Pro Perspectives 2/9/23

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February 9, 2023
 
Yesterday, we talked about the President's use of the country's Strategic Petroleum Reserves, in effort manipulate oil prices lower (and therefore gas prices).
 
It started November 23, 2021, with the announcement of a 50 million barrel release over "several months" to address the "mismatch between demand [related to] exiting the pandemic, and supply."  The price of oil closed that day at $78.
 
Biden then announced on March 31, 2022, a plan to release 180 million barrels of oil, to address the significant global supply disruption caused by Putin's war on Ukraine."  The price of oil closed that day at $100.
 
Then in October of last year, he announced an end to the planned sale by December, BUT also said he would authorize significant additional sales in the coming months if required.  So far, he's done 26 million barrels more than the March plan.
 
The price of oil today is $77.  And the U.S. Strategic Petroleum Reserves is now nearly 40% leaner.  
As you can see in the chart, we are back to 1983 levels.
 
That said, the U.S. population is now 43% bigger than it was in 1983, and the economy is seven times bigger.
 
For national security, these barrels will have to be replenished.  The question is, at what price?
 
Likely much higher.  And the government will become a tailwind for oil prices.    
 

Pro Perspectives 2/8/23

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February 8, 2023
 
Let’s talk about oil…
 
Last night, Biden, unwittingly, in off-script comments in his State of the Union address, made the case for precisely why oil and gas companies have no incentive (more like disincentive) to invest in new production, and every incentive to produce and return profits to shareholders, at higher and higher oil prices, driven by lower and lower supply.
 
This was Biden’s script:
 
“You may have noticed that Big Oil just reported record profits.  Last year, they made $200 billion in the midst of a global energy crisis. It’s outrageous.  They invested too little of that profit to increase domestic production and keep gas prices down.“
 
Here’s what he said off-script:  “When I talk to a couple of them [oil executives], they say ‘we’re afraid you’re going to shut down all of the oil wells and all of the oil refineries anyway, so why should we invest in them?‘   I said, we’re going to need oil at least another decade.“
 
Exactly.
 
So, both domestic and global anti-oil policies are ensuring structural oil supply deficits, into perpetuity.  And energy companies are doing the right thing by their owners (shareholders), by maximizing profitability on existing production (while they can) — and then returning loads of cash flow to the owners.
 
With this model, energy earnings are proving to be levered to the performance of oil.  The average price of oil in Q4 of 2022 was up 7% compared to Q4 of 2021.  During the same period, the reports from the energy sector thus far, show earnings growth of 58% year-over-year.
 
And keep in mind, those earnings are generated from oil prices that were trading in the lowest quintile of the range of the past year.  With the lack of incentive to invest in new supply (globally), prices will be going higher, much higher.
 
This comes as the President has drained 40% of the country’s Strategic Petroleum Reserves, in an explicit effort to manipulate oil prices lower.  It has worked.  But it’s temporary.  And they will be forced to restock those reserves as prices are moving higher, which will exacerbate the rise.
 
With oil prices now in the high $70s, this is a second chance to get involved. 
 
This dynamic in the energy sector is what led a Texas billionaire, that made his money in distressed real estate, to set up a company buying existing, cash flowing oil and gas assets, at a discount. He says it’s the biggest opportunity of his lifetime. 
 
We own his stock in our Billionaire’s Portfolio, along with two other stocks that give us the opportunity to see gains leveraged to the price of oil.  For details, subscribe to our Billionaire’s Portfolio here. 

Pro Perspectives 2/7/23

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February 7, 2023
 
We heard from Jerome Powell (again) today, just days after his post-FOMC press conference. 
 
There was anticipation that he might use today’s Q&A session at the Washington Economic Club to address Friday’s hot jobs report.
 
Let’s talk about what happened …
 
Remember, on Wednesday, despite telegraphing a continued, but slower, rise in interest rates toward the low 5% area, he did nothing to push back against a stock market that has been on a tear since the beginning of the year, and an interest rate market that has been pricing in rate CUTS by the end of the year.   
 
As we discussed last week, this mix of higher equity prices and cheaper borrowing costs (based on benchmark market interest rates) is stimulative to the very economy that Powell and company have been trying to suffocate for the past ten months (in effort to bring inflation down). 
 
