Making future projections is always a hard thing to do, as doing so opens oneself to potential criticism. “What if we are wrong?”, is often the worry.
Why do we at RMH bring this up? A while back we wrote about the most crowded trade in history at the time was (the incessant all hands-on deck from all the experts on TV), when interest rates would rise. Well, they have, and it is our assertion they have almost peaked.
This now brings us to the next most crowded trade in history: when will the Federal Reserve (FED) start to lower interest rates? A reminder that the FED is the only central bank in the world to have a dual mandate, the control of inflation and full employment. Two contradictions to say the least.
We will explore the inflation mandate first. Please see the chart below from the Economist:
While this chart depicts investment mainly in infrastructure, there are a whole host of other industries that are being revitalized as the US retools its manufacturing. The pandemic exposed that having something now was more important than having something in the future at a lower price. As a result, we had significant inflation as industries/consumers paid whatever price to get a good. On a humorous side note: remember standing in line at Costco to get toilet paper, I do.
In the last several years we have progressed to the point where the supply issues of the past that contributed to higher prices are behind us. Good. We have now created some new price pressures as we rebuild our infrastructure domestically.
Second: Full Employment
The rebuilding in the chart from the Economist above spills over to all sorts of ancillary industries creating price pressures in labor, materials, and energy consumption, to name a few. As an aside, we have not even begun to tackle the energy grid infrastructure problem in our country that desperately needs to be fixed!
With demographic shifts well under way in the western world, it is our belief we will be continuing at under 5% unemployment due to the aging of our population. Currently there are approximately 1.35 jobs for every person looking for a job. This creates a situation where if one does not get a raise, they look for another job at a higher pay scale, and a lot of the time they get it. There are other considerations as well, work from home, come into the office on a limited number of days, better healthcare, more time off…. Look at the recent wage demands from the unions representing the auto workers. Only time will tell if these increased wages play a successful or unsuccessful role in the success of these companies.
In summary, this is why the issue of inflation will be so hard to fix, it will take time.
Well now that we have got the bad news out of the way, let’s look at one of the major advantages the US has over the rest of the world.
Energy infrastructure: The United States (Canada as well) has an abundant supply of oil and natural gas. In addition, we have the technological knowledge to harness these fuels to run our society. This gives us a cost competitive advantage over the rest of the world. The reason we have this technology is that generally we have free markets where successful companies with good management and cost control survive. In the past, they have had to face several crises where the oil producers in the Middle East dumped barrels of oil on the market to bankrupt our least profitable firms. They were successful. Now, the surviving firms have maintained their cost discipline, invested in technology for advanced drilling and capture techniques, to the point where the cost of $40 barrel oil equivalent is attainable.
The chart above shows the interconnectedness of our major fields and to leads to the conclusion of lower energy costs for our domestic industrial revival.
Drilling a little deeper into the above chart with the consolidation going on in the “energy patch”, suggests to us the strength of the pipeline infrastructure in the US and Canada. Pipelines have “take or pay” contracts for the movement of cubic feet in their pipelines. As consolidation occurs the credit quality of the companies committing to take or pay contracts goes up, making pipeline companies more financially sound.
If there are ever any topics you wish for us to explore, please let us know. We are here to help and guide you through these times.
We thank you all for taking the time and reading “Market Watch.” It is meant as an educational piece on the always evolving markets. It is something we plan on providing every month, and your feedback is very important to us.
On a personal note, RMH is now in the position to bring on new clients so please be sure to share this informational letter with whomever you wish. RMH’s focus is on the customizable investment needs of individuals, families, and foundations. We enjoy working with our clients to better understand their goals, values, and passions for what is important in their lives. In expanding our client base, we look forward to working with people who share these same desires.
Richard Mundinger, CFA
Ashlyn Brooke Tucker