In the blog just posted prior to this one, we pointed out that the Fed’s inflation favorite, the core personal consumption expenditure (PCE) index, was up only 1.3% year-over-year with the last number actually flat month-over-month. I indicated that inflation could remain lower longer thus leading to a slow rate of increase in the Fed Funds’ target rate for some time. I did point out there was a wild card to watch. I still plan on including this as one of the predictions in the “What to Expect in 2016…” Perspectives piece, which will be coming out shortly. However, here is a brief description of what I expect could happen that might surprise the markets and, maybe, the Fed later next year. It does relate to energy. But, you will point out, energy is not included in the core PCE calculation. That is true. However, the impact of a reduction in oil prices and energy in general doesn’t just affect consumers’ transportation and heating costs—putting more money in their pockets. It affects businesses as well, reducing both their energy and transportation costs and, in some businesses, the cost of hydrocarbon-based feedstock as a part of their product. When I hear, anecdotally, that a friend in the paint business is experiencing record profits because of a reduction in cost-of-hydrocarbon-based goods, transportation costs and maybe a bit of a lift in remodeling and new home construction, I can translate that into similar experiences in other industrial and commercial businesses. It does add to corporate profits. While it is difficult to make a precise calculation, the 50% reduction in oil and gas prices over the last year could easily have added $90-$135 billion to the more than $2 trillion in pre-tax corporate profits. That 4%-5% pickup in profits may have reduced the price increases that, otherwise, would have been needed to make up for part of the labor cost increases that were being incurred. While that addition to profits will hold as long as energy prices stay flat, it won’t increase further. Thus, corporations may have to look for price increases to offset the continued more than 2% annual increase in unit labor costs. If energy prices continue to stay around these levels or rise, the direct impact on the core PCE index won’t happen, but the indirect effect of having to absorb the increased labor costs without additional energy offset could start showing up in final price increases. Excess supply in certain industries could mitigate the ability for certain companies to raise prices, but by sometime next year—maybe mid-year—we could start to see more price increases. It will not happen across the board, but specific company and industry analysis could turn up some profit surprises, positive or negative, as the energy transfer of wealth dissipates. Worth paying attention.
My favorite disclaimer
The two topics in this blog have no direct relation to each other. However, I did make a reference to Eric Peters in the last blog. Eric is CEO and CIO of One River Asset Management located in Greenwich, Connecticut. Eric and his team create very interesting theme-oriented bespoke portfolios for several major institutions. His comments on what is going on in the world are shared regularly with a specific qualified list in the form of direct observations, stories and quotes involving several re-occurring characters, his family members and other occasional guests. The observations are always thought-provoking, succinct and very readable. As a financial advisor, Eric always ends his pieces with the appropriate disclaimers and a few additional ones as well. I asked Eric if I could share his disclaimer with our readers. I think he said “yes,” although it could have been someone else. So let’s end this blog with his disclaimer (by the way, I disclaim any claim to his disclaimer…):
The Eric Peters’ Disclaimer:
“All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.”