So, did he use today’s platform as a second chance to tighten the grip on financial conditions (to talk down stocks and bonds)?  He didn’t. 
 
Why?
 
As we also discussed last week, this recent Fed rate hike now puts the Fed Funds rate ABOVE the Fed’s favored gauge of inflation (core PCE).
 
That’s historically where the Fed has gone to get inflation under control. So it’s sensible to think the Fed should be satisfied and ready to step back and watch from here (i.e. pause).
 
But what about this 2% inflation target they keep going on about?  The Fed’s favored gauge of inflation is still at 4.4% – quite a distance away.
 
Let’s address that by revisiting a very important keynote speech Jerome Powell gave back in 2020 at the annual global economic symposium in Jackson Hole.
 
It was in that speech, that Powell made it official policy, that the Fed was changing the way it evaluates its 2% inflation target.
 
Here’s the important part of his speech:  “Our new statement indicates that we will seek to achieve inflation that averages 2% over time.  Therefore following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” 
 
Translation:  Inflation has been too low for too long (at the time of this speech in 2020).  And with this policy change, Powell told us he would let inflation run hot, to bring inflation back to 2% on average over time.
 
In that respect, he is (still) delivering. 
 
Let’s take a look at what this “average” looks like dating back to the ultra-low inflation era of the post-financial crisis, and into this pandemic era. 
As can see, inflation ran below the Fed’s 2% target for the better part of thirteen years.  And for the past two years, it has run well above target. 
 
On average, inflation over the fifteen-year period remains below target.
 
This policy objective for the Fed, argues that they should be happy with stable, but higher than target inflation for a while longer.  
 
And this aligns with what we discussed in my note yesterday:  We need a period of hot growth, rising wages, and stable (but higher than average) inflation (to inflate away debt).  
 
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Pro Perspectives 2/6/23

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February 6, 2023
 
After another round of rate hikes last week, we ended the week with a hot jobs report.
 
That said, the wage component of the jobs report continued the trend lower, from the March peak. 
 
Following the jobs numbers on Friday, the January report on economic activity in the services sector was strong.  It showed a return to growth, after a dip in December.
 
Meanwhile, the price component of the services report showed the slowest rise in prices in nine months (on a steady trend of slowing). 
 
The inflation data in these reports should be well received by the Fed. 
 
Remember, the massive monetary and fiscal response to the pandemic (plus the subsequent Democrat agenda spending binge) ramped the money supply by 40% in just two years.  That was ten years worth of money supply growth (on an absolute basis), dumped onto the economy over just two years.
 
With that, we expected the price of everything to reset higher.  We've seen it.
 
Now, what we don't want, is to see the level of prices decline. 
 
Deflation would kill growth, and leave us with trillions-of-dollars of fiscal bullets fired, with no growth to show for it (only the massive increase in debt, with no growth offset).  
 
What matters now is rate-of-change in prices (i.e. slower). 
 
Inflation is slowing.  
 
And, importantly, it seems to be happening without destroying the economic firepower of six-trillion dollars of new money floating around.  That's good news. 
 
Growth solves a lot of problems. 
 
We need a period of hot growth, rising wages, and stable (but higher than average) inflation (to inflate away debt).  
 
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Pro Perspectives 2/2/23

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February 2, 2023
 
The central banks in the UK and euro zone did as expected this morning, raising rates another half a point, respectively. 
 
With the Fed’s move yesterday, we now have the Fed at 4.75%, the Bank of England at 4% and the European Central Bank at 3%.
 
As we discussed yesterday, Jerome Powell gave plenty of signals that the Fed has finished the job on the inflation fight.  After all, the Fed has now successfully raised rates ABOVE the rate of inflation (above core PCE). 
 
On that front, the BOE and ECB still have a ways to go.
 
But both have this chart working in their favor …
Gas prices in Europe have collapsed since August, down more than 80%!  With that, we've seen three consecutive months of falling prices (month-to-month) in the euro zone.  It's a matter of time until that feeds into the year-over-year inflation number. 
 
With perhaps a sense of deflationary forces lurking, market-determined interest rates (10-year government bond yields) are signaling that these three central banks won't be able to follow through with their pledge to hold rates "higher for longer."
 
