Beware value traps when hunting for stock market bargains

European stock markets recouped all the ground lost since the February 24 Russian invasion of Ukraine, but investor optimism may be misplaced.

Despite speculation that peace talks could be edging towards some sort of common position, market observers should remember that Vladimir Putin has not excelled at pragmatism since the 2014 forced annexation of Crimea – and probably even before that.

If this war has a purpose for Putin, he has yet to reveal it. His main demands – that the Crimean annexation be recognised by the West, and that Ukraine pledges to never join NATO – could have been negotiated diplomatically.

Instead, he decided to launch a brutal attack that has cost many lives, displaced millions of people and brought the world to the brink of nuclear catastrophe. An end to the invasion through dialogue is probably not as near as many in the markets would like to believe.

Another reason why investors could be buying up stocks is because they think (or hope, rather) that the worst has been priced in.

The market mood until not long ago was not too cheerful, to put it mildly. The latest Bank of America survey of investors showed cash at the highest level since the beginning of the Covid-19 pandemic, and optimism at the lowest level since the collapse of Lehman Brothers in 2008.

Expectations for economic growth hit a 14-year low in the survey, while the majority of fund managers polled expect inflation to be permanent, with 62% forecasting stagflation –a dreaded combination of economic stagnation and inflation that is hard to get out of. In fact, stagflation expectations were the highest since the collapse of Lehman Brothers.

For 95% of fund managers in the survey, the greatest risk to financial markets stability is geopolitics, followed closely by monetary policy risk (81%). Business cycle risk was quoted by 61% of those polled.

So much bearishness in the stock market

With so much bearishness around, perhaps it is no wonder that investors went on a bit of a buying spree. Bargain-hunting is normal, but in the stock market one person’s bargain is usually another person’s junk.

It is probably way too early to dive back into the market. The war could drag on for a while, but even if it ends soon, the consequences for the global economy are still to be calculated and priced in.

Bargain hunting may not be enough to lift the markets. Picture by Skitterphoto on Pixabay.

The worst will be inflation. Energy prices, and oil in particular, have already jumped because of the war, but they could go even higher. The initial shock was due to the war, then came the sanctions on Russia and next will be the actual damage to the Russian energy infrastructure.

Geopolitical strategist Peter Zeihan recently pointed out that Russia’s oil reserves are becoming harder to reach, many fields are past their peak and the country relies on thousands of miles of pipelines to deliver the crude to refineries or to foreign buyers.

With major foreign oil companies such as Shell and BP leaving the country and workers voting with their feet, it will be increasingly difficult for Russia’s oil infrastructure to remain efficient. This will have a big impact on oil exports, even without taking sanctions into account.

With summer coming in the northern hemisphere, immediate pressure on energy prices could be lessening. However, after two years of lockdown due to the Covid-19 pandemic, many people will want to travel, and fuel prices will most likely increase further.

Before long, this will very likely feed into already high inflation and hit people’s purchasing power even more. In turn, this will dampen demand for goods, and companies’ earnings would suffer.

Perhaps investors should wait until they have more clarity on which stock is a bargain and which is a value trap before diving back into the stock markets.