2022 has been rough all-around for the American consumer. Not only are we battling decades-high inflation, but investors’ portfolios are off to one of the worst starts to a year in history as we near the halfway point. Technical analysis is rooted in trend following, and the trend in both stock and bond prices so far this year have been down. One trend, however, that has been strongly higher is energy prices. There are some signs that energy trends could be shifting, which would not only have positive implications for consumers’ wallets, but also potentially for investors’ investment portfolios.
The single price that matters most to consumers is the price of gas. Even if you drive an electric car, it would be hard not to notice the huge increase in gas prices over the past year. The AAA national average price for a gallon of gasoline just hit $5 for the first time ever. For many Americans, the amount of gasoline they need is simply fixed, as they must drive to work, school, etc. When prices rise, the money must come from somewhere, and it should therefore be no surprise that the consumer discretionary sector is the worst performing S&P 500 Index sector year-to-date with a more than a 30% loss.
What matters to consumers also matters to politicians. President Biden’s approval rating has continued to decline amid higher inflation numbers, with a near perfect inverse correlation to gas prices. That has implications for the midterm elections, where Republicans will look to capitalize on inflation and spin their energy policies as the solution. Currently, betting markets show about 3:1 odds that Republicans will be able to take control of both the House of Representatives and the Senate in November.
The Biden administration, while focused squarely on its policy of transitioning the economy towards a non-fossil fuel environment, has been trying to alleviate the burden of rising gasoline and diesel prices by attempting to introduce a federal gasoline tax holiday. The administration wants the federal tax holiday, which would take 18.4 cents off a gallon of gasoline, to be introduced along with a state tax holiday. A tax break from both state and federal governments is expected to give consumers approximately $30 of savings per month for one weekly fill-up. The breakdown in savings comes from the 18.4 cents a gallon for the federal tax and 31 cents a gallon on average from state governments. The tax holiday, which would last for three months, requires congressional approval, and so far, despite intense lobbying efforts, approval does not appear forthcoming.
In addition, the administration has become increasingly vocal in encouraging energy companies to increase drilling. An upcoming presidential visit to Saudi Arabia is being highlighted as an opportunity to discuss measures to foster peace in the Middle East. Still,
given that Saudi Arabia is the de facto leader of OPEC, the goals of the visit undoubtedly include an attempt to return with an agreement for higher oil production levels. OPEC, despite raising production levels in July and August, is seemingly intent on keeping prices high as member countries recover from the drought of demand incurred during the pandemic.
A long-term solution remains unclear, as the low oil price environment that has reigned over much of the past eight years has consistently punished American oil companies for investment and rewarded more shareholder-friendly policies such as dividends and share buybacks. Still, the all-important U.S. consumer needs a break regardless of how it is delivered.
Nothing addressed so far is especially positive, so let’s get to that part. While gasoline prices are just pennies removed from all-time highs, gas prices at the pump tend to operate on a lag from real world commodity prices. In the past few weeks, the price of West Texas Intermediate (WTI) crude oil has fallen approximately 15%, crossing a technical support level of $115/barrel.
While the trend in most energy/oil prices is still higher from a long-term perspective, numerous other commodities that have experienced strong bullish runs appear to be more clearly breaking down, so the odds of a top in oil prices may also be possible. As global central banks fight inflationary pressures with rate hikes, the result has been a perception that the economy will not be able to withstand continued tightening of financial conditions and will fall into a marked slowdown, if not an all-out recession. For instance, copper, often referred to as Dr. Copper for its ability to forecast economic conditions, just hit its lowest level since February 2021. Market-based inflation expectations are highly correlated with commodities, especially oil, and those appear to be rolling over, with the two-year breakeven implied inflation rate recently hitting its lowest level in four months.
Fundamentals still matter, but it would be naïve to suggest that the Federal Reserve (Fed) and the potential path of its rate hikes have not been the primary focus of short-term market moves this year. So far, that shows little signs of changing. Any shift towards a more dovish Fed, whether it be from economic weakness or lowered inflation expectations, would almost certainly be a positive for bonds, which have fallen dramatically amid the latest surge in inflation and skyrocketing interest rates. A shift may also be a positive for equities, which seem potentially already priced for a recession.
So far in 2022, energy investors have been rewarded, with the sector up approximately 30% year to date, and the only S&P 500 sector in positive territory. While the outlook for
energy prices remains positive longer term, any easing of the upward pressure on prices would still allow energy companies to thrive, while providing relief to consumers and the current inflation dynamic. Expectations are just that, expectations, but if the commodity price decline combined with easing supply chain issues can bring inflation lower over the second half of 2022, things may improve for both stocks and bonds.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by LPL Financial, tracking #1-05297784.
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