ukraine, leading many to believe China was fully aware of Putin's plans. China refused to condemn the move, nor agree to the economic sanctions levied against Russia by most of the West.

 

Relations between the U.S. and China have deteriorated further since then as China now appears to be helping Russia circumvent the sanctions. This issue goes away with a cease fire between Ukraine and China.

 

And while all of this is going on in the international front, China's economy has taken a massive hit last year due to its over-leveraged real estate market. But the latest economic figures for January through February 2022 were well above expectations, with industrial output rising 7.5 percent versus last year, fixed investment grew by 12.2 percent and retail sales up by 6.7 percent. These were double the estimates of most economists. Growth this year is estimated to fall to 5.5 percent, which is still a healthy rate, but down from last year's 6 percent. 

 

Unfortunately, over the last week, the Chinese have suddenly been forced to begin shutting down some areas of their economy thanks to a resurgence in the Omicron variant of the coronavirus. This may call into question whether the country can sustain its expected growth rate.

 

China's zero-COVID strategy, which was introduced early in the pandemic involves large-scale lockdowns, mass testing, and international travel bans. Tens of millions of people country-wide are facing restrictions. Shenzhen Province, home to 12.5 million people, has been locked down. It is the nation's technology hub and a critical supplier to major auto companies and many semiconductor suppliers.   

 

Jilin Province has also been shut down, with residents banned from moving around. This is the first time China has locked down entire provinces since the Wuhan and Hebei lockdown at the beginning of the pandemic. More lockdowns are expected in the next few days. However, if the global experience with Omicron is any guide, the surge in cases may be short-lived.

 

In my opinion, if you are willing to take a higher-than-normal level of risk, it is time to once again dip your toes into the Chinese stock market.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Commodity prices are flying. Nickel doubled in price in two days. Wheat is up 50 percent and has experienced trading halts for five straight days. Gold has breached $2,000 an ounce and we all know what has happened to the price of oil. How long can it last?

 

As longtime readers know, I formally recommended commodities as out-performers back in January 2021. At that time, I was bullish on oil, copper, and soft commodities like food and lumber. I also liked crypto currencies. As for precious metals like gold and silver, not so much.

 

Back then, most market participants had dumped gold and were piling into Bitcoin and the like. These digital currencies were touted as the "new gold" and precious metals were relegated to the sidelines.

 

It wasn’t until five months later (May 2021) that I began to warm up to precious metals as cryptos hit all-time highs. As I said back then, "I believe we may be on the cusp of a new move higher in this precious metal (and silver along with it)." But it wasn’t as if gold had gone nowhere in the meantime.

 

Gold made what I believe was a cycle low back in November 2020 at $1,767.20 an ounce and hit $1,882.70 by the time I recommended it. That amounted to a 6.5 percent gain from the cycle low. The gold price hit $2,082 this week before profit taking took it back down below $2,000 per ounce. Most of the other commodities on my list have done equally as well, or even better. Granted, the gains are good, but what do we do now?

 

Unlike many investments, the time to buy commodities is when prices continue to climb higher as they have been doing for the past year or so. Traditionally, as prices increase, experienced traders know to chase prices higher. A virtuous and somewhat vicious cycle of higher and higher prices erupts. That behavior has hit home to many investors during the past few weeks. Commodities are in a parabolic move higher.

 

Common sense would tell you that this phase of price gains, were it to continue, would cause severe dislocations in the economy. These stratospheric prices would boost the cost of manufacturing inputs to the point where production would begin to falter. Inflation would leap, and prices skyrocket for goods to the point that most global economies would fall into a recession, or a period of stagflation. As such, I believe it is time to take some profits.

 

The problem with calling a top in commodities in this environment is that their rise (and ultimate fall) depends on several geopolitical events that cannot be predicted. Take it from an old-time, commodity investor, the way to handle this rise is to begin selling into these price gains. I made my bones in the commodity market by buying and selling gold and silver, while working as a bunker oil salesman in New York Harbor. I made enough to pay my way through graduate school back in 1979 and I never looked back.

 

Since then, over the decades, I have seen several huge moves in commodity cycles. The most successful traders I know begin to sell (slowly) when there are a series of limit-up moves and/or trading halts. That is the environment we are in today.

 

 Another sell sign is when analysts and experts begin to increase their price targets for various commodities. Recently, I am beginning to see forecasts that gold prices could get above $3,000 per ounce, and oil prices as high as $200 per barrel. That should tell you to start profit-taking. My own view is that after the end of the present geopolitical turmoil, we could see gold down several hundred dollars by mid-year.