Wentz Weekly Insights
What Higher Oil Prices Means for the Economy
The geopolitical crisis in Eastern Europe has created higher commodity prices, more uncertainty for markets, and dampened expectations that the Fed will tighten policy at a more aggressive pace. Going into the year the market was expecting about three rate increases in 2022, but with no signs of inflation easing the market began pricing in more rate increases, at one point even expecting more rate increases than there were Fed meetings. It is our expectation the Fed will raise at the next several meetings, while announcing its plans on how it will runoff its balance sheet, before pausing around election time to avoid any conflict during the mid-term elections. The flight to safety and the expectation rates will not rise as much as previously thought, brought Treasury yields lower last week with the 10-year note falling as low as 1.68% after reaching a high of 2.07% just two weeks prior. At the same time, the short end of the yield curve, specifically the 2-year Treasury note, has remained near 1.50%, resulting in a spread between the 2 and 10-year yields that is at the lowest levels since before the pandemic. This is adding to uncertainty in the markets as the narrowing of spread leads to recession worries. Every time that spread went negative a recession.
Because of the war in Ukraine, Powell said in his testimony he believes inflation will move higher, but he still expects the Fed to “proceed along the lines we had in mind before the Ukraine invasion.” That thought is being felt throughout the markets as well, due mostly to higher commodity prices – JPMorgan economists revised its 2022 forecasts for inflation to 4.6%, up from 3.8% while downgrading economic growth to 3.1%, down from 3.9%, while revising its inflation forecast in the U.S. to 4.9%, up from 3.9%. The reason is Russia is such a large player in global supply of energy, particularly oil. It provides roughly 10 million barrels of oil per day, or 10% of the global supply with much of that sent to Europe. The supply situation will get worse before it gets better – the U.S. and European allies are now considering a ban on Russian oil, OPEC decided to maintain its current production quotas (production targets many of its members have been unable to reach), and U.S. shale producers are reluctant to drill more wells due to a combination of the time it takes and the high costs. With no relief in sight, we see commodity prices as being elevated for some time.
Higher commodity prices are showing for Americans in the price we pay at the pump and will eventually affect prices of most goods and services we use. This will immediately cut into American’s discretionary spending. A note by JPMorgan says if oil rises to $120/barrel, lower income households will see the percentage they spend on energy rise to 13.9% from 10.1%. The difference will ultimately show in economic growth as nearly 70% GDP in the U.S. is derived from growth in consumer spending. At a price of $119/barrel, oil would have doubled from a year ago. The last three times that has happened – in 1990, 2000, and 2008 – the U.S. economy found itself in a recession, per data from DataTrek Research. How we can take advantage of this is making sure there is energy exposure in portfolios. The energy sector makes up a good portion of the value category, and as we have been reiterating over the past several months, we have favored value and cyclical companies over growth. We maintain our conviction in value companies and expect the category to continue to outperform growth, but stress we will continue to see heightened volatility along the way.
