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Investing

Energy prices are soaring. Should you be worried?

We don’t believe these recent moves will derail our constructive view.


 

Our Top Market Takeaways for October 8, 2021.

Market thoughts

Sweet relief

After a crummy close to the third quarter, stocks seem to be finding a foothold. The S&P 500 headed into Friday morning up +1% on the week, with every sector (and more than two-thirds of companies in the index) in the green. Meanwhile, Treasury yields across the curve have edged higher (overnight, the 10-year touched 1.60% for the first time since June).

Just last week, we offered a litany of reasons why broad market sentiment was skewing more bearish than bullish. What changed?

  • Congress put fears of a debt ceiling breach on ice. The Senate passed a bill to raise the government’s borrowing capacity by enough to keep its financial taps open for another month. The House is expected to pass the measure early next week. A longer-term solution is still up in the air, but investors seemed to take the news as good enough for now. There’s no doubt we’re due for more D.C. drama in the weeks ahead, but regardless, we don’t think this story ends in default.
  • Economic data got out of the dumps. September brought a slew of disappointments, but October is so far exceeding expectations. In the United States, measures of industrial orders, services and manufacturing activity, consumer sentiment and labor market gains—among others—have beaten estimates. And while today's jobs report came in well below expectations (the economy added 194,000 jobs in September versus the 500,000 expected), there were bright spots in the details: Last month’s figures saw significant upward revisions, the unemployment rate continued to decline (now standing at 4.8%), and the private payrolls trend—which strips out government jobs—remains solid. We don’t think today’s report changes anything about the likelihood of the Federal Reserve announcing tapering next month.
  • New earnings results reminded us that not every company is hamstringed by supply chain struggles. For example, Levi bested expectations thanks to strong back-to-school spending and diversified production resourcing (and probably because millennials are frantically refreshing their jean collections to avoid being labeled as “cheugs” by Gen Z 1). Earnings drive stocks over the long run, and we have an upbeat outlook heading into the kickoff of the Q3 reporting season next week. 

The strength of demand, still-low borrowing costs encouraging investment, and improving COVID-19 trends contribute to our ongoing optimism about stocks into 2022. We’re keen on putting excess cash to work in ways that balance growth and value exposures in equities, or in yield-seeking active managers able to navigate what may be a volatile interest rate environment ahead. But as investors position for more upside, they should acknowledge there may be near-term muck to trudge through such as the recent and torrid rise in energy prices, for example.

Spotlight

What’s up with the surge in energy prices?

U.K. and European natural gas prices are hitting records, forcing a number of suppliers to shut down. Oil prices are likewise climbing higher, and altogether the surge has majorly poked the big inflation bear. Eurozone headline inflation just came in at a 13-year high, and investors are questioning how long it will last, what it means, and what the policy response might be.

First things first: How did this even happen?

In short, a whole lotta supply issues, mostly out of Europe. The combination of a cold winter and import disruptions in Russia and Norway (which produce about half of Europe’s gas) has chipped Europe’s stockpiles away to their lowest seasonal levels in more than a decade.

At the same time, other energy alternatives have gotten squeezed. Wind turbines slowed unexpectedly from a still summer. Coal got pinched amid already low supply from European mines and high demand from China. And in the case of oil, OPEC producers haven’t been meeting their production targets.

Last, a shift toward climate-friendlier policies has made “traditional” energy commodities with a larger carbon footprint—such as coal, oil and natural gas—more expensive.

But we have some good news. This energy crisis doesn’t spell doom for our positive outlook on the expansion.

For a few reasons:

  • At least one key player is already moving to mitigate the pain. Russia (again, a big gas supplier) has said it will send more than it’s contractually supposed to this year (which helped lead to some respite in the price spike during the latter half of this week—UK natural gas prices have fallen -9% over the last two days).
  • Growth is a lot less reliant on energy than in years past. The energy intensity of the U.S. economy (GDP generated per unit of oil) is down by a whopping 70% since the 1970s.
  • Governments seem willing to step in to bear some of these costs, suggesting help could be on the way for plagued suppliers, and the full brunt of it is less likely to be passed on to consumers. The EU has already promised to revise market rules around energy prices before the end of the year, as well as to telegraph measures such as tax cuts and state aid.
  • The surge shouldn’t put too much pressure on consumers. Americans only spend about 3% of their after-tax incomes on gas (though the biggest impact would be felt by the lowest income earners). Such spending is similarly low in Europe—gas, electricity, and fuel account for 2.5% of U.K. and 3.8% of Eurozone consumer spending. Not to mention consumer balance sheets are still flush with cash.
  • The Fed and the ECB haven’t blinked. Central bankers tend to focus on “core” inflation, which excludes food and energy, to guide their policy decisions, and inflation expectations haven’t gotten out of control.

That all said, the full impact will ultimately depend on how long prices stay elevated.

This issue is one of the many ongoing supply bottlenecks plaguing the recovery, and there could be more pain ahead. But also like other supply woes, we expect the tensions to dissipate into 2022. These moves do not cause us to change our constructive outlook on growth and risk assets. The economy is less reliant on energy than in the past, energy costs represent a small proportion of consumers’ pocketbooks (which are also already strong), governments seem willing to socialize some of the costs, and Fed and ECB policymakers seem apt to remain patient and data-dependent in their approaches.

Culture

A big fat bear

It’s that time of year again: Fat Bear Week! Alaska’s Katmai National Park put on its annual battle for the title of “bulkiest bear.” The contenders have been putting on the poundage ahead of their annual slumber, thanks to a lot of salmon. Now, after extensive voting and much hype, 480 Otis has been crowned the chonkiest boy around town, weighing in at over 1,000 pounds. This isn’t his first win, either—he was also the champ in 2014, 2016 and 2017. Have a good snooze, Otis; you’ve earned it.

 

1. Gen Z has charmingly dubbed a “cheug” as someone who tends to be unhip, follows out of date trends, and generally falls into the Millennial demographic. We can’t keep up, either. 

 

All market and economic data as of October 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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  • Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

IMPORTANT INFORMATION

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

All market and economic data as of October 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision.


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