THE SPENDING WAVE AND WHERE IT LEADS – PART II

Last week we discussed the spending wave for adults which appears to peak about age 47 and we looked at the shortage of drivers in the trucking industry which appears symptomatic of our whole economy. So here in Par II we’ll take a look at the impact of oil and its importance on the spending wave, as well as the entire economy. To discuss oil, you must start with the Yum Kippur War of 1973 between a coalition of Arab nations and Israel—it did not end in a draw.

“In the first days of fighting, the Arabs caught the Jewish State by surprise and drove into Israeli territory. As the Israelis mobilized, they were able to stop the Egyptian incursion on the Southern border and then drive the Syrians out in the north. Eventually Israel took more ground, but then retreated to the borders established after the 1967 war to keep other nations, namely Russia, from joining in.

“The Arab nations celebrated as if they’d won the war, even though they lost thousands of soldiers and gained no ground. While they did not achieve a single objective in terms of land, they showed that Israel wasn’t invincible. And they established something else.

“In the midst of the war, the oil-producing nations of The Organization of Petroleum Exporting Countries (OPEC) cut off oil shipments to nations supporting Israel, mainly the United States. Over the next few months, the price of oil shot up 300%, from $3 per barrel to $12. Once the cash started flowing in, OPEC kept the price of oil high for the rest of the decade, demonstrating that the cartel now controlled prices.

“The price of oil fluctuated after the 1970s, heading lower for much of the 1980s and 1990s after the Saudis dramatically increased capacity. Oil prices shot higher in the early 2000s as the Chinese economic miracle took hold, and then fell when American fracking opened a new supply. Prices climbed for the last two years after OPEC and several non-members agreed to cut supply in the face of low prices, so now we sit at roughly $70 per barrel. That’s more than twice the recent low, but less than half the price at the top in 2008. While $70 per barrel sounds high, if we adjust it for inflation, the price seems more tame.

“With the new trade sanctions on Iran, Venezuela’s pumping capacity in shambles, the OPEC agreement to limit supply still in place, and disruptions frequently occurring in places like Libya and Nigeria, oil could remain in the $65 to $80 per barrel price range for the next 12 to 18 months.

“And then things get interesting! Even though prices have risen lately, outside of shale, companies aren’t doing much to look for oil. In 2016, oil companies discovered the lowest amount of new oil in 70 years, and 2017 was about the same.

“With prices low in 2014 and 2015, shale oil rocking the markets, and the constant talk of renewable energy, oil companies weren’t motivated to spend their resources on exploration. Shale is great, but in the U.S. we don’t have the infrastructure to move more oil from where it is sourced to export facilities. Renewables make up a tiny fraction of world energy production and can’t possibly grow fast enough to satisfy energy needs in the new few years.

“Energy should be one of the booming sectors in the U.S. for years to come, lining the pockets of related companies, their workers, and even state coffers. But there’s another side to the equation. As prices move up or simply remain at current levels, we must pay more for everything that contains or is moved by petroleum.

“Have you ever considered which products are made with petroleum? Excluding food (which is typically grown using farm equipment that runs on gas or diesel), it’s probably easier to list the things that don’t contain oil. Obviously propane and gasoline come from oil, but we also use the stuff to make ink, ballpoint pens, floor wax, basketballs, lipstick, insecticides, aspirin, phones, refrigerators, plastics, and toothpaste!

“It’s safe to say that everything you pick up at the grocery store contains oil, was shipped using oil, or both. If oil prices remain elevated, then the prices of many everyday items will increase. So, we’ll be paying more to truckers to ship them. This scenario is already playing out in transportation. Recently, the major airlines have announced fare increases because of higher fuel charges. We can expect the same thing from FedEx and UPS as they gear up for the holiday season.

The Outcome

“The equity markets will struggle to adjust. Investors won’t know which signals to follow. Do you invest for growth based on inflation, which typically signals that the economy is heating up, or do you prepare for a recession based on the yield curve?

“Do rising wages mean that workers will soon be bidding up prices on goods and services, or do they mean that companies are going to take an earnings hit as they pay more to attract and retain workers? The confusion should lead to vitality, and that maybe good for us.

“As employers pay more, workers will have higher incomes. Inflation will eat away at the gains, but inflation is lumpy, it doesn’t hit everyone equally. If long-term interest rates remain steady, then the combination of higher pay and steady interest rates could give some working families the push they need to buy homes. Rising pay could also give many consumers with student loans a way to boost their spending while remaining current on their debts.

“How creeping inflation will affect you depends on your situation.

“If you’re retired, then chances are your expenses are skewed more toward energy, travel, and healthcare, so this could hurt. Energy and travel obviously are tied together, whereas healthcare costs are driven higher by overriding demographic factors.

“On the income side, most retirees or those near retirement aren’t job hunting, so that keeps a lid on earned income that might be pushed higher. For Millennials, this could be very beneficial. The group tends to have little in the markets, so they won’t suffer valuation swings, and they are the perfect group to leave their current employer for better pay at a competitor.

“If interest rates remain low as expected, then the income boost could be just the thing to push them to buy homes at a faster clip, which might finally move the generation closer to starting families and moving up their Spending Wave.”

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