Since energy is a top issue right now, we’ll start the good news there. The war-related disruptions, plus the inflation that preceded them, are breaking down some of the entrenched positions that delay progress.

I’m especially pleased to see more flexibility on nuclear power. Germany is reconsidering its plan to shut down nuclear plants and France plans to build more. That’s major progress. Modern nuclear technology greatly reduces the risks of older designs that caused incidents like Chernobyl and Fukushima. They can provide “base load” electricity when weather conditions don’t favor wind and solar. There are numerous projects focused on small, clean nuclear plants that would provide cheap power.

And it’s getting even better. A staggering amount of research funding is going into nuclear fusion (as opposed to the current fission) reactors. These would produce more energy while reducing radiation and radioactive waste. A fusion reactor essentially replicates the sun on a tiny scale. So in a sense, it will be 24-hour “solar” energy.

Fusion is no longer 30‒40 years out. We could see it working by the end of this decade, which would be a worldwide game changer.

Geothermal power, tapping into the Earth’s natural heat, also has tremendous potential. Right now it is only feasible in volcanically active places like Iceland. Quaise Energy, a startup spun out of MIT, is developing microwave drill technology that could punch 12-mile holes anywhere on the planet. The vision is to sink shafts near existing coal and natural gas generators, refitting them to use the geothermal heat instead. That could be a quick and relatively easy transition.

Looking at Hover Energy, a small company with a completely new technology for wind power, they have created a small wind turbine that is far more efficient than the typical windmills we associate with wind power. Basically it’s a 10-foot cube sitting on top of a platform which contains a large cylinder. The cylindrical turbine is surrounded by airfoils which direct the wind and multiply wind force. (Physics nerds will love figuring out why in an array of seven of these turbines the middle turbine will be 50% more productive than the outer turbines.) In places like Puerto Rico and the Caribbean islands where energy is incredibly expensive, they are far and away the competitive choice.

There’s also a lot of progress happening with air transportation. That’s a particular challenge because you have to carry your power aloft with you. Petroleum delivers a lot of energy for its weight, but there are other ways being developed. Last year United Airlines actually flew a 737 with 100 passengers from Chicago to Washington using a sugar/corn fuel mix . Separately, ZeroAvia, a startup backed by British Airways, thinks it can have a 50-seat hydrogen-powered plane in the air by 2026.

And speaking of hydrogen, a project is underway using nuclear fission to manufacturer hydrogen cheaply. Think about the progress being made by fuel cell companies which would be an environmentally cleaner and potentially less expensive competitor for electric vehicles. This race is not over.

Abundant energy will make the world more peaceful and prosperous. Removing the need to fight for this precious resource and then laboriously move it around the globe will free attention for better things. I think that’s something we will all welcome.

 

US Economy

 

  • Existing home sales were softer than expected last month.
  • Inventories remain extraordinarily tight.
  • Affordability keeps deteriorating.

 

 

  • Are new home prices facing a correction?

 

 

  • Homebuilder shares are underperforming the S&P as mortgage rates hit the highest level in three years.
  • Despite some of the headwinds, Moody’s expects residential construction activity to keep climbing.
  • The markets are pricing in even odds of a 50 bps rate increase in May (rather than 25 bps).
  • The yield curve flattening has been relentless.
  • The combination of a strong dollar, rising oil prices, and higher rates will weigh on economic growth.
  • Consumer sentiment continues to deteriorate.
  • Supply chain stress levels remain elevated.
  • One way to ease supply issues (and therefore inflation) is by slowing consumer demand. Will the Fed’s aggressive rate hikes accomplish this without forcing the economy into recession?
  • Inflation is expected to peak just below 9%, according to Fitch Ratings.
  • Consumer inflation expectations could be nearing a peak.
  • The Richmond Fed’s regional manufacturing index improved this month.
  • But forward-looking indicators deteriorated.

 

 

  • Cost pressures remain extreme, but price indicators appear to have peaked.
  • The Dallas Fed sees a global recession without Russian energy supplies.

 

 

  • Durable goods orders declined in February, with the weakness surprising some economists.
  • The Kansas City Fed’s regional factory activity index hit a record high.
  • Initial jobless claims are at multi-decade lows.
  • Labor force participation among workers aged 35-44 has risen over the past few months.
  • Historically, rising oil prices combined with tighter monetary policy have preceded recessions.

 

The Fed

 

There was more hawkish rhetoric from Jerome Powell on Monday, indicating that he is open to one or more 50 bps rate hikes.

We will take the necessary steps to ensure a return to price stability. In particular, if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.

The probability of a 50 basis point increase in May (as opposed to 25 bps) climbed above 60%.

The 2-year Treasury yield blasted past 2%.

 

 

The market is increasingly confident that the Fed will be cutting rates at the start of 2024.

The Treasury curve is nearing inversion, with the 10yr – 3yr spread already in negative territory.

The Fed balance sheet total currently sits at close to $9 trillion. Pre-pandemic, the number was around $4.2 trillion.

That’s a lot of dollar liquidity that needs to come out of the system. The change could weigh on the economic and earnings growth outlook near term.

To which we say, prepare accordingly… for economic growth to slow… for dollars to become relatively more expensive… and, as we’ve said here for months, for inflation to remain higher than normal until further notice.

The Fed is stuck between a rock (inflation) and a hard place (recession). In the middle sits stagflation. An outcome that seems increasingly likely. Risk remains high for both stocks and bonds.

 

Inflation

 

Gavekal co-founder Anatole Kaletsky usually tilts bullish. A few weeks ago he still had hope the Ukraine War would end quickly and give markets a relief rally. He has now turned more bearish, and explains why in this short essay.

Key Points:

  • Tough Russia sanctions and sharply higher energy prices haven’t kept global equity markets from rising.
  • Kaletsky believes this is a bear market rally caused by excessive short positions, and prices will fall once the short covering ends.
  • All wars are inflationary but this one especially so, coming at a time when inflation pressures were already high.
  • US inflation is higher today than it was when the 1973 Yom Kippur War triggered an Arab oil embargo. Monetary and fiscal policy were also tighter.
  • This cycle may be less shocking than the 1970s because today’s economy is less energy-intensive.
  • A series of small rate hikes are not likely to reduce US inflation, if real rates stay deeply negative as they are now.
  • Inflation of 4-5% seems likely to be embedded in the US economy.

Kaletsky foresees different impacts by region: Inflation and a wage-price spiral in the US, stagnation or recession in Europe. He thinks China is in the best position for this new environment and may emerge as the Ukraine War’s economic winner.

 

Market Data

 

  • Stocks have been resilient in the face of an increasingly hawkish Federal Reserve. But if we follow the 2018-19 trend, there is more pain to come.

 

 

  • Stocks continue to rebound, with some analysts viewing the equity market as a “haven” against inflation.
  • Stagflation periods tend to pressure both stocks and bonds.

 

 

Thought of the week

 

“Strive for progress, NOT perfection”

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker