The energy crisis that is tearing up the markets leaves a trail of losers

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The energy crisis that has fueled inflation around the world is getting worse every week, leaving stock traders with the challenge of figuring out where to put their money.

The nightmare scenario that has unfolded this year has already taken a toll on stocks, which suffered a meltdown in the first half. A summer rally helped par the losses, but the worsening crisis, which appears far from over, poses a huge obstacle to further gains.

Rising electricity prices, along with supply threats, are affecting businesses from China to Germany to the US. It drives up costs and threatens profit margins, while also sucking money out of their customers’ pockets, destroying demand. And from industrial gas burners to retailers who rely on consumers with money to spend, the damage is proving widespread.

Germany’s heavy reliance on Russian fuel has left its heavyweights particularly vulnerable. A basket of Citigroup Inc. stocks. sensitive to a natural gas shock that includes Covestro AG, Thyssenkrupp AG and Siemens AG has underperformed the broader European Stoxx 600 market this year.

As pressure mounts, retail looks like another loser. In the US last week, two big names reminded investors that any concerns are valid. Nordstrom Inc. plunged 20% in just one day after cutting its full-year outlook, while Macy’s Inc. also lowered its forecasts. In the UK, the retail stock index has fallen around 35% so far this year.

“The energy crisis brings a huge number of unknowns and concerns to the market,” said Clive Burstow, head of global resources at Barings in London. “High prices are driving inflation and pushing industrial capacity out of business, exacerbating an already tight supply chain.”

The rise in inflation also prompted an aggressive response from the world’s major central banks, which raised interest rates to bring the situation under control.

Federal Reserve Chairman Jerome Powell noted on Friday that the US central bank will continue to tighten policy and played down the idea that it would soon reverse course. Some European Central Bank officials want to discuss a 75 basis point hike in September.

“Consumers are facing higher prices for, frankly, everything,” said Ben Powell, investment strategist at BlackRock Investment Institute. Earnings “look a little wobbly over the next several quarters,” he said.

Investor concerns were reflected in the latest flow numbers from EPFR Global data. Global equity mutual funds had outflows of $5.1 billion in the week to Aug. 24, with U.S. stocks seeing their first buys in three weeks.

Russia’s stranglehold on gas supplies to Europe means electricity prices there are spiraling out of control. Economists at UBS Group AG say the eurozone economy has already entered recession, and Morgan Stanley last week cut its growth forecast. In the UK, energy bills are set to almost triple this winter, adding to the squeeze in a country where inflation is already at its highest in four decades.

But the pain from higher prices is being felt everywhere and governments are considering dramatic options. Japan plans to return to nuclear power and Germany is reviving old coal-fired plants. Kosovo has begun to blackout, which could spread to other countries as the need to conserve resources becomes more pressing.

Power sharing will affect many sectors, including chipmakers who use vast amounts of electricity to make ever-smaller semiconductors.

Damage has already broken out in industrial and chemical enterprises. Yara International ASA and Grupa Azoty SA cut production and lower fertilizer supply could hit agriculture, with implications for food costs. British carmakers said rising energy costs threatened production, while a Honda Motor Co. in China it has been shut down amid an order to curb energy use.

“Governments will print money to help, but they can’t print natural gas,” said Beata Manthey, global equity strategist at Citigroup Inc. , particularly in the consumer, technology and retail sectors.”

Picking Winners

Avoiding pitfalls is only half the battle in any crisis, and identifying potential winners is high on the list of stock traders’ priorities. The most obvious are commodity companies, from oil and gas producers to miners. In Europe, the energy index increased by 26% this year.

“We are looking for market opportunities in the energy sector,” said Gary Dugan, managing director at the Global CIO Office. “We could see very strong earnings with good dividend payouts making it particularly attractive in the US, where there is less risk of tax windfalls in the sector.”

Bank of America Private Wealth Management sticks to the so-called FAANG 2.0 strategy — fuels, aerospace and defense, agriculture, nuclear and renewables, and gold and metals.

“It’s a hard asset and hard power play,” said Joseph Quinlan, chief market strategist. “That’s where we’ve been hiding, it’s doing well relative to the rest of the market.”

Governments and the business world have turned massively to renewable energy sources in their fight to reduce dependence on fossil fuels, boosting the outlook for the sector. But in the short term, the investment case is murkier. Building capacity, infrastructure and updating the grid to accommodate green energy will take time and industrial equipment such as steel and aluminum, which are currently in short supply.

Meanwhile, for all the daily headlines highlighting rising energy prices and their impact on households, businesses, economic growth and profits, ultimately stock buyers will just have to accept that they’re in a new world that doesn’t go away.

“The energy crisis, I think the market has kind of come to terms with it,” said Mehvish Ayub, senior investment strategist at State Street Global Advisors. “It was a very big shock at the start of the year and now it is a key element of the macro picture and we are able to focus on the fundamentals of equity earnings.”

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