Yields moved lower, not higher, in each respective government bond market, following the central bank rate hikes of the past two days.
 
That signal from the bond market, is a welcome one for stocks … 
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Pro Perspectives 2/1/23

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February 1, 2023
 
The Fed meeting came and went today with another quarter point hike. 
 
As we’ve discussed in recent days, that puts the Fed Funds rate ABOVE the Fed’s favored gauge of inflation (core PCE).  
 
That’s where, historically, the Fed has gone to quell inflation, so it’s sensible to think the Fed should be satisfied and ready to step back and watch from here (i.e. pause).
 
Today, Jerome Powell maintained the mantra of “finishing the job” on inflation, but he spent far more time making the case that the job is done.
 
He’s spent the past year telling us they have “more ground to cover.”  Today he said they’ve “covered a lot of ground.”
 
He’s told us “we’ll want to reach real positive rates.”  Today he said, “real rates are positive.”
 
In the December press conference, Powell used the word disinflation (falling inflation) zero times.  Today, he used it a lot!
 
But, what’s the one thing the Fed has been targeting for the past ten months?  Jobs.  Specifically, Powell has talked endlessly about the mismatch between the number of job seekers and the number of job openings. 
 
Ten months ago, when the Fed started the tightening campaign, there were two jobs for every one job seeker.    
 
The concern?  With leverage in the job market, job seekers and employees can command higher wages.  With that, the Fed has feared an upward spiral in wages, where wages feed into higher prices (inflation), which feeds into higher wages … and so the self-reinforcing cycle goes.
 
So, the latest “job openings” data came in this morning.  It’s virtually unchanged from ten months ago, no progress. 
 
So what did Jerome Powell say about today’s job openings report, when asked? 
 
Dismissively, he said “it’s been quite volatile.” 
 
“I do think, it’s probably an important indicator.” 
 
“It’s an indicator.”  Ha!       
 
Perhaps the biggest clue that the Fed has changed its stance:  Powell said nothing today to push back against a stock market that has been on a tear since the beginning of the year, and an interest rate market that has been pricing in rate CUTS by the end of the year (which includes a 10-year government bond yield that’s now trading 225 basis points lower than the historical average, relative to the Fed Funds rate). 
 
Of course, this mix of higher equity prices and cheaper borrowing costs (based on benchmark market interest rates) is stimulative to the very economy that Powell and company have been trying to suffocate for the past ten months.

Pro Perspectives 1/31/23

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January 31, 2023
 
The Fed will decide on rates tomorrow.  The Bank of England and the European Central Bank will follow with rate decisions on Thursday morning. 
 
By Thursday afternoon, U.S. benchmark rates will be 4.75%, the UK will be at 4% and the euro zone will be at 3%.
 
Now, as we discussed last Thursday, this level of interest rates in the U.S. has already resulted in more than a quarter of a trillion dollars in additional interest payments on U.S. sovereign debt.  
 
This will be funded by more deficit spending, which compounds an already massive, and unsustainable, government debt-load.
 
What does unsustainable look like?  See the UK and Europe.  They've already had a run on their vulnerable sovereign debt markets, in the second half of last year.  And both respective central banks were forced to (once again) become the buyer of last resort, to prop up their government bond markets, to avert a spiral toward default.
 
As we discussed last week, this unsustainable debt problem is precisely why the world needs inflation.  Governments need to inflate away the value of debt.  But it only works if, simultaneously, we have hot growth.  And it only works if wages reset/adjust to maintain the standard of living.
 
The good news:  Though with a healthy mix of government intervention along the way, the major central banks of the world (excluding Japan) have somewhat normalized interest rates, without killing the job market and the consumer.
 
With the fundamentals in place for continued solid consumption, and with China re-opening and the Western world rate cycle coming to an end, we are positioned to see some hot economic growth.   That would align with a persistently higher inflation environment, but one that can inflate away debt problems.  To regain, and maintain, standard of living, wages need to reset higher. 

Pro Perspectives 1/30/23

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January 30, 2023
 
It's Fed week.  The Fed is expected to raise another quarter point on Wednesday.  That will take the Fed Funds rate to the range of 4.5%-4.75%.
 
