8-23-22: Winter is Coming, and Europe May Freeze

by Louis Navellier

August 23, 2022

On the scene in the Baltic Sea, one thing I learned is that the small nation of Estonia, bordering Russia, is proud that it is building a large LNG terminal to help Finland and other European countries diversify away from Russian natural gas. Spain has also proposed a new natural gas pipeline to France that would help deliver natural gas within a year. Unfortunately, winter is coming fast, and Klaus Muller, president of Germany’s energy regulatory agency, told The Financial Times last week, “If we fail to reach our target (of 20% gas savings), then there is a serious risk that we will not have enough gas” by winter.

Complicating matters further, Russia’s Gazprom announced on Friday that it would shut down the Nord Stream pipeline three days for maintenance later this month. As a result, natural gas prices are expected to remain abnormally high. Germany is expected to lose trade competitiveness and may be forced to move some operations to lower-cost countries. Not surprisingly, due to potential electricity shortages, Germany postponed shutting down its three remaining nuclear plants that were scheduled to close later this year.

Germany is now running a trade deficit for the first time in over 30 years and the low water levels on the Rhine River are holding up shipments of coal and other commodities. BASF, which has factories on the Rhine, is now relying on rail transportation. Essentially, the tonnage on barges will have to be reduced.

I should also add that the French energy supplier EDP has reduced its electricity output at nuclear power stations along the Rhone and Garonne rivers in France to the lowest power in over 30 years due to low water levels. France has traditionally been an electricity exporter but is now relying on electricity imports.

Due to the high cost of electricity as well as supply shortages, thermostats have been raised across Europe as some countries, like Spain, have ordered air conditioning to be set at 27 degrees Celsius (80.6 degrees Fahrenheit). My youngest daughter was in Madrid with a friend, and she confirmed it was very hot there.

On the Forbes cruise, I chatted with one of the British Conservative Party members that will be voting for the new Prime Minister, who will be announced September 5^th. So far, Liz Truss is the top candidate, with middle class roots most British like, especially as many citizens struggle with high electricity bills.

Under outgoing Prime Minister Boris Johnson, taxes rose to a record level and many British citizens are struggling with high inflation, so the candidate that can connect best to the people is expected to become the next Prime Minister on September 5^th. I should add that new electricity price hikes are expected to begin on October 1^st in Britain, so the new Prime Minister is expected to either defer those electricity rate hikes and/or provide relief to struggling households burdened by record high electricity rates.

As far as Europe is concerned, the fall rainy season cannot come soon enough. With the help of natural gas rationing, Europe may have enough natural gas until alternative pipelines and/or LNG supply can be added so that they can finally break away from relying so much on Russian natural gas. However, natural gas prices are near a 14-year high and are expected to rise further as winter approaches. Also, most of the European Union is trying to break away from importing Russian crude oil by the end of the year, so crude oil prices could follow natural gas prices and soar back to recent highs as we get closer to fall and winter.

Interestingly, some central European countries that are reluctant to stop using Russian natural gas, like Hungary, are landing new business. For example, the biggest battery supplier in the world, CATL, just announced a massive $7.5 billion, 100 Gwh EV battery plant in Debrecen, Hungary, which will produce battery cells and modules for European automakers, like BMW, Mercedes, Stellantis, and VW Group.

The Fed Minutes Signal (Perhaps) Just One More Rate Increase

The latest Federal Open Market Committee (FOMC) minutes, released last Wednesday, revealed that the Fed acknowledged “a slower pace of rate hikes at some point,” raising speculation that the FOMC may only hike rates another 0.50% or 0.75% in September and then… that’s it. In the Fed’s best “cover all the probabilities” language, the minutes also revealed that the “bulk of the tightening had yet to be felt,” implying a “risk of tightening more than necessary” to get inflation under control. Finally, the FOMC minutes also said that rates may need to reach a level that restricts economic growth “for some time.”

If you don’t mind me cutting through all this Fed double-talk, I feel that the Fed is indicating they will raise key interest rates 0.75% on September 21^st to get in-line with market rates (i.e., Treasury yields). Then the Fed will be neutral and not raise rates at its November FOMC meeting, since the date falls less than a week before the mid-term elections. Then, if the Fed feels it needs to fine-tune its interest rate policy again, it can do so at its December FOMC meeting when no one is paying attention, since investors will be distracted by the holidays. Why they can’t say something clear like this just boils down to politics.

What I expect with the September 21^st Fed rate hike is an FOMC statement that acknowledges the Fed is now “neutral,” and continues to be “data dependent” moving forward, which will be seen as the kind of dovish comment that Wall Street likes to hear; so I expect the stock market to rally after September 21^st. I also expect inflation to cool off big time in September and October, since the trailing 12-month inflation rates will naturally start to decline more rapidly. Furthermore, crude oil prices may cool off faster in the fall.

Speaking of energy, the big new green energy bill that Congress passed and President Biden signed into law last week is expected to put upward pressure on both interest rates and the price of fossil fuels (due to higher energy taxes), so our elected leaders just prolonged their inflation problem. By and large, this new wave of spending is expected to evolve slowly, since it is rewarding domestic green energy, like battery production, that is not fully up to scale; so new federal spending volume might be constrained for now.

Basically, there is really no hope in sight for the EV industry to expand due to the high prices of lithium, nickel, and cobalt for lithium-ion batteries that continue to rise in price due to raw material costs. At the Forbes conference, several speakers have been discussing how challenging the supply bottlenecks are for raw battery materials and how the EV industry has stalled due to a shortage of lithium-ion batteries.

