Winter Is Coming

In this week's MIM edition, we dive into Europe's energy nightmare, coming earnings recession, drying up NFT liquidity & more...

Morning MIMs,

Not to be serial party poopers, but we’re starting yet another weekly on a rather grim note. In our spotlight this week, real household income across the world that has taken the sharpest nosedive on record:

And this lost purchasing power doesn’t even account for the inflationary perfect storm that’s coming up in the next few months…

🏛️ Macro

Winter Is Coming

The European energy fiasco is reaching a climax.

As long feared, last Friday, the Kremlin-controlled gas giant Gazprom announced that it is shutting down Nord Stream indefinitely. Later, Putin threatened the tap would be closed for as long as the West holds its sanctions.

On that news, energy prices once again blasted through the roof. European gas (Dutch TTF) went up 35%, back to a near all-time high—which, for perspective, is 6x higher than two years ago.

Households are feeling the pinch.

Even before the latest hike, energy bills in Europe have grown twofold compared to a year ago. And the Brits—who are paying the highest toll—are seeing their energy bills triple from last year.

Meanwhile, Europe’s leaders are scrambling to implement emergency measures, one of which is a massive $375 fiscal package to cap energy prices. The UK alone is planning to spend a whopping $150 billion over the next 18 months.

For perspective, that amounts to a $1 trillion package relative to the US economy size.

So what’s all the fuss about that Russian pipe?

🔍 Zooming out

Europe is dead reliant on Russia because it generates over two-thirds of its energy from natural gas—40% of which comes from, you’ve guessed it, Nord Stream. For some countries, including the Czech Republic, Hungary, it is the one and only source of gas:

The Kremlin now plays on Europe’s energy impotence to blackmail the West into lifting sanctions.

In June, Nord Stream cut its gas flows to 40% of its capacity. Then, during a regular mid-summer maintenance, the flow came to a full stop for ten days. Finally, on July 21, it was restarted, but at only 40% of pre-maintenance levels. And last Friday, Gazprom shut the gas flows “indefinitely.”

Why can’t Europe source gas from elsewhere?

It can, but it’s impossible to do so on short notice because the alternative is to ship a liquefied form of gas through LNG terminals, which requires an entirely different infrastructure.

Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics, wrote: “You’ve still got to get all the pipeline infrastructure laid. So it’s certainly not going to happen this year; it’s too late for this to be a relevant source of supply for Germany this winter, even if it will be a major role during the next one.”  

Besides, there isn’t enough LNG supply on the market to replace all the Russian gas that Europe just lost. And ramping it up will, again, take time.

🔮 Looking ahead

Nord Stream’s shutdown wasn’t that much of a surprise for European leaders who have actually been bracing for this worst-case scenario for months.

Since the beginning of the summer, Europe has been implementing voluntary rationing programs and pumping up as much gas as possible into its reserves ahead of the cold season.

But unfortunately, that’s not enough.

For example, Germany’s national gas reserves are currently at 85%. But Klaus Mueller, president of Germany’s energy regulator, warned that even 95% storage would last for only two months of average demand.

So, there’s a good chance that Europe will have to switch from voluntary to obligatory rationing. In fact, by Goldman Sachs calculations, in the worst-case scenario, “Germany [wouldn’t] have many options and we estimate it could mean a 65% industry curtailment in Germany if flows stopped coming entirely.”

In other words, this energy fiasco could bring part of the industry in Europe to its knees. And the worst part, even the $375 billion fiscal package Europe has mustered may not save it because, well, you can’t buy gas that isn't there, right?

📉 Stocks

Earnings Recession Incoming

Morgan Stanley bears are back at it.

In a recent note, its CIO Mike Wilson predicted yet another rout in the stock market. His thesis hinges on over-optimistic earnings expectations that, he thinks, will shatter in the next few quarters.

“We think the next several quarters will end up containing some of the most significant downward revisions to forward EPS forecasts we have seen in the past several cycles,” Wilson wrote in a note on Tuesday.

In fact, Morgan Stanley’s leading earnings indicator shows a massive drop in earnings growth for the end of the year:

Wilson isn’t the only analyst skeptical of rose-colored earnings projections.

According to Citigroup’s US Earnings Revision Index, which tracks the upgrades vs downgrades of earnings estimates, revisions to the downside have outnumbered upgrades for 13 weeks now:

🔍 Zooming out

Last month, we broke down multiple compression—which is a reduction in the price investors are willing to pay for a dollar in a company’s earnings—and how it triggered the bear market in the first half.

For a quick recap:

“By JPMorgan’s calculations, the first half of 2020 saw the most savage compression in the past 30 years—beating the dot-com crash and the aftermath of the 2008 housing collapse. (Case in point, as the S&P 500 cratered in Q1 2020, its earnings grew 4.4% compared to a year ago.).”

Now, for the second half, stocks are likely in for another blow—this time from the reduction in the earnings themselves.

🔮 Looking ahead

Take note. 

Wilson was among the earliest bears to predict the crash at the beginning of this year. And even when stocks rebounded this summer, he firmly held ground as one of the few party poopers warning the bear market wasn’t over.

If his track record during this cycle is any indication, the next earning season is going to be quite a spectacle.

🚀 Digital Assets

Here's a run-through of important things that happened in crypto over the past week:

• The bleed-out in digital assets rages on. Over the past week, the bitcoin price shed 7.7% of its value, hitting a low of just over $18,750. Altcoins are bleeding too. Solana dipped just over 4%. And XRP, BNB, dogecoin, and shiba inu are down 2.4%, 8.2%, 5.9%, and 2.6% respectively. Meanwhile, ethereum jumped 6.2% on the news...

• Ethereum’s long-awaited merge has begun with “the Bellatrix hard fork” and is expected to finalize in the middle of September. The merge will turn a new page for Ethereum as it transitions from energy-intensive proof-of-work (PoW) to proof-of-stake (PoS) consensus mechanism.

• Remember those scenes from old westerns with tumbleweeds bouncing across the road? That’s OpenSea today. According to a report from DappRadar, NFT trading volume on the world's largest NFT marketplace dropped a staggering 90% from May.

💬 Remember, it’s just a blip…

With all that said, it’s time to put things in perspective and remember that this is just one little bump on a long, long road. After all, all of us here are in for the long haul, aren’t we?

As Charlie Munger famously said, “If you’re going to be in this game for the long pull, which is the way to do it, you better be able to handle a 50% decline without fussing too much about it.”