Week in Review:
Equity markets opened the week remaining on edge over the worsening situation in Ukraine with unsuccessful talks on ceasefire over the weekend. Investors again made the move to safe haven assets like U.S. Treasuries and gold with the 10-year yield on the Treasury note down to 1.83%, pressuring financials which was the worst performing sector for the week. Oil rose to over $95/barrel making energy by far the best performing sector on the day. Further sanctions were place on Russia over the weekend including prohibiting transactions with its central bank and freezing Russian assets held in the U.S. Stocks finished mixed with weak internals, the S&P 500 and Dow closed negative and NASDAQ and Russell 2000 positive. The markets remained on high alert Tuesday due to reports that Russia was sending a 40 mile long convoy to Ukraine’s capital Kyiv and warned it was going to attack intelligence facilities and urged citizens to leave. In economic data, spending on construction materials rose at a much faster pace than expected despite the rough winter weather while manufacturing indices suggested activity picked up in February after slowing in January from Omicron. Oil moved over $100/barrel over increased tensions in Russia despite the US and 30 other countries saying they will release 60 million barrels from emergency stockpiles (minimal impact – global demand is 100 million barrels/day). Stocks remained on edge with the S&P 500 closing down 1.55%. President Biden made his State of the Union address in the evening, which highlighted unity around Ukraine and sanctions on Russia, inflation, the economy, China, healthcare/drug costs, and his Build Back Better agenda. Futures rose heading into Wednesday’s open following the lead of Europe over reports Ukraine may hold a second round of talks with Russia. OPEC said it will maintain its current production quotas, ones it hasn’t been able to meet anyways, sending oil higher again to the highest since 2011. Powell, in his testimony to Congress, ended the thought of a 50 basis point increase in rates in March and said he was recommending a 25 bps increase while saying we will see upward pressure on inflation due to the war in Ukraine and Russia’s role in the global energy market. Oil moved higher, yields lower while stocks finished positive by 1.86%. Oil made another moved higher Thursday with markets seeing more downside pressure with the S&P 500 down 0.53% on the day as Russian forces took control of the strategically important southern Ukrainian city of Kherson. On Friday the DOL’s employment report said there were 678,000 job gains in February as concerns over Omicron waned, but there was no wage growth in the month, likely because most of the job gains were from lower paying jobs that skewed wage gains to the downside, however still up 5.5% from a year ago. Commodities were higher again with crude oil reaching $115/barrel, the highest since 2008. A nuclear disaster was avoided after report of shelling and a fire at a nuclear plant in Ukraine that Russia ultimately took control over, but fortunately the fire was extinguished with reactors being unaffected. There were several talks over a much needed ceasefire in Ukraine, but all went unsuccessful. Stocks moved lower again with the S&P 500 finishing down 0.79% and 10.1% from its all-time highs while the Russell 2000 was down 1.61% and down 18.6% from its highs. For the week, the 10-year Treasury yield saw a significant pullback, settling at 1.72% after ending the prior week near 2.0%, while the major U.S. stock indices finished as follows: S&P 500 -1.27%, Dow -1.30%, Russell 2000 -1.96%, NASDAQ -2.78%.
Recent Economic Data
- The Department of Labor said there were 678,000 job gains in February versus roughly 400,000 expected, with an additional 92,000 jobs added from the prior two months due to upward revisions. The household survey showed there are still currently 6.3 million Americans unemployed, compared to 5.7 million pre-pandemic. The media reported unemployment rate was 3.8%, compared to 3.5% pre-pandemic, while the much broader measure of unemployment, the U-6 rate, was 7.2%, compared to 7.1% pre-pandemic. The labor force participation rate was at 62.3% vs 63.3% pre-pandemic, reflecting the ongoing challenge of the lack of individuals in the labor force. Wages were flat in the month, a surprise to the downside but likely reflects more lower paying jobs being added in the month. Compared to a year ago wages are 5.5% higher. Many of the pandemic sensitive sectors (think leisure/hospitality/restaurants) saw large increases which was largely Omicron related as Covid fears eased in February. However, one month does not make a trend, and the trend over the past 1-2 years continues to be strong employment gains with much higher wages.
- Vehicle sales in February fell 6.4% from January to an annualized pace of 14.1 million. The sector continues to be pressured by supply constraints. Sales are expected to gradually improve as we move through 2022 as supply issues ease, but that is more uncertain at this time due to the war in Ukraine.
- Construction spending in January rose much more than expected with a 1.3% monthly increase, which is interesting because the weather was terrible and that was reflected in several housing reports for January. Expectations were for a 0.2% decline and compares to an upward revised 0.8% gain in December. This was the best monthly increase since last January where we saw a 3.0% gain for a cycle high. The increase was split between a 1.3% rise in both residential and nonresidential spending, both of which are up 13.2% and 3.7% from a year ago, respectively.
- The Purchasers Manufacturing Index, a survey by manufacturers that reflects manufacturing activity, was 57.3 for February, up 1.8 points from the prior month and near expectations. A reading of over 50 reflects expanding conditions while a reading under 50 reflects contracting activity. The survey noted a sharp pickup in activity near the end of the month, after an Omicron related slowdown in January, and saw signs of easing supply chains and the fastest growth in new orders since October. It does note output is still constrained from raw material supply bottlenecks and labor shortages.