As I have said in several previous issues, the reason Tesla can make more EVs in this environment is that its Shanghai plant is making EVs with CATL’s iron phosphate batteries, which are less efficient and heavier, but also safer, since iron phosphate batteries won’t catch on fire. If more companies (like Ford, Rivian, and VW Group) follow Tesla by using CATL’s iron phosphate batteries, the EV revolution can proceed faster. I am worried about GM’s EV strategy, since GM is stuck with LG Chem’s more expensive lithium-ion batteries. They do not yet have an iron phosphate battery solution.

So right now, my winners in the EV race are Panasonic and Toyota (using solid state batteries in hybrids in 2025), plus CATL, Ford, and VW Group (for utilizing both iron phosphate and lithium-ion batteries).

Most U.S. Economic Indicators Are Turning Up, While Real Estate Sags

The best economic news is that the soft landing in energy prices means that inflation will continue to gradually cool, which helped to boost the University of Michigan’s preliminary consumer sentiment index to 55.1 in August, up from 51.5 in July. The University of Michigan’s consumer sentiment index had hit all-time lows a few months ago, so this improvement is a great sign for improving GDP growth.

This is a good time to remind everyone that about 70% of U.S. GDP growth is attributable to consumer spending. Although consumers can be fickle, recent reports from Home Depot and Walmart show that consumers are still spending strongly, although where they spend has been changing.  Strong retail sales show that the “velocity of money,” which is how fast consumers are spending, appears to be picking up.

Speaking of retail sales, the Commerce Department announced on Wednesday that retail sales were unchanged in July, which was slightly below economists’ consensus estimate of a 0.1% increase, but that was mostly because gas station sales declined 1.8% in July due entirely to lower prices at the pump.

Excluding gas stations and vehicle sales, July retail sales rose a healthy 0.7% (month-over-month) as nine of 13 industries surveyed reported improvement. On-line sales rose a robust 2.7% in July, so consumers were “clicking” on their computers and cell phones. Overall, July retail sales were at least keeping pace with inflation and there were positive indications that consumers will keep “clicking” and spending.

Housing is a different story. Hot real estate sales led the economy last year, but the reverse is true now. The Commerce Department announced on Tuesday that housing starts plunged 9.6% in July to an annual pace of 1.446 million. Housing starts are now running at the lowest annual pace since February 2021. Building permits fared a bit better and declined only 1.3% in July to an annual pace of 1.674 million.

According to the National Association of Home Builders, homebuilder sentiment has fallen for eight consecutive months and fell below 50 for the first time since May 2020. Clearly, homebuilders are worried about rising mortgage rates, since residential investment is now running at an -18.8% annual pace. I should add that the Atlanta Fed lowered its third-quarter GDP estimate to an annual pace of 1.8% on Tuesday, down from its previous estimate of 2.5%, due largely to the drop in residential investment.

The National Association of Realtors announced on Thursday that existing home sales declined 5.9% in July to a 4.81 million annual pace. This was the sixth straight monthly decline in existing home sales. The inventory of unsold homes is currently 1.31 million, a 3.3-month supply at the current annual sales pace. Median home prices have risen 10.8% in the past year to $403,800, but the median price fell 2.4% in the past month from June’s $413,800, so the Fed’s higher interest rate policy is now causing housing inflation to cool off, which is further evidence that the Fed will likely only have one more interest rate increase.

Finally, the Labor Department reported on Thursday that weekly unemployment claims declined for the first time in three weeks. Specifically, weekly unemployment claims declined to 250,000 in the latest week, down from a revised 252,000 in the previous week. Continuing unemployment claims rose to 1,437,000 in the latest week, compared to a revised 1,430,000 in the previous week and are now at the highest level since last April. Overall, the labor market looks healthy as new job creation keeps growing.

China is moving in the opposite direction, in many measures. While our Fed is raising rates, China surprised the world last week with another key interest rate cut in response to weaker-than-expected retail sales and industrial production, along with a staggering 19.9% youth unemployment rate (for those between 16 to 24 years of age). The Covid-19 lockdowns in China have hurt employment, especially technology workers. Furthermore, home prices continue to fall in China, so the People’s Bank of China continues to cut interest rates to try to re-stimulate its housing sector. The Chinese yuan naturally declined against the U.S. dollar, since China continues to cut rates, while the U.S. offers higher interest rates.

Due to China’s ongoing economic woes, crude oil prices have settled down and should fall to between $80 and $85 per barrel in the fall as worldwide demand ebbs from seasonal pressures. Despite this anticipated drop in crude oil prices, energy stocks will continue to sport the best earnings growth of any sector for the next couple of quarters. Furthermore, many energy stocks are returning money to their shareholders at a fast pace. For example, Devon Energy (DVN) has a 9.67% annual dividend yield. When I run my weekly stock selection screens, energy continues to dominate, especially since the analyst community has become more cautious and cut earnings estimates for companies in other sectors.

Navellier & Associates does own Tesla (TSLA), and Home Depot Inc. (HD),  for one client, per client request, Toyota (TM), VW Group (VWAGY), or Ford (F), Devon Energy Corp. (DVN), and Panasonic Corp. (PCRFY) in managed accounts.  We do not own Stellantis (STLA), or General Motors (GM), Rivian, (RIVN), or Wal-Mart Stores Inc. (WMT). Louis Navellier and his family own Toyota (TM), VW Group (VWAGY), or Ford (F), Devon Energy Corp. (DVN), and Panasonic Corp (PCRFY), via a Navellier managed account. They do not own Tesla (TSLA), Stellantis (STLA), or General Motors (GM), Rivian, (RIVN), Home Depot Inc. (HD), or Wal-Mart Stores Inc. (WMT) personally.