To be successful in the current market environment, we need to remain invested in companies that are able to maintain robust earnings and sales growth, as well as benefit from positive analyst estimates.
Right now, the majority of those stocks continue to be found in the energy sector.
As to “why?” energy is maintaining robust earnings and sales growth, all eyes are on Vladimir Putin and his stranglehold over European energy.
In the wake of the Russian invasion into Ukraine and the resulting Western sanctions on Russian energy, Russian President Vladimir Putin has been weaponizing his energy exports to Europe.
Yesterday, that weaponization took a sharp turn for the worse.
From The Wall Street Journal:
Power prices surged, European currencies hit multidecade lows and governments scrambled to contain the economic hit after Russia cut its main natural-gas pipeline to Europe.
The cutoff, which the Kremlin blamed Monday on Western sanctions and said would be long-lasting, realizes the worst-case scenario Europe had been girding for since Russia invaded Ukraine in February.
The natural gas pipeline referenced in the article above is the Nord Stream pipeline. On Monday, when the shutdown was announced, natural-gas and electricity prices initially leapt by roughly 33% before settling up more than 10%.
Back to Louis:
Energy markets around the world remain elevated, as most of Europe strives to break away from Russian crude oil and natural gas.
While some European officials reportedly secured enough natural gas to avoid rationing this winter, it’s a struggle to replace Russian natural gas for 2023 and beyond, despite LNG imports for the U.S., Canada and Qatar.
Building on Louis’ point, here the WSJ:
Gas storage levels have risen ahead of European targets and analysts increasingly think the region will survive the winter without state-directed rationing, albeit at exorbitant costs to the economy through record prices.
Now, we need to throw a wrinkle in here just so you’re aware of what’s going on
From where is Europe now getting its natural gas, if not Russia?
Well, it’s still from Russia…but now, it features a side trip through China.
From New18:
…In the first half of 2022, China’s imports of liquefied natural gas (LNG) jumped 60 per cent year-on-year…
Russia’s sales of pipeline gas to China have increased even more dramatically, growing by almost 65 per cent year on year. However, at a time when China is experiencing an economic slowdown, the Communist nation simply has no use for such volumes of gas.
It is here that Europe comes in.
China has been exporting the surplus natural gas in its storage to Europe at inflated prices, and European buyers, who are desperate for even the smallest of LNG drops, are readily buying the resource from spot markets.
Europeans are paying for the same Russian gas, only that they are now shelling out two to three times more money than they would have had their governments not prematurely sanctioned and antagonised Russia…
Therefore, a major part of natural gas currently in European storages continues to be of Russian origin – with the obvious caveat of it having been bought from China.
Is it any wonder that Europeans are now paying absurdly-inflated prices for energy? It’s the same Russian oil, only now with additional mark-ups to nosebleed prices.
In the midst of this spike in prices and geopolitical turmoil, OPEC and Russia just agreed to cut oil production
On Monday, OPEC+ decided to cut oil production for the first time in more than a year, targeting a reduction of 100,000 barrels a day.
Why would they do this?
Global concerns over a worldwide recession have kneecapped oil prices since this summer. And OPEC+ doesn’t like kneecapped prices.
Back to the WSJ:
…The market’s recent slide prompted the Organization of the Petroleum Exporting Countries and Moscow-led allies, collectively known as OPEC+, to prop up a market that had been lifting petrostate economies from Moscow to Riyadh.
The small cut would reverse the 100,000 barrels a day that OPEC+ said it would add to the market last month following President Biden’s trip to Saudi Arabia, the world’s largest oil exporter. The U.S. and the West have called on OPEC+ to pump more oil to help tame rising inflation, but the group had resisted.
So, where will energy go from here?
To get a bead on what to expect from market prices, let’s jump from Louis’ Weekly Profit Guide to his Platinum Growth Club Special Market Podcast:
Oil prices (yesterday) are pretty flat. The main reason is: China is locking down more of its provinces for Covid. So, their zero-tolerance policy is still impacting their economy.
So, worldwide demand is down for oil. And our demand in North America drops because the summer driving season is largely over…
We’ll see how this impacts everything. I’m expecting crude oil prices to remain relatively firm. They might go down four- or five-dollars a barrel, but they’re going to remain elevated because of all the supply disruptions internationally.
As soon as China picks up, or Europe picks back up – and of course, our demand will resurge in the spring – then oil will be headed higher.
Moving away from energy prices, let’s keep our eye on Europe for another reason
Inflation has been soaring in Europe, hitting a record high of 9.1% in August.
Last month, when inflation was at 8.9%, the European Central Bank (ECB) surprised the world by raising interest rates for the first time in more than 11 years to try to control this runaway inflation.
