The problem with energy inflation is that energy is the base of nearly everything we produce and/or part of every product in the supply chain.
To get a product to market requires energy. If it is shipped from China, Taiwan, Vietnam, or Mexico – it requires energy to get to our shores. Further energy is required to move those products to your doorstep or your local store. Food. Everything you buy at Target or Costco. Medicine (all those pesky plastic pill bottles). Tires. Nearly everything we use daily has some connection to energy. When energy prices go up, it can act like a tax on the economy and slow down economic activity. “Just go buy a Tesla”, isn’t always a practical solution since the price of electric cars is quite high, let alone the fact that while electric vehicles are great for the environment, they do nothing to help get a ship across the ocean filled with goods headed for Walmart. Green energy is clearly our future. But where does that leave pill bottles? Electric cars draw on the grid which is still fueled by nuclear and natural gas. I have a feeling we may still need some oil production for a while.
Combine energy inflation with rising interest rates and …. Boom!
Our economy is growing and still adding jobs with unemployment falling. But the strong economy is one driver behind the Federal Reserve feeling that it’s OK to raise interest rates because the economy can “handle it”.
The first impact felt by raising rates is in the mortgage market. Mortgage refinancing demand has dropped by 60%. 30-year fixed mortgage rates hit almost 5% at the end of this quarter which is 1.64% higher than 1-year ago. Clearly this will slow down home sales. Yet, much of this is already priced into some home building stocks.
So, can energy, inflation, and higher rates cause enough headwinds to send the economy into RECESSION?
That is the question we wrestle with every day here at Warren Financial. Currently, these headwinds are NOT enough to send the economy into recession. However, they are strong enough to slow the economy and change the direction of some aspects of our investment portfolios. Specifically, we have been jettisoning stocks with relatively high financial fundamentals, such as high P/E ratios or high P/Sales ratio.
Why eliminate some stocks, but keep Microsoft, Google, Apple, Amazon, etc?
Because those larger, stronger companies are making massive earnings profits today. Companies we have to sell only have the “hope” of large future profits as opposed to making large money today. Complicating the issue is that companies are continuously changing, such as Tesla which used to have “hope”, but now is debt free and deliveries are growing exponentially – now, today. Yet even still, it is expensive.
So, the answers aren’t always easy or clear. That’s why we wrestle with all this data on a daily basis.
Bottom line: as of today, still no recession.
However, the possibility/probability of recession has grown significantly.
People are getting out.
Airports are packed.
Airplanes are packed.
Mask mandates are being dropped.
“We the People…” want to travel.
BTW, if you need a great travel agent, one of our clients is one of the best – we can put you in contact.
The Federal Reserve is really talking tough. Will they follow through? Or will the tough talk resonate with people such that inflation expectations come down after only a few rate hikes this year?
Corporations have been able to mostly pass along inflationary input costs to consumers without sacrificing profit margins. Passing along inflation is good for corporations and good for you as an investor, but bad for consumers. Yet another reason it’s so important to be an equity investor.
As the market declined in the first quarter, it’s always nice to remember that these declines present buying opportunities if you have cash that you don’t need anytime soon.
