10-18-22: Inflation Stays Stubbornly High, So the Fed Will Likely Stay Aggressive

by Louis Navellier

October 18, 2022

Both major inflation indexes came out last week, and both were higher than expected. On Wednesday, the Labor Department announced that its Producer Price Index (PPI) rose 0.4% in September and 8.5% in the past 12 months. The core PPI, excluding food, energy, and trade margins, rose 0.4% in September and 5.6% in the past 12 months. Food prices rose 1.2% in September, while energy prices rose 0.7%.

Then, on Thursday, the Labor Department announced that its Consumer Price Index (CPI) rose 0.4% in September and 8.2% in the past 12 months. The core CPI, excluding food and energy, rose 0.6% in September and 6.6% in the past 12 months. In August, the core CPI was running at a 6.3% annual pace, so this acceleration in the core rate to 6.6%, the highest in 40 years (since August 1982) is very alarming.

The Owners’ Equivalent Rent rose 0.8% in September, so high housing costs are part of the problem. Gasoline prices declined 4.9% in September, while natural gas prices rose 2.9%. Overall energy costs declined 2.1% in September, while food prices rose 0.8%. In summary, both inflation reports guarantee the Fed will continue to raise rates. The good news is that Social Security benefits will rise 8.7% in 2023.

The latest Federal Open Market Committee (FOMC) minutes were released on Wednesday, revealing that Fed officials were concerned about the persistence of high inflation. As a result, a 0.75% key interest rate hike at the November FOMC meeting is virtually certain. Furthermore, another rate hike of 0.50% or perhaps 0.75% in December may be necessary to get the federal funds rate in-line with market rates.

In the weekly job report, the Labor Department announced on Thursday that new claims for unemployment rose to 228,000 in the latest week, up from 219,000 in the previous week. Continuing unemployment claims rose to 1.368 million in the latest week up from a revised 1.365 million in the previous week. The 4-week moving average of unemployment claims and continuing claims is now starting to rise, so it appears that the unemployment rate will also start to rise in the upcoming months.

The Commerce Department on Friday announced that retail sales were unchanged in September, which was below economists’ consensus estimate of a 0.3% increase. This is a big disappointment and will likely cause economists to cut their third-quarter GDP estimates. There are mounting concerns that higher interest rates and inflation are now impeding consumer spending. When retail sales run below the inflation rate, that signifies an economic contraction, and since consumer spending accounts for approximately 70% of GDP growth, that indicates a potential recession. The only good news was that August retail sales were revised up slightly to a 0.4% increase, up from 0.3% previously reported.

The Atlanta Fed is now estimating 2.8% annual GDP growth for the third quarter. They cited a shrinking trade deficit as the primary reason for this strong third-quarter GDP estimate. Specifically, the shrinking trade deficit (due partially to SPR crude oil exports) is now accounting for 2.2% of their 2.8% GDP estimate.

Russia and China’s Leaders May Be Facing New Realities

While Russia and Ukraine are involved in a real war, and the U.S. is providing billions in aid, the Biden Administration is also escalating its trade war with China. Specifically, the U.S. restrictions on the export of semiconductor chips and semiconductor-making equipment to China, spooked many semiconductor stocks last week. Also last week, the Commerce Department announced their new rules that require semiconductor companies to obtain a license to export advanced semiconductor chips as well as chip-making equipment. As a result, The Wall Street Journal reported on Thursday that KLA Corporation and Lam Research suspended supplying China’s Yangtze Memory Technology after the Biden Administration’s sweeping curbs to Chinese firms. The bottom line is that the Biden Administration is striving to force U.S. semiconductor companies to repatriate their semiconductor manufacturing and stifle China’s emerging semiconductor industry. Unfortunately, the Biden Administration actions are hurting all semiconductor companies, whether they are based in China, Singapore, Taiwan, or the U.S.

In the midst of these economic and military conflicts, the leadership in China and Russia remain extremely authoritarian. It will be very interesting to see if Xi and/or Putin will show up at the G20 meeting scheduled in Bali, Indonesia in mid-November. Interestingly, both Xi and Putin have been reluctant to travel due to their respective domestic problems. The world needs to prepare for a potential leadership change in China and/or Russia in the upcoming years, since neither Xi nor Putin seems to be in control of their respective citizens.

Vladimir Putin is under tremendous domestic pressure in Russia as reservists flee the country, since they do not want to join the fight in Ukraine. The surrender and retreat of Russian soldiers in Ukraine is expected to possibly overthrow Putin’s leadership. In the meantime, the blast on the Crimean bridge is further isolating Russian troops, since a key supply line has been cut off. Putin’s retaliation for the bridge blast was a series of long-range cruise missile attacks on Kiev and other major Ukrainian cities.

The uncertainty of whether Russia will allow Ukraine to continue exporting wheat from its port in Odessa caused wheat prices to soar after cruise missile attacks. In this environment, the only certainty is that fossil fuels will remain in high demand in 2023 as Europe strives to diversify away from Russia. An economic recovery in China as well as Europe would also put more upward pressure on crude oil prices.

Worldwide demand for crude oil naturally rises in the spring when demand picks up, so $120 per barrel crude oil is very possible next spring, especially if China’s economic engine fires up again. China’s “Covid Zero” lockdown in key provinces is now being cited as a possible cover for President Xi Jinping squelching opposition after dispatching tanks to confront people upset that they could not withdraw their savings from the People’s Bank of China. The Communist Party is meeting in mid-October and over 2,000 members are taking part in selecting the new leadership for the party’s Central Committee, the 25-person Politburo, and the 7-person Politburo Standing Committee. President Xi Jinping is vying for an unprecedented third term after his previous two predecessors stepped down after only two consecutive 5-year terms.

