Invest: Inflation, gas price and recession

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The stock market closed the week on a sour note after U.S. inflation accelerated to a fresh 40-year high and consumer sentiment plunged to a record low. Friday’s selloff was broad, with all 30 Dow stocks closing lower and decliners outnumbering advancers on the New York Stock Exchange by 8 to 1. The hot inflation numbers, which showed inflation soaring 8.6% on an annualized rate, sparked heightened concerns about a recession and more aggressive interest rate policy from the Federal Reserve starting at next week’s meeting. The 2-year Treasury yield, considered highly sensitive to Fed rate hikes, spiked 22 basis points to 3.04%, its highest level since 2008. For the week, it was the worst showing for stocks since January, with the Dow diving 4.6%, the S&P 500 shedding 5% and the tech-heavy Nasdaq Composite plunging 5.6%.

CPI historical graph.
Consumer sentiment plunged.

The national average price at the pump has surpassed $5.00 per gallon, according to GasBuddy, an industry consultant that surveys prices at more than 150K stations nationwide. The average from AAA is also likely to reach that level this weekend, with prices standing at $4.986 per gallon as of early Friday. For energy investors, the supply-demand imbalance appears most acute in the refining sector, where names like Valero (VLO), HF Sinclair (DINO) and Par Pacific (PARR) stand to benefit from record margins, while integrated producers like Exxon (XOM), BP (BP) and Chevron (CVX) are better equipped to manage a refining bottleneck than upstream peers.

Recession worries

It’s unclear where the breaking point is, but gasoline underpins much of the economy, from transport and travel to production and construction. It also guides a significant amount of consumer behavior, as well as inflation expectations, which can have even more damaging consequences on the economic outlook. Many see trouble in store if fuel prices continue to rise, or stay at elevated levels for an extended period of time, though Treasury Secretary Janet Yellen said Thursday that “there’s nothing to suggest that a recession is in the works” after admitting last week that she was wrong about the trajectory of inflation. Meaning she could again be wrong about recession.

There’s a theory out there that the U.S. economy generally runs into trouble when interest rates (the cost of money, which everyone uses) together with energy prices (the cost of energy, which everyone uses) reaches double digits. To calculate the indicator, the average rate on the 30-year fixed-rate mortgage (5.23% as of Thursday) is added to the prices at the pump (now averaging $5). The rule was coined by Strategas chief economist Don Rissmiller in 2011, when the U.S. was still recovering from the global financial crisis. Simple math, 5.23 + 5 = 10.23, and that’s double digits.

Maybe this can explain the graph below.