Energy doesn't care
The sector continues to lead through broader market turmoil.
January’s stunning nonfarm jobs gain (more below)—“the biggest miss in history” and “strangest,” commentators opined—added to wage-price spiral fears. Year-over-year (y/y) hourly earnings jumped 5.7%, yields across the curve spiked with the biggest increases on the shorter end and West Texas Intermediate topped $90 a barrel to a 7-year high. Fed futures raised odds of a 50-point move in March and now imply more than five rate hikes this year. Whatever the Fed does, and the market does or doesn’t price in, none of it seems to matter to Energy. Global oil consumption is back to pre-pandemic levels and growing, Saudi Arabia is signaling it will tolerate pricing in the $80s and U.S. production is coming back slowly, hampered by the lack of capital expenditure growth in recent years. Then there’s the risk of embargoes, boycotts and a crude-price spike as the Russia-Ukraine-NATO standoff drags on. While investors worry about it all (inflation, a faster Fed, geopolitical risks), Energy doesn’t care. It just delivered double-digit returns on better earnings and P/E multiple expansion in a January that was the S&P 500’s worst since 2009—Energy names made up 16 of the top 20 S&P performers last month.
Equity sectors whose valuations were the most stretched going into the year—Consumer Discretionary (34x forward P/E), Information Technology (30x) and Communication Services (22x)—have suffered the biggest year-to-date losses. Applied Global Macro Research has looked at all situations over the past 30 years where the market is in risk-off mode and a recession was not imminent and found buying on the day the S&P dropped 10% from its previous high made money in 14 of 14 cases over the next 100 days. It’s not illogical to expect some consolidation after the late January/early February run-up—the S&P’s 260+ points in just four trading days marked its largest 4-day percentage gain in 14 months. Momentum indicators suggest the market became near-term overbought and weekly momentum remains negative—signs of a 2-steps-forward, 1-step-back market. Bank of America puts resistance at 4,718-4,750 on the S&P. Meanwhile, Fundstrat gives compelling reasons to expect a violent V-shaped rally in February. Retail investors have raised cash at the fastest pace since before the pandemic (contrarian positive), and AAII bearishness is at extremes, with bulls at 2013 lows. With nearly half of the equity market structurally bearish, this is another contrarian buy signal—six of six past extreme readings saw higher equity markets three, six and 12 months out. But the takeaway from January: the first half is likely to be messy. In the 12 instances since 1938 where markets were down in January while the economy was expanding, the mean first-half return was -0.3%; the February through June return was 2.9% and the second-half return was 7.8%.
So, why doesn’t Energy care? Historically when financial conditions are tightening (even the European Central Bank is signaling it’ll raise rates this year), oil and emerging markets have been at the bottom of the pack. But what is working now remains completely different than what worked historically, and the most notable difference compared to those prior examples is inflation. As the global economy reopens, crude stockpiles are their lowest in 20 years and could get worse if Russia is cut off or cuts itself off. It’s a major global supplier of oil and natural gas, particularly to Europe. So, all roads would appear to point to higher Energy prices—many predict oil could reach $100 per barrel or more. An energy crisis through shortages and spiking prices leaves two possible long-term outcomes. Either the West puts aside differences and embraces Russia—or, at least, Europe does. Or it continues to treat Russia as a pariah, which means additional energy production would have to be found beyond the Middle East, a problem for the U.S. due to shale underinvestment and a growing focus on alternative energy sources that may take decades to develop. Either way, it seems we’re in the early innings of a major shift in Energy, with the bias on prices higher. No wonder Energy doesn’t care. If I were Energy, neither would I.
- Omicron schmomicron? This morning’s surprise 467K jump in January nonfarm payrolls more than tripled consensus. Many were forecasting an outright decline as omicron absences run their course. Revisions added another 700K jobs to the prior two months, and both labor force participation rate and wages rose significantly. The separate household survey similarly surprised, as residential employment and labor force growth expanded by 1.2 million and 1.4 million, respectively, pushing the jobless rate up a tick to 4%.
- Americans buying big-ticket items January light vehicle sales unexpectedly soared 20% to 15.2 million annualized, with trucks driving the increase and accounting for a near-record 80% of all light vehicle sales. On the housing front, mortgage purchase applications rose again and are up nearly 9% the past six weeks as buyers act to get ahead of mortgage rate increases.
- Supply strains are easing The manufacturing ISM and regional indexes on net show supplier deliveries at their lowest levels since November 2020, in line with the beginning of past global manufacturing rebounds. Factories also are beginning to catch up with backlogs, which also fell to a November 2020 low, while inventories have been running above a breakeven 50 since the start of Q3.
- What happened to peak inflation? After pulling off its highs in late 2021, the ISM manufacturing prices paid index jumped in January, and the average prices-paid and prices-received subindexes in five monthly regional Fed surveys held at record highs for a six straight month. Overseas, eurozone consumer prices that were expected to moderate shot up 5.1% y/y, a record high since the euro’s inception. Energy prices, up 28.6% y/y, drove the increase. Energy doesn’t care.
- Blaming omicron Although they remained elevated, manufacturing and services ISMs dipped in the U.S. in January, while Markit’s final take for the month held at 2020 lows. The story was similar globally, with nine countries posting lower services PMIs. The fading omicron variant was cited across continents as the primary drag last month.
- The economy needs capex to pick up For all the talk last year of plans to boost capital expenditures, global business capex for all of 2021 rose only 1.3%, a third of its trend growth rate the prior nine years. Supply bottlenecks were a key factor—it’s hard to build without materials and labor. There are signs companies are stepping up, as the past few weeks saw large manufacturing plant announcements from Intel, GM, Toyota, Micron Technology, Samsung and U.S. Steel.
Let the robot games begin To cut down on human interactions at the 2022 Olympic Games in Beijing, a robot bartender serves drinks, a robot barista whips up cups of coffee and another machine provides cups of soft-serve ice cream. Food is delivered via a mobile shelf that drops down from the ceiling to a diner’s location, and room service is the specialty of a short, rectangular robot.
In the end, it’s all about profit margins, isn’t it? Inflation is undoubtedly boosting revenues. However, rising labor and materials costs—as well as shortages of both—aren’t depressing earnings, as evidenced by the fact that S&P 500/600 forward profit margins both rose to record highs of 13.3% and 7.2% during the Jan. 20 week. The forward profit margin for the S&P 400 has stalled around a record high of 8.5%.
What are you doing online?? Every day, there are 500 million completely new Google searches, i.e., queries that have never been looked up before. Also, gamers have collectively spent more time playing Call of Duty (25 billion hours) than humanity has existed on Earth, and Americans now spend more time on TikTok than on YouTube.