“The national average price for regular gasoline is a full dollar (or more) a gallon lower than a year ago. Drivers paid over $4.60 in May 2022, and prices had reached $5 by the second week of June. They recently paid just over $3.50 (or lower prices) a gallon for regular gasoline, according to AAA, the motor club.”
(“Gasoline Prices, a Source of Pain Last Year, Have Come Way Down,” https://www.nytimes.com/2023/05/26/business/energy-environment/oil-gasoline-prices-summer.html)
To translate the NYTimes story into economics and markets, we used this source to estimate what the change in gasoline price really means: “How Much Money Would a Gas Tax Increase Raise?” https://www.enotrans.org/article/how-much-money-would-a-gas-tax-increase-raise/.
Let’s simplify. A penny a gallon spread across all the fuel categories amounts to about $1.7 billion a year. Using the price history of the last year, that means the American consumer has had a tax cut of about $200 billion. And the tax cut is continuing as this is written.
That’s huge.
If you’re in NY City and don’t own a car and you ride the subway to work, the impact is secondary only and quite small. If you’re in Montana and drive 100 miles to work each way, it is big. If you own an electric car, the impact is only on secondary costs. But most of the United States is running on oil and what is derived from oil. So, the metric of a penny a gallon is valid, and its validity is declining only very slowly, as the citation sourced above discusses.
This leads us to several inferences.
Bullets:
1. The Fed’s anti-inflation fight has been helped by the fall in oil and energy pricing. Meanwhile, the Fed is still witnessing inflation above 4% as measured by the Fed’s important indicators, and that is after the benefit of the oil price decline. Do we expect a second year of declining oil prices? Could this $200 billion annualized gift be repeated? Of course, anything can happen, but we don’t expect it to happen. It would take persisting $50-a-barrel oil to get this gift again.
We think most of the benefit of the oil price decline is behind us. Furthermore, the strategic outlook is for higher, not lower, oil prices. Russian production declining, China’s eventual reopening, a mixed US policy that is not favorable to rapid expansion of US oil production, and a refilling of the Strategic Petroleum Reserve (SPR) all point to oil prices making a pricing floor now. OPEC will weigh in on that, too. Bottom line for the Fed is, the help from falling oil is probably over.
2. The American consumer still has about a half trillion in estimated excess Covid savings. And we got this tax cut from the falling gasoline prices. The spending of those excess savings shows up in consumer discretionary spending by those people who have the savings to spend. Hence airlines are booming and cruise lines are busy.
3. This scenario is outside the debt ceiling negotiation results and outside the existing budget effects. Furthermore, the outlook over the next two years is for little change in the post-debt ceiling structure.
4. Sure, electric cars are going to become more prevalent, and that seems to be desirable for many folks who are in favor of environmentally sensitive policies. But that is happening at a slowly progressing pace, and the anti-ESG governors are slowing the pace of change.
Texas’s assault on renewable energy is an example. The Wall Street Journal had this to say about the situation in Texas:
“Wind and solar have grown to provide 31% of the electricity in Texas, closing in on natural gas at 43%. Several coal plants have closed, unable to compete against natural gas or the plummeting cost of building renewables, fueling more green investment. But the success of wind and solar has provoked powerful enemies.”
(“Texas, a Clean-Energy Pioneer, Turns Against Renewables,” https://www.wsj.com/articles/texas-clean-energy-renewables-opposition-a654a2d5)
The investment implications to our US Equity ETF strategy are important.
We have an overweight position established in the travel, leisure, and aviation sectors. We are also preserving the overweight energy position with a blended mix of domestic US oil and gas production and a continuation of our renewable and alternative energy positions.
We continue to expect the Fed to lean against inflation, as it cannot credibly abandon its 2% target. That means the current level of interest rates is likely to stay in place for some time; it may even go higher. Market agents seem to be changing their views about a Fed “pivot” to lowering rates several times in the second half of this year. We don’t see it happening without a major sort of shock like a “TARP moment” in politics or a sequence of banking system collapses. The banks have had failures, but the depositors are intact. That is key. No contagion. And the debt ceiling fight did billions in harm, but the US didn’t default. The damage is already done.
We are still maintaining a strategic cash reserve. Remember, that could change at any time. We are not chasing the narrow five or seven or eight large-cap tech stocks that are driving up the S&P 500 Index. We have instead positioned with equal weight of that index. The difference in performance between these two measures of the same 500 stocks is about 10% year-to-date, with the tech-heavy, cap-weighted index outperforming the equal-weighted version. The last time we saw that wide a disparity was in the 1998–1999 tech stock bubble period.
We encourage readers to enjoy the energy price cut while it lasts.
A postscript on the debt ceiling is in order.
Up until 2011, the debt ceiling was lifted many times and without all this nonsense we just witnessed. What is little noted is that Newt Gingrich led the change in rules in 2011 and avoided the House using the old Gephardt rule. Here’s the link to the story about the rule: “Developing Debt-Limit Legislation: The House's ‘Gephardt Rule,’” https://congressionalresearch.com/RL31913/document.php . The rule is simple: If you (House of Representatives) appropriate and approve spending, you have to pay for it. The rule links spending appropriations with payment obligations and therefore eliminates the nonsense we have just witnessed, which was imposed at high cost to the nation.
Here’s a Brookings paper about the debt ceiling, for background: https://www.brookings.edu/2023/01/19/7-things-to-know-about-the-debt-limit/.
In my opinion, Congress should permanently repeal the debt ceiling.
David R. Kotok
Chairman & Chief Investment Officer
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