For context, the interest rate has been negative since 2014 as the ECB has been trying to stimulate economic growth after years of weakness.
Similar to the Fed’s challenge here in the U.S., the ECB is walking a tightrope. It has to raise rates to curb inflation, but higher rates threaten to crush the economy at a time when Europe is already teetering on a major recession.
Be that as it may, more rate hikes are coming – today and tomorrow, in fact.
From Bloomberg:
Central banks around the globe are set to continue an assault on high inflation this week, even as vulnerabilities in their economies become ever clearer.
Northern-hemisphere policy makers are forecast to deliver the more aggressive actions. Unprecedented tightening in the form of a 75-basis-point rate increase is expected from the European Central Bank on Thursday, a day after the Bank of Canada hikes by a similar amount.
That would follow half-point moves anticipated on Tuesday in Australia and Chile. At least five other central banks around the world are also expected to raise rates in the coming week.
On this note, earlier today, the Bank of Canada did, in fact, raise rates by 75 basis points, while signaling there are more hikes to come.
Now, what’s interesting is that this has both positive and negative implications for your portfolio.
The push and pull of global rate hikes
As the Fed has cannonballed into its rate-hiking campaign, the U.S. dollar relative to other currencies has soared.
To see this, below, we look at the U.S. Dollar Index. It’s a measure of the value of the U.S. dollar relative to the value of a basket of six major global currencies – the Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona.
The dollar is up 18% over the last year – a big move for a currency.
Chart showing the US Dollar Index climbing 18% in 2 years
Source: StockCharts.com
As we’ve pointed out in recent Digests, this strong dollar has been bad for U.S. stocks. That’s because roughly 30% of the market-weighted sales of the S&P 500 are international.
So, while a strong dollar is great for U.S. tourists headed to the Italian coastline, it’s terrible for U.S. companies who are getting paid in weakened currencies.
Now, we can’t blame all of the S&P’s woes on the strengthening dollar, but take a look at the chart below and decide for yourself if you see some correlation. The S&P is in green, the Dollar Index in black.
Chart showing the US dollar index and the S&P moving in rough inverse correlation
Source: StockCharts.com
With the ECB and the Bank of England finally raising rates, this should begin to weaken the Dollar Index. And that will be bullish for U.S. stocks.
But that brings up another question…
To what degree will this bullish influence be offset by the bearishness of a hobbled European consumer?
The cost of living in Europe is exploding thanks to energy costs (again, we’d point you toward the absurd new sales route through China).
Here’s Bloomberg with those details:
Energy bills for European households will surge by 2 trillion euros ($2 trillion) at their peak early next year, underscoring the need for government intervention, according to Goldman Sachs Group Inc. utilities analysts.
At their height, energy bills will represent about 15% of Europe’s gross domestic product, the analysts, led by Alberto Gandolfi and Mafalda Pombeiro, wrote in a note dated Sunday.
“In our view, the market continues to underestimate the depth, the breadth and the structural repercussions of the crisis,” they wrote. “We believe these will be even deeper than the 1970s oil crisis.”
And here’s The New York Times:
Economic anxiety is palpable across Europe.
In Prague, a day after the government survived a no-confidence vote over accusations that it had failed to act on soaring prices, tens of thousands of protesters took to the streets on Saturday to voice outrage over energy costs.
Led by far-right and fringe political groups, many demonstrators also criticized the Czech Republic’s membership in NATO and the European Union.
The protests underline growing concerns among European leaders that the energy crisis and soaring inflation could trigger political instability.
Many citizens said they feared for their savings, and worried they might be unable to pay their bills come winter.
Clearly, if Europeans are fearing for their savings and unable to pay their bills come winter, they’re not going to be splurging on, say, those new running shoes from Nike, or the latest iPhone upgrade – and with so much of the S&P’s revenues coming from Europe, that’s bad news for your portfolio.
Two weeks ago, economists polled by Bloomberg put the odds of a euro-area recession at 60%. That’s the highest level since before Russian invaded Ukraine.
And in the face of this, many prominent European politicians are calling for the ECB to hike rates by 75 basis points tomorrow.
Yes, such a hike might begin to chip away at inflation. But equally yes, it will continue to chip away at the health of the European consumer.
So, which will be the biggest influence on your portfolio? Currency tailwinds (meaning a weakening U.S. dollar)? Or demand headwinds (meaning reduced European demand for U.S. products)?
This is what we’ll be monitoring as we move late into the year. For now, following Louis into top-tier energy plays is a great bet.
Wrapping up, we’ll quote Louis: “Fascinating times we’re living in.”
