Gas shortage, meet money shortage
A recession is unlikely to solve an energy shortfall, but that won't stop us from trying! Plus, scenes from the housing market and bullish on BNPappLe
The why and what of this inflation aren’t actually that complicated, so why are we doing it exactly wrong? Random Walk makes some predictions and has never wanted to be wronger.
Gas, Gas, Baby
Energy inflation is not the same as goods inflation
The recent CPI report shows inflation coming in hot. Inflation is bad. We must raise rates to cool the economy and so the Fed did. Money is now more expensive. Things like houses that require lots of borrowed money are now more expensive. Stocks are now a lot cheaper.
Good news, right? Random Walk has long taken the position that inflation is not transitory and that monetary policy (rates) has at least something to do with it. Random Walk should be happy that consensus has finally caught up. Right . . ?
Wrong.
The thing about inflation (and prices generally) is that it’s a composite signal of supply(ies) and demand(s). In the case of the CPI, it’s really a bucket of prices—a composite of composites (of composites), if you will. Prices can indeed go up if it’s too easy to get money. Prices can also go up if it’s too hard to get stuff. ‘How easy’ is the right amount of easy and ‘how hard’ is the right amount of hard are both pretty thorny questions. Whether it’s bad and what’s to be done about it both very much turn on those same thorny questions.
A good place to start, however, is to actually look at the prices:
That light blue line running away from the pack is energy—energy is clocking in at a whopping ~36% annual change.
Gas prices specifically are nearly 2x what they were before the pandemic:
So it’s pretty clear that the inflation we care about is energy prices, and its derivative, food prices.1 Everything else, as denoted by the red line, is actually doing ok, or at least trending in the right direction.
Energy was never a pandemic must-have item
As to the first question, “is it bad?” skyrocketing energy and food prices seem bad. As to the second question, “what is to be done?” well it depends on how we got here. [NB: read ahead for the 5-minute version or skip to the 15-second Twitter meme finale.]
If “raise rates” was the smart treatment, the diagnosis story would go something like this: with all that stimulus and free money, we went on a gas-buying binge and created a shortage. Similar to what happened with the price of goods, the remedy is to remove the conditions that made the binging possible. That would make sense, except that no such thing happened and no binging ever really occurred.
Take a look at this plot of gas prices v. gas sold and follow the pink spiky line (follow, follow, follow, follow, follow . . . ):
That pink line—gasoline sold—is still below pre-pandemic levels. In other words, we consumed less gas during the pandemic and we’re still consuming less gas than we did before the pandemic.
McKinsey, too, points out that energy consumption was down relatively speaking, and the increase in spend is driven by the increase in prices (which obviously could not have been driven by an increase in consumption):
So if we didn’t go on a buying binge, then what changed? Why the gradual-then-sudden run-up in prices? It’s gotta be the supply, Random. Supply changed. That’s what.
If we just stopped making energy, what could go wrong?
Random Walk is no oil expert, but he has played one on TV. Either way, we’re going to shoot from the hip a bit, but the data tells a pretty consistent story: supply took a pandemic nosedive, but then took an awfully long time to “get back to normal” and by some measures still has not returned to normal:
US Field Production of Crude Oil (which is still not back to normal):
Change in capacity—still not back to normal—and GDP as a proxy for demand:
Changes in US Refinery output of both gas and distillate (also not back to normal):
Drilling permits (on life support):
Here’s what seems to have happened: when the pandemic hit, prices dropped and so did production. That makes sense. But as the economy (and demand) came “roaring back to life” supply did not, or it did so far more slowly and only with a great deal of coaxing from exorbitantly high prices, which remain high because shortages persist.
Why does supply take its sweet time? I suppose any number of reasons, but Random Walk has to assume that ESGs and Green New Deals (gradual) have at least something to do with it, and then, a war (sudden).2 The not-so-subtle hostility to fossil fuels put supply on the backpedal and prices on the march as supply lagged demand, but when the war in Europe broke out (even as Russian oil continues to mostly flow), people really started to get skittish. I mean, goodness, look what we’ve done to our strategic reserves:
More expensive money will not make more energy
Anyways, it seems pretty clear that prices have gone up as supply has gone down (and not as consumption has gone up), which brings us back to the story at hand—the why (and therefore the what to do about it) of inflation: none of this has much to do with “too much money chasing too little stuff,” interest rates, supply chains, or even government spending. That was the last inflation. This inflation is about an energy supply shock—war in Ukraine—topping off a longer-term energy supply handicap—ESG. We didn’t buy too much gas. We made too little.
