West Texas Intermediate Crude jumps … oil’s upward pressure on May inflation … why we need to look beyond inflation numbers … checking in on the U.S. consumer
The price of West Texas Intermediate Crude (WTIC) came within striking distance of $120 a barrel yesterday.
In the morning, price surged on news that EU leaders had reached an agreement to ban 90% of Russian crude by the end of the year,
The agreement resolves a deadlock after Hungary initially held up talks. Hungary is a major user of Russian oil and its leader, Viktor Orban, has been on friendly terms with Russia’s Vladimir Putin.
Charles Michel, president of the European Council, said the move would immediately hit 75% of Russian oil imports.
Those gains disappeared later in the day when The Wall Street Journal reported that OPEC is considering suspending Russia from the group’s output agreement.
From the WSJ:
Exempting Russia from its oil-production targets could potentially pave the way for Saudi Arabia, the United Arab Emirates and other producers in the Organization of the Petroleum Exporting Countries to pump significantly more crude, something that the U.S. and European nations have pressed them to do as the invasion of Ukraine sent oil prices soaring above $100 a barrel.
As I write on Wednesday, WTIC is up again, trading at $117.
Regardless of how this latest twist plays out, the oil trade has plenty of life left in it. That’s because even if prices moderate, the margins for top-tier oil companies are so thick with oil over $100 a barrel, that these companies will be printing money for quarters to come.
Our macro specialist Eric Fry has been all over the oil trade. The obvious plays are those that benefit from rising oil prices. Think Occidental, Diamondback Energy, or perhaps XOP, which is the SPDR S&P Oil & Gas ETF.
But the great thing about the oil opportunity is the variety of ways to play it.
***Finding income in the oil patch
Beyond recommendations that target gains related to oil’s surging price, Eric also has recommended “MLPs,” which are a great way to put income in your pocket.
For readers less familiar, an MLP, or “Master Limited Partnership,” offers investors tax benefits, usually alongside healthy, cash-flow yields.
These MLPs provide the physical infrastructure that moves oil and gas to refineries and distribution hubs. We’re talking the pipelines that serve as the veins of the U.S.’s sprawling energy complex.
Back to the idea of income, Eric’s most recent MLP recommendation in Investment Report pays an annual dividend of 8.5%. I should add it’s also up 19% on the year.
If you’re looking for a way to make your dollars work harder in today’s inflationary world, check out MLPs.
***Speaking of oil and inflation, prepare yourself for what could be an uptick in the CPI number in a couple weeks courtesy of rising oil prices
The Consumer Price Index (CPI) measures the price of a basket of consumer goods and services purchased by households.
As you’re aware, CPI figures have been skyrocketing for more than a year, reflecting the hideous inflation in our economy.
However, last month, we finally saw a drop in the CPI. The April number came in at 8.3% year-over-year. While that’s still around the highest reading in 40ish years, it was below March’s reading of 8.5%.
When we pop the hood on what goes into the CPI calculation, we find that “energy goods and services” (think gasoline, natural gas, propane, etc.) make up about 7.5% of the overall number.
Clearly, with that heavy of a weighting, the price of energy has a material impact on CPI levels.
Now, let’s look at the average price of WTIC in recent months:
December 2021: $71.71
January 2022: $83.22
February 2022: $91.64
March 2022: $108.50
Just higher and higher, right?
But then came April…
The average price of WTIC fell to $101.78. That was 6.2% below March’s reading.
This is a major reason why CPI cooled off in April.
Oil prices were down for a variety of reason – decreased demand due to China lockdowns, profit-taking, optimism about various macroeconomic challenges which resulted in lower futures prices…
Regardless of why, oil prices fell…which helped pull down the CPI reading.
***But how is May’s average cost for WTIC shaping up?
It’s not official, but I just crunched the daily numbers, and we’re looking at about $109.33.
That’s higher than March’s average. Plus, it’s 7% higher than April’s average.
Translation, oil’s climb in May is going to put upward pressure on the next CPI number. That doesn’t mean the overall CPI number will be higher. But it certainly won’t help.
Given that the Fed is watching all of these data closely as it formulates interest rate policy, we’ll be watching this too.
The next CPI release is schedule for June 10th. We’ll keep you updated.
***Despite this discussion of the CPI, we need to begin shifting our attention away from inflation numbers, and onto the shape of the U.S. consumer
Because we’re approaching a period when we should see inflation subside – because, mathematically, it just about has to – however, prices could still remain so high that they hurt the American consumer.