And as we discussed on Friday, that would take short term rates ABOVE the rate of inflation, which is historically the formula for beating inflation. 
 
In this case, instead of chasing inflation, the Fed used a new mix of tools (which included help from the White House on gas prices) to manufacture a (somewhat) meeting in the middle of inflation and interest rates.  
 
Here's another look at the chart, as it will stand on Thursday…
If we step back and take an objective look at the "point-in-time" data, we have an economy that grew at a near 3% pace in Q4.  Inflation expectations remain tame.  The job market is tight.  Household net worth has dipped, but from record levels.  It's still 23% higher than it was pre-pandemic. 
 
Consumers are taking on more credit, but doing so with record high credit scores and historically strong balance sheets.  With that, as you can see in the chart below, household debt service has returned to pre-pandemic levels (which were record lows at the time). 
Bottom line:  The fundamentals for consumption remain very solid, even with the introduction of an historically normal/average interest rate (for the first time in 15-years). 

Pro Perspectives 1/27/23

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January 27, 2023
 
The Fed’s favored gauge of inflation is core PCE (personal consumption expenditures).  It measures the change in prices of goods and services that people have actually paid — not just a selling price. “Core,” means excluding food and energy prices. 
 
The December report on core PCE came in this morning. 
 
With the Fed meeting next Wednesday, how might this most important data point guide them on next moves? 
 
The answer:  It should give them justification to pause on the tightening cycle.  
 
Why? 
 
As we’ve discussed often here in my daily notes, the inflation storms of the past have only been quelled when interest rates are taken ABOVE the rate of inflation.
 
In this case, the Fed has used a combination of tools to manufacture the desired outcome.  They’ve used a combination of rates, quantitative tightening AND a copious amount of talking (talking markets down, talking demand down).
 
With that mix, the Fed managed to stop the rise in core PCE early last year, and reverse it, without having to take rates to the double-digit levels of the early 80s. 
 
So, we now have the latest year-over-year change in core PCE at just 4.4%!  
 
As you can see in the chart below,  assuming the Fed goes through with another quarter point hike next Wednesday, we will have interest rates (the effective Fed funds rate) ABOVE the rate of inflation (core PCE).
 
This should give the Fed plenty of justification to hit the pause button, as the Bank of Canada has just done.    

Pro Perspectives 1/26/23

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January 26, 2023
 
As I said in my Tuesday note, we are in a hot economy, where demand is being throttled by the Fed. 
 
This was intended to be a reminder, with all of the recession talk, that this is not the economy of the post-financial crisis decade.  It's a not a sputtering economy with a demand problem.
 
The Fed is holding the beach ball under water.
 
With that, I posed the question, "what happens when the Fed backs off (let's go)?"
 
Some say that's precisely why they won't.
 
That makes sense, assuming they had a choice.  They don't.
 
They have this thing called debt service to think about it.
 
Let's take a look at what the Congressional Budget Office (CBO) has said about the sensitivity of debt service to the Fed's tightening campaign. 
 
If rates rose faster than their projections, they estimated that each 100 basis points higher would equate to $187 billion in additional annual interest costs.
 
Indeed, they have undershot a Fed that moved 425 basis points in nine months. 
 
The result:  About a quarter of a trillion dollars in additional interest payments for 2022.  And this year, if the Fed does what it projected in December (5.1% on the Fed Funds rate), and if the 10-year yield reverts to its historical average spread of 90 basis points (above the Fed Funds rate), the  Fed will have inflicted another $600 billion of interest payments on the U.S. government. 
 
That will be funded by larger and larger deficits.  And that compounds an already massive, and unsustainable, government debt-load.  
 
Ironically, this unsustainable debt problem is precisely why we need inflation.  We need to inflate away the value of the debt.  But it only works if, simultaneously, we have hot growth.  And it only works if wages reset/adjust to maintain the standard of living.
 
So, if we're lucky, we've just seen phase one of this inflationary environment, where the Fed normalizes interest rates.  Now, phase two should be a Fed that sits tight, let's growth bounce back (driven by the mountain of new money created over the past three years), inflation will bounce back with it, and, as they are doing in Japan, policymakers should encourage employers to raise wages.