The solution to this inflation is, therefore, to bring supply back online, (a) in the near term, by ending a war, and (b) in the longer term, by increasing the supply of fossil fuels (which signals markets in the near term). Now, one may reasonably object to either of those things for any number of very good reasons, but it doesn’t change the fact that inflation is the price we pay.
Raising rates? That’s just going to cause a recession. To be fair, it will reduce inflation (at least somewhat) by destroying demand and productivity—no need to drive, if you’re unemployed—but that’s the kind of inflation we like. It will do nothing, however, to restore the supply of gas. To reiterate, it’s possible that this is the “real price” of gas, when you take into account the cost to the environment—pain now, or pain later, it’s pain either way. Even if that makes sense, i.e. energy inflation is good and right, it still doesn’t make sense to add insult to injury by making money more expensive too.
Twitter meme finale
Random Walk finds it hard not to be cynical, mad even, under the circumstances. The Fed is basically saying that “we must control inflation but since we don’t control foreign policy or energy policy we have no chance but to grind the economy into the dirt and make homes and cars really expensive while doing nothing to address the most proximate cause of inflation.” No bueno:
Subsidize demand via a tax holiday? That we might do. Price caps to exacerbate shortages? That too, in defiance of all reason and history, we might do. Remove supply-side barriers to actually bring costs down? No sirree:
Yellen rejected the idea of reviving the Canada-U.S. Keystone XL oil pipeline project as a way to ease upward pressure on near-term oil prices caused by Russia's invasion of Ukraine.
U.S. President Joe Biden on his first day in office rejected the permit for Keystone XL, which would have carried modified bitumen from Canada's oil sands to refineries in the U.S. Midwest and Gulf Coast, arguing that it would lock in decades of carbon intensive fossil fuel use in the United States.
To recap:
back then, we topped off a decade-long run of low rates and high borrowing (secular trend) with a hot-cash injection straight into our shop-or-die veins (shock). We bought way more stuff than anyone anticipated and the result was shortages and expensive goods (which we blamed on “supply chains” but that’s like blaming bartenders for SantaCon). The remedy for too-much-money-same-amount-of-stuff was ending stimulus and lockdowns, and getting gradual rate hikes back on track (while reducing government spend);3
back now, we topped off years-long efforts to punish fossil fuel production with a sudden interruption of a major source of fossil fuels (and its derivative products like fertilizer and food). Our consumption habits didn’t change, we just have a lot less (and the anticipation of even less going forward) of a thing we consume a lot of in the normal course. The remedy for same-amount-of-money-too-little-gas is most certainly not even less money. That is lunacy. And yet, here we apparently go.
The Housing Hold Steady Holds Steady
To solve soaring gas prices, we’ve made it much more expensive to buy a house because that is science, and you just wouldn’t understand:
Rates haven’t been this high since ~2008 and the change has been sudden. This is not the “V-Shaped Recovery” we typically root for:
The immediate implications are pretty straightforward. If it costs more to finance a home, then people aren’t going to be able to spend as much on homes as they did before—that’s a headwind for home prices.
As of now, home prices are still holding steady, but prices should cool as supply is starting to come online and price cuts are in the offing:
It also means that anything related to new home sales is going to take a hit, like Redfin and Compass, both of whom laid a bunch of people off.
It also, also means that anything homeowners would pay for with a refi is probably going to take a hit. No one is going to be refinancing their pre-2022 mortgage anytime soon:
It does not mean that housing prices will collapse, however (something Random Walk has covered before)—delinquency rates are still very low (Black Knight) and in-place fixed rates are also very low so there is no reason to expect a glut of foreclosures (unless things get very bad):
Demand is cooling, but supply is still way behind.
BNPappLe
Apple announced it was introducing a BNPL product. I am reminded of the Piper Sandler “Taking Stock with Teens” that Random Walk shared a few episodes prior, which revealed that all teens have iPhones (87%) and unsurprisingly it’s how they like to pay for things:
Good luck to the field. It was nice knowing you.