In the end, fossil fuels accounted for 80% of global energy production in 2020, according to the Energy Information Administration. However, due to the fact that Europe, India, Indonesia, and China are all now burning more coal, it is estimated that fossil fuels in 2022 are likely to account for up to 84% of global energy production. The green revolution has been stalled by soaring prices of lithium, nickel, and cobalt, which is why Ford, Lucid, Rivian, Tesla, and other EV companies keep raising the price of their EVs.

The truth of the matter is that ESG policies drove most energy stocks out of the Dow Jones index (with the exception of Chevron) and energy stocks fell to barely 2% of the S&P 500 at the end of 2021. Today, energy stocks have risen to almost 6% of the S&P 500 and they could rise to as high as 30% if coal, crude oil, and natural gas prices continue to rise for the foreseeable future.

Our Portfolio Strategies in Light of These New Realities

As you know, our dividend and growth portfolios remain grossly overweighted in energy stocks, which is why we anticipate they will post strong sales and earnings for the next couple of quarters. As a result, we are extremely optimistic about the upcoming third-quarter announcement season. We are poised to profit from the high prices of coal, crude oil, and natural gas. I also recommend companies profiting from solar energy, powerwalls, and EVs, even though the transition to green economy has stalled, due to rising costs.

Speaking of powerwalls, General Motors now wants to get into the powerwall business. Specifically, Travis Hester, the head of GM’s EV growth initiatives, said in the Wall Street Journal, “We have become an expert battery manufacturer,” adding that, “It’s a natural evolution for us to move in here.”

Energy stocks are in the midst of a massive “mean reversion rally” after being shunned and neglected by ESG investment policies. The world cannot easily break away from fossil fuels, as Europe has clearly demonstrated this year. Furthermore, a strong U.S. dollar is driving the cost of energy and other commodities higher outside of the U.S., since commodities are priced in U.S. dollars.

The Inflation Reduction Act has also angered our allies, since it provides lucrative tax credits for lithium batteries that will be 80% U.S. sourced by 2026, which caused Tesla to cancel its Berlin battery-making plans and divert that manufacturing back to the U.S. The truth of the matter is that the price of EVs soar as battery costs soar, so the green revolution may be postponed until battery costs stop soaring.

Tesla’s energy storage business generated $866 million in revenue in the second quarter. Toyota also began sales in Japan of a battery-storage system for homes, so it appears that the powerwall business may get more competitive quickly. Due to an acute lithium battery shortage, it may make more sense for GM and Toyota to allow their EV and hybrid vehicles to act as possible backup for home electricity.

A strong U.S. dollar impedes multinational companies’ earnings, because approximately 50% of the S&P 500’s sales are from outside of the U.S., so the third- and fourth-quarter earnings announcements for the S&P 500 are expected to be lackluster. However, energy and many other commodity stocks are expected to continue to post record sales and earnings for the third and fourth quarters. As a result, I expect that our dividend and growth stocks will emerge as leaders and oasis stocks in this environment.

Price-to-earnings (PE) ratios have been compressed to ultralow levels due to the fact that the Fed has not raised key interest rates this rapidly since the Paul Volcker era in 1981, when key interest rates hit 20%. We are not back in 1981, with hyper-inflation and double-digit unemployment rates. The Fed mistakenly allowed the money supply to swell by over 30% in recent years, when the underlying economic growth did not justify such a rapid money supply explosion. Essentially, the Fed is now hitting the brakes hard, by raising key interest rates in giant steps, while shrinking its balance sheet by $95 billion per month.

The U.S. has emerged as an oasis around the world, since we do not have (1) tanks in the streets, like China does (to discourage bank withdrawals), or (2) zero percent interest rates, like Japan does, or ultra-low rates, like much of Europe, nor (3) soaring utility bills, like much of Europe. A strong U.S. dollar should encourage more foreign capital flight and help to stabilize Treasury bond yields.

Unfortunately, despite record tax revenues, the federal government also has record budget deficits. The Biden Administration has been trying to manipulate crude oil prices by releasing a million barrels per day from the SPR, which has also shrunk the trade deficit. However, due to the recent OPEC+ production cut, oil prices have resumed rising and could hit $120 per barrel in the spring, when seasonal demand soars.

In summary, my A-rated dividend and growth stocks are poised to profit from the current environment due to the many energy stocks in our portfolios, so we expect these stocks to continue to be a silver lining, critical path that all investors can follow. Although most of our energy-related stocks do not pass ESG standards, fossil fuel usage is soaring worldwide due to Europe divesting from Russian energy, as well as soaring prices for battery components. The fourth quarter is usually seasonally strong, so we are expecting a strong finish to the year, fueled by our fundamentally superior dividend and growth stocks!

Navellier & Associates owns Chevron Corp.(CHV), Kla-Tencor Corp. (KLAC), Toyota Motor Corp. (TM), and Ford Motor Co. (F), in managed accounts and a few accounts own Tesla (TSLA), per client request in managed accounts. We do not own Rivian Automotive (RIVN), General Motors (GM), LAM Research Corp (LRCX) or Lucid Group (LCID). Louis Navellier and his family own Toyota Motor Corp. (TM), Kla-Tencor Corp. (KLAC), and Ford Motor Co. (F), via a Navellier managed account. He does not own Tesla (TSLA), Rivian Automotive (RIVN), General Motors (GM), LAM Research Corp (LRCX), Chevron Corp.(CHV), or Lucid Group (LCID) personally.