Rising energy prices will shake up the stock markets


Worried about inflation? You are not alone. A survey conducted by Aegon this week showed that 64% of people are concerned about “the impact of rising inflation on their finances.”

Businesses are also (very) worried: the latest quarterly report from the UK Chambers of Commerce showed that 59% of businesses expect prices to rise in the next three months; 66% said inflation was a “concern”. These two figures are records.

What is the driver? Some 30 percent of companies said wage settlements were part of it (you could think of that as good inflation!), But 94 percent blamed commodities (bad inflation).

Much of this relates to energy prices: Wholesale gas prices have been climbing everywhere – in the UK they are five times higher than a year ago, which will hurt everyone’s cash flow. housework.

The Bank of America estimates that the average European household spent around € 1,200 on electricity and gas in 2020, a number which, based on current wholesale prices, will rise to € 1,850 by the end of 2022, an increase of 55%.

Next year is unlikely to be much better. Energy prices will continue to rise. Why? Because too many governments have jumped on renewables – believing that we can phase out fossil fuels in favor of deeply unreliable renewables much faster than we actually can – if we ever can.

This is a decarbonization shock – which one fund manager says could even end up causing as much pain as the oil shocks caused by OPEC in the 1970s. Maybe it should make you angry. against environmental activists who forced divestment from fossil fuels a decade too early and argued for these painful green taxes on energy bills.

There is some relief to come, for example, the EU’s acceptance better late than never that natural gas and nuclear power must be part of the transition. But, for now at least, prices will continue to rise. It is, according to analysts at JPMorgan, a simple question of supply and demand, as always. . .

There has been a collapse in investment in oil and gas production – capital spending on new projects is down 75% from its peak. But at the same time, the global demand for thermal energy sources as a whole has “barely declined” – and the demand for oil keeps increasing.

JPM expects global oil demand to increase by 3.5 million barrels per day in 2022, ending the year both slightly above 2019 levels and at an all time high. There will be a new high in 2023 – there are a lot of records in today’s column – no more unwanted inflation, I’m afraid. JPMorgan’s various research teams predict that oil prices in 2022 will be between $ 80 and $ 125 per barrel. The world’s efforts in favor of energy transition are obviously well-intentioned. But good intentions often come at a surprisingly high price. No exceptions here.

However, while it’s easy to hang on to gas bills and prices at the pump – UK politicians have all but forgotten about Covid in their rush to argue over it – rising energy prices may have an impact. far greater impact on your long-term wealth than on your short-term cash flow. to flow.

Why? Because energy, and the transformation of that energy into goods and services, is the basis of most economic activities. That’s how much it costs and how efficiently we can turn it into absolutely essential variables in market valuation.

So much so that you can, according to Charles Gave de Gavekal, use the relationship between oil prices and the S&P 500 to forecast both bull and bear markets. All of the “structural bear markets in the US all started when the S&P 500 was significantly overvalued relative to Energy,” Gave explains.

This was the case in 1912, 1929, 1968 and 2000. In each of these years, valuations reflected investors underestimating the future cost of energy and therefore overestimating the future profitability of listed companies.

Those who are not yet nervous enough may also note that all of these bear markets, with the exception of the one of 1929-34, happened with rising inflation and “lasted as long as inflation lasted.”

It makes sense if you think about it in terms of rising energy prices driving up costs and then companies not being able to add value or improve efficiency quickly enough to absorb. costs without raising prices or experiencing a severe collapse in profits.

The former creates inflation and causes demand to fall – which affects earnings anyway – so that, in any case, valued stocks with low energy costs built into the models start to look wickedly overvalued.

One more point to make here. In recent decades, one of the disinflationary impulses in the West has been the cheap goods from China. These products were cheap partly because they were made with cheap labor – now becoming more expensive – but also because they were made with the cheapest thermal fuel available – coal.

This is something that is also changing. China, anxious to reduce pollution and perhaps even to decarbonize, aims to reduce coal to 20% of its energy mix by 2026. This is far from certain of course, given the political pressures and internal economics, but you can see which way things are going.

The key point here is that energy prices matter even more than you might think. Bull markets start when energy is plentiful and cheap (1922, 1949, 1982, 2010 according to Gave). Bear markets start at times when they don’t. Times like these.

The investment implications are clear. Energy stocks performed very well last year. They will probably do the same this year. But their strength may very well be reflected in serious weakness elsewhere.

You have to cover the first with the second. The easiest way to get exposure to oil and gas in the UK is to use an exchange traded fund, such as the iShares S&P Commodity Producers Oil and Gas ETF. Alternatively, there’s the TB Guinness Global Energy Fund, which is all about old energy, or if you want to hedge your energy bets, take a look at the BlackRock Energy and Resources Income Trust, which is around 33 percent. cent invested in old energy, or the diversified Temple Bar Investment Trust with 15 percent (which I own).

Merryn Somerset Webb is the managing editor of MoneyWeek. The opinions expressed are personal; [email protected]; Twitter: @MerrynSW


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