Things we read
Alphasense finds $225M at a $1.7B valuation: customer numbers growing by 110% in 2021, with the range of typical uses including companies in the S&P 100 (75% are customers); the Dow 50 (97%); and large asset management firms and banks (70% of all of these in the U.S., the company claims, are users); along with those working within energy, industrials, consumer goods and technology sectors. . . ‘We focus on the search for unstructured information, and we provide structure to it,” [the CEO] said. Web search intelligence is a problem that is constantly being fed through machine learning algorithms. The more people search on Google, the better Google gets. “But our system has to understand language and land on the right information without the benefit and insights of millions of web searches. None of that exists for private information.’
In Active Management, Alpha Comes Down to One Thing: When it comes to generating alpha, nothing matters more than picking the right stocks. The average alpha derived from stock research is 319 basis points, according to the latest study from Inalytics. In comparison, sizing, which refers to deciding how much capital to deploy to specific stocks, produced a small alpha loss of 11 basis points. The results signify that “elite managers are highly adept at deciding what to own through the research process,” according to the study. But unfortunately, “all the effort that then goes into deciding how much to own” is not as effective in generating outsized returns.
Private Equity Races for Data: An overwhelming majority of respondents (90%) agree that increased competition for assets is driving their firm to reassess its use of data and technology, with just over one-third (37%) strongly agreeing with that analysis. . . Delving further into the reasons why PE firms invest in data analytics, the desire to spot emerging trends in markets more quickly is the primary motivating factor for the largest share (50%) of respondents.
Is there a housing shortage or not? So, historical evidence suggests that the US is short at least several million housing units. This shortage largely shows up as too few vacancies, which we would expect to drive up housing prices and make it harder to find a home (which of course has been the story of the last 2 years of the housing market.) A shortage of vacancies also helps explain why simple eyeballing of building rates and population growth rates doesn’t seem to reveal much of a problem - since there’s only a small fraction of homes on the market at any given time, a small percentage point change in total housing units vacant can make a big difference.
Fetch Rewards Finds Record-Breaking Grocery Prices Are Changing How Consumers Shop: Consumers leaving the store with fewer units is a challenge for retailers and brands. However, those retailers with the lowest price increases are experiencing the least disruption in basket size. Costco remains an outlier, showing strong performance in Items Per Trip despite the largest increase in average unit price, likely a result of dominating the stock-up trip game while gas prices remain high.
Food prices are worthy of their own post, but it takes fossil fuel fertilizer to grow food and fossil fuel energy to move it around.
Matt Levine posits the following, albeit with a slightly different inquiry in mind:
Let’s say that you are a giant universal investor and you own 10% of every company in the world. The chief executive officer of one of your portfolio companies, a US oil and gas exploration and production business, calls you up and says “hey, oil prices are really high, I want to drill a bunch of wells and ramp up production to sell lots of oil at $120 a barrel, whaddaya think?” What do you think?
Here are some things that you might say to this CEO, specifically because you are a giant universal investor and you own 10% of every company in the world:
Look: I own 10% of your company, but I also own 10% of every other oil driller. They’re all going to call me up and say the same thing: “Let’s drill more oil.” If I say yes to all of them, the volume of oil production will go up, but the price will go down. Everyone will drill more oil and sell it for less money, and we’ll all be worse off. Sure if only you drilled more oil you would make more money, but I own all of your competitors, so I can’t think in those terms. If everyone drilled more oil, no one would make more money. And in fact in the last big oil boom, everyone did drill more oil, and it cost public investors like me hundreds of billions of dollars. So, no.
Look: I own 10% of your company, but I also own 10% of every beachfront hotel company, and of every other company in the world for that matter. More oil drilling will make you more money, sure, but it will also cause more global warming, which will cause lots of economic destruction and instability. As a universal investor, I am paid primarily to think about systemic risks, not to care about the operations of any one company. The systemic risks to my portfolio from the global warming will be much greater than the profits to me from you drilling a bit more oil, so I am philosophically trying to transition all my portfolio companies away from fossil-fuel extraction.[1] So, no
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