- The Institute of Supply Management’s manufacturing index was 58.6 for February, 1 point above January and above expectations. The report notes Omicron still impacted activity in February but those effects eased through the month, there was a higher quits rate and more early retirements resulting in additional labor shortages, optimism picked up and new orders and backlogs saw strong growth.
- For the week ended February 26, 215,000 Americans filed for unemployment benefits, down 18k from the prior week and averaging 230,500 the past 4 weeks, both near 45 year lows. Continuing claims were 1.476 million matching the prior weeks with the four-week average at 1.539 million, also near multi-decade lows.
- Ford announced plans to reorganize its operations where it will create a distinct electric vehicle division separate of its internal-combustion operating division. Ford Blue will be the name of the internal combustion engine business where it will “attack costs, simplifying operations and improving quality,” while Ford Model e is the name of the EV business that will accelerate innovation and deliver electric vehicles at scale, per the company.
- Walgreens dropped last week after a report that a group of private equity firms dropped out of budding for Walgreen’s Boots UK drugstore operations, a unit of Walgreen’s the company looks to shed. The report by Sky News said the PE firms dropped bids due to price expectations from Walgreens.
- Chevron said it will raise its stock buyback program to $5 billion to $10 billion per year, up from $3-$5 billion and said it would target a 12% return on capital employed at $60 per barrel/oil. It also said it expects to grow cash flow per share by 10% annually through 2026, benefiting from reduced costs and higher energy prices.
Did You Know…?
The Port of Cleveland Activity:
U.S. ports saw a big increase in activity in 2021 as American’s demand for goods and services ramped up, helped by government stimulus and easy money by the Fed, while businesses rushed to restock shelves. The Port of Cleveland was not left out – it said it saw a 69% increase in tonnage across its docks, compared to 2020 levels. Driving the increase was significant increases in goods both in and out of containers, as well as a large increase in iron ore shipments to the Cleveland-Cliffs steel mill in Cleveland. The general cargo terminal saw about 650,000 metric tons go across its docks, the second-highest total in the past decade, behind just 2015 numbers. The port said cargo owners used the Port of Cleveland, the only one on the Great Lakes with container shipping, as a solution to avoid coastal ports which have seen record high backlogs.
Update on Tax Forms
As tax time is upon us, please be aware of this important note:
- Clients with retirement accounts (traditional IRA, Roth IRAs, etc.) will be receiving TWO 2021 Retirement Tax Packages (this includes Forms 1099-R and/or 5498). Raymond James made a back-office change where Raymond James Trust Company of New Hampshire (RJTCNH) is the new custodian of IRAs (you and your accounts are unaffected by this change). This change became effective September 7, 2021 and as a result accounts that had reportable activity before and after the Raymond James custodianship change will be receiving TWO tax packages. Please take note the second package is not a duplicate of the first. All forms must be used when completing the 2021 tax return.
- The first package contains reportable activity occurring from January 1, 2021 – September 3, 2021, under the RJA custodianship
- The second package will contain reportable activity occurring from September 7, 2021 – December 31, 2021, under the RJTCNH custodianship.
For more information on when you will be receiving your tax documents, please refer to this email.
The Week Ahead
This week the energy sector, and commodities in general, will continue to get much of the attention of the markets due to the 54% rise in crude oil year-to-date. The economic calendar is not as crowded as last week but investors will be focused on the inflation report Thursday morning where the expectation is a 7.9% increase from a year ago, higher than the 7.5% pace in January. Elsewhere, we will see trade data Tuesday morning, the Job Openings and Labor Turnover Survey Wednesday, weekly jobless claims Thursday, and consumer sentiment on Friday. We would not be surprised if sentiment falls due to higher prices consumers are paying at the pump. There will be several notable earnings releases, including Dick’s Sporting Goods and MongoDB on Tuesday, Campbell Soup and CrowdStrike on Wednesday, and JD.com, Oracle, Ulta Beauty, and DocuSign on Thursday. In addition, there will be a handful of annual shareholder meetings and investor days with notable meetings from Qualcomm, Disney, eBay, GE, and AT&T, as well as a product event from Apple on Tuesday.