Personal Finances: A look at the state of the stock market now and in the future

Equity markets rebounded and bonds declined last week following September’s fall and the first 5% pullback in about a year. A temporary deal to raise the debt ceiling until December boosted investor optimism, but volatility remained elevated amid a surge in energy prices, persistent supply-chain disruptions, and labor-market shortages. We offer the following perspective on two factors that are currently clogging the pipes of an economy that remains well supported by pent-up demand, strong consumer finances, and increased corporate spending.
Energy Crunch

  • The price action in commodities stole the spotlight last week, contributing to the elevated volatility in equity and fixed-income markets. Among the eye-catching moves are that oil rose to a seven-year high, natural gas prices briefly spiked to 2008 levels after having doubled this year, and coal rose to record highs. The rocketing prices have triggered an energy crunch in Europe and China, hitting factory output and adding another complication in the long list of supply-chain issues that are holding back the global economic recovery.
  • There is no single cause for the emerging commodity inflation. We see a combination of factors boosting demand and limiting supply.
  • Demand is primarily benefiting from the gradual return of the economy to normal. On top of that, the ongoing pandemic and the restrictions that are still in place in many parts of the world have shifted consumption patterns towards goods and away from services, which translates to higher energy consumption for the manufacturing-focused economies.
  • The recent parabolic rise in coal and natural gas prices has sparked fears that a similar move could be in the cards for oil. We believe that prices will stay supported as oil demand continues to recover from the pandemic. However, the rise in prices is likely to prove self-limiting, as high prices will incentivize increased production.
  • Over the last decade the U.S. rig count, an important barometer for the oil-drilling industry, has closely followed oil prices, as seen in the graph below. However, following last year’s collapse in oil and amid pressures from investors to exercise capital discipline, U.S. shale producers have been very cautious in adding supply. With WTI oil near $80, U.S. producers are able to generate enough profits to maintain healthy financial positions and reinvest in production at the same time.
  • Even as prices have climbed, OPEC and its allies have maintained their output targets, slowly adding back production. But based on the difference between what the cartel is capable of producing and what it is actually producing, there is plenty of room to increase production to offset supply shortages, if they persist.
    High energy prices generally act as a tax on the consumer and have the potential to dent consumption and therefore economic growth. However, we think that currently the economy can withstand any temporary commodity inflationary pressures.
  • Consumers and business are no strangers to $80 or even $100 oil. In the years between 2011 and mid-2014 oil prices averaged $96, while the economy grew at a 2% pace despite a slow labor-market recovery and consumers focusing on paying down debt and saving more. In contrast now, household finances are in good shape, with the personal savings rate elevated and wages rising at the fastest rate in more than a decade.
  • The U.S. and global economies are less reliant on oil than in the past due to significant energy efficiency gains over the years. Energy intensity, or the amount of oil necessary to produce a product or a service, has fallen by more than half since the 1970s, when frequent energy shocks caused stagflation (slow economic growth and rising inflation)
    Worsening Labor Shortages
    The U.S. economy added 194,000 jobs in September, the smallest gain this year and well below estimates. More encouraging was that the August numbers were revised meaningfully higher and the miss in private-sector jobs was less severe. Employment in leisure and hospitality increased by 74,000, even though it remains about 10% below its pre-pandemic level1. The biggest detractor and disappointment came from the 180,000 decline in education (90% in the government sector), which was likely impacted by seasonal factors. With job openings at record levels, the expiration of pandemic benefits, and improving delta-variant trends, we think that hiring will pick up in the coming months, but the path towards returning to full employment will not be a straight line.
  • Despite the disappointing job gains, the unemployment rate fell more than expected, to 4.8%, a new post-pandemic low. However, that was driven by an unexpected drop in the labor-force participation rate, indicating that more people left the workforce. With labor shortages appearing to worsen, employers are boosting pay as they compete to attract workers. Average hourly earnings (wages) rose 4.6% from last year and 0.6% from the previous month, the strongest advance since April.
    The bottom line
    Simultaneous labor and material shortages are causing snags in supply chains, constraining economic activity, and driving prices higher. We think these tensions in the economy will prove to be temporary but are likely to trigger increased market volatility and more moderate returns than experienced over the last 18 months. With our outlook for next year still positive, supported by an improving labor market, excess household savings, low interest rates, and a likely inventory rebuilding, we would view any deep pullbacks as buying or re-balancing opportunities.