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It’s been a good week all things considered. OK, today’s action hurt things a little especially with social media companies and US telecom players getting sideswiped with higher costs and/or lower revenues. The worst of the bunch was Snap which plunged over 35% on weaker than anticipated advertising revenue and cast a dark cloud over the whole sector including Twitter, Pinterest, Meta, and Google. On the other hand, slowing economic stats imply a less aggressive move by the Fed when they raise interest rates next Wednesday. You may recall US Housing starts dipped last month, matched by increased weekly jobless claims and Philadelphia Fed index dropped from -3.3 to -12.3. Finally, Friday’s HIS Markit Services PMI index dropped from 52.7 (expansion) to 47 (contraction). But what does it all mean? Well, we are still of the opinion that the Fed will still need to raise short term interest rates to curb the inflationary spiral that has gripped economies courtesy of the Ukraine war and Covid shut down protocols in China.

Ok, I also believe we have a third leg to the inflation spiral and that has been severe under investment in oil and gas and the diversion of operational cashflow to zero carbon energy programs.  Don’t get me wrong, we need to transition to a lower carbon economy, but governments have set unrealistic targets without considering the infrastructure component of the transition. Take solar energy as an example. The IEA just published a 126 page report on global supply chains in the Solar PV market. https://www.iea.org/reports/solar-pv-global-supply-chains

China has invested over $US 50 Billion in the last decade and created more than 300,000 manufacturing jobs. Solar PV produced energy is now cheaper than other sources like coal and natural gas but… ”Annual solar PV capacity additions need to more than quadruple to 630 gigawatts (GW) by 2030 to be on track with the IEA’s roadmap to net zero emissions by 2050.” The article goes on to say that investments into new machinery would also need to double by 2030 to meet that goal. By my math that would be a combined $100 billion in the next 8 years. To put that in perspective, the $50 billion China invested is 10 times more than what Europe invested over the last decade. With China’s long lead and low-cost position, it is doubtful, in my opinion, that private sector investment will come to the rescue even with the global energy giants diverting massive funding away from drilling and into green investments.

That leaves government initiatives, and we all know how well governments run businesses. The site C dam is now budgeted at $16 billion, just a smidge over the $6.6 billion original estimate. And don’t get me started on the Transmountain pipeline expansion. You may recall, the Federal Liberals bought it from Kinder Morgan in 2018 for $4.5 billion. The latest figure for Kinder Morgan, according to a February CBC article is now $21.4 billion just a wee bit higher than the original $12.6 billion estimate.

My point is the idea of transitioning to a lower carbon society is a good one, but you cannot just wave a magic wand and go “ta da” and expect it to magically appear. Meanwhile the world needs hydrocarbons (if for no other reason to strip hydrogen from natural gas for zero emission fuel cell transportation sources) and the industry has been discouraged from drilling for more. Meanwhile the only strategy central banks have to reduce inflation is demand destruction. Raise rates enough to get consumers to change their spending habits (less driving, ride sharing or work from home) but not so high as to tip the whole economy into a prolonged recession. Note, I believe the US economy probably tipped into recession as I write this ( Q1GDP -1.5% and Q2 does not look any better) but recessions are a normal part of the business cycle. It forces capital efficiencies and weeds out unprofitable businesses and usually resets labor’s expectations for wage hikes.

Take the bond market for example. For too long central banks forced bond yields close to zero, crippling fixed income investors and forcing them to take increased risk to their retirement capital, but have now reversed that strategy bringing them closer to long run rates of return. We started the year with 10-year bond yields at 1.68% in the US and Canada at 1.60%. Today ten-year bonds are 2.77% and 2.83% respectively. Unfortunately, one-year bonds are 2.91% in the US and 3.31% in Canada which means short term rates are higher than long term rates aka “inverted” and as most economists will tell you, the longer rates stay inverted, the greater the odds of a prolonged recession rather than a short one. This, more than anything else, spooks stock market investors.

This week Tiff Macklem came out with prognostications that their aggressive rate hikes will bring inflation back to their target rate without sending the economy into a tailspin. I am not holding my breath and neither is Wall or Bay Streets. Central banker’s myopic backward-looking strategies have not generated totally favorable outcomes. They spent all of 2021 flooding the monetary system with boatloads of cash only to find themselves reversing course and desperately raising rates to stem inflation. What did they think would happen especially when it was combined with unprecedented government handouts? Hmm… near zero interest rates, empty store shelves, “well might as well gamble in real estate and stock markets.” What could go wrong?

Ok enough cynicism, next week we get consumer confidence and inflation data plus the Fed rate hike. So, expect some volatility in the bond markets which could spill into the stock market. Mind you with over 900 companies reporting next week with a boat load of marquee names on the docket, expect greater than average price swings. The biggest problem as I see it is the reluctance on the part of executives to make forecasts in an uncertain interest rate environment. That could result in a net down week and could set the stage for an August rebound. Anyone remember the summer of 1982?

Happy trading and stay safe.

Steve and Michele.

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