In explaining this, remember, inflation measures the change in price of a basket of goods over time.
When we measure inflation year-over-year, or month-over-month, our starting values change. This is important because a higher starting value serves as a natural brake on inflation readings. After all, maintaining, say, 10% inflation requires increasingly large nominal values.
After a while, those nominal values get so enormous that they simply can’t keep climbing at the same percentage rate. This makes the percentage change begin to come down even though nominal changes are still huge.
Let’s see what this looks like from a different perspective.
Below, we assume a basket of goods begins with a $100 price tag. It then increases in price every month by a fixed $20 rate.
Notice what happens to the inflation rate thanks to math.
Because each month uses a higher starting value, the inflation rate drops slowly – even though prices are still increasing every month by the same $20.
(Note: As we’re going to press, I realized I didn’t properly align the inflation rate to the appropriate cost increase. It’s one position off. However, this makes no difference to the point I’m making.)
Cost Inflation Rate
Realistically, is the shopper better off because inflation cooled from 16.7% to 5%?
The basket of goods began at $100. At the end of the period, it cost $400.
Prices still went up the same $20 every single month. The decrease in inflation was just mathematic smoke and mirrors.
We’re entering a period in which the starting values for our inflation calculations will be so high that headline inflation numbers should drop. But that’s not going to tell us a thing about real prices impacting your wallet.
Given this, we have to use other measures to check in on the U.S. consumer and our economy. This is important because consumer spending makes up about 70% of the U.S. GDP.
***So far, it’s mostly good news – but we need to keep an eye on this
From The Wall Street Journal:
Recession fears have markets in a panic, but the leaders of America’s biggest bank said U.S. consumers appear to be in good financial health.
JPMorgan Chase & Co. expects credit losses to remain abnormally low through much of 2023, because customers haven’t yet drained cash balances that grew fatter during the pandemic, executives said at the bank’s investor day on Monday.
“Big picture, the near-term credit outlook, especially for the U.S. consumer, remains strong,” said Chief Financial Officer Jeremy Barnum.
Obviously, this is positive. But there are some cracks we need to watch. Deloitte published a “State of the US Consumer: May 2022” report last week.
From its findings:
The percentage of Americans concerned about making upcoming payments hit 35% in May—the highest this metric has reached in two years. This increase joins an uptrend in concerns around savings and credit card debt…
Interestingly, higher-income shoppers appear to be doing fine. Where we’re seeing signs of trouble is lower-income shoppers. Q1 earnings season has shown that lower-income shoppers are already tightening their purse strings.
It will be interesting to see whether Q2 earnings reveal that lower-income shoppers are recovering and buying more…or higher-income shoppers are buying less.
…There is a split in shopping behavior that runs along economic lines, some companies say.
Federal stimulus spending has ended, and inflation has grown at the fastest pace in decades, leading lower-income consumers to alter their buying patterns.
Companies say lower-income shoppers are slowing their spending on discretionary items, buying cheaper private-label brands and adding fewer items to their shopping carts.
“I think what we’re seeing is a bit of a bifurcation. So, we are seeing some customers who are trading up into those more premium brands,” said Kohl’s (KSS) CEO Michelle Gass…
“Obviously, with higher fuel and food prices, discretionary spending for the lower-end customer is being squeezed,” said Ross Stores (ROST) chief operating officer Michael Hartshorn.
“We saw customers… pull back on spending in the first quarter.”
Finally, we also need to be cautious about sentiment.
While a gloomy investor can be a great contrarian indicator, too much gloom (especially with shoppers, as different from investors) can lead to a self-fulfilling downward economic spiral.
Yesterday, we learned that Gallup’s Economic Confidence Index reading for May reflects some souring moods.
Gallup’s Economic Confidence Index measured -45 in May, down from -39 in each of the previous two months. It is the lowest reading in Gallup’s trend during the coronavirus pandemic, and likely the lowest confidence has been since the tail end of the Great Recession in early 2009…
The latest results are based on a May 2-22 Gallup poll, conducted at a time of record-high gas prices, elevated inflation, government reports of declining economic growth in the first quarter, and a slumping stock market.
Bottom line, inflation should start dropping. But that’s no longer the most relevant variable.
At this point, keep your eye on the consumer. After all, as the U.S. shopper goes, so goes the economy.
We’ll keep you updated.
Have a good evening,
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