The Lowry Letter®

Week of 6/23/2022

Recession concerns weigh on many investors’ minds, but in many ways the economy is doing okay. This may sound crazy, given market declines this year, but it is a good time to remember that the economy and the markets are not the same.

The stock and bond markets are price-setting mechanisms. The prices are set by the aggregation of countless pieces of information, all influencing investor behavior. Over the last 20 years, the pace of information flow has greatly increased. More information, more quickly, means more rapid price adjustments as investors decide what to do about what they learn.

Recently, the markets have started to price in a higher level of risk, hence the declines in bonds and stocks. It started with more-persistent-than-expected inflation leading to aggressive federal reserve action. Investors have taken that information and acted swiftly, to the point that we feel that most damage in the bond market is behind us. The health of the bond market is strong, meaning there is not significant default risk and the financial system itself is not in any systemic danger, a la 2008.

Stock investors see the Fed action and worry that it will kill demand for goods and services by making it harder to borrow money for things like cars and houses. The market declines may be overstating that case, as there is considerable momentum remaining. Employment remains very tight and wage growth is up. Much of the price inflation is because demand for goods and services exceeding supply.

The pandemic is still the driving force behind all of this. Initial, helpful stimulus was followed by excessive stimulus, including too-long loan forbearance programs for many people who didn’t need it.

The Fed may go too far, and we won’t actually know if we are in a recession until it is already part-way through. But it is not a foregone conclusion that we are in one or likely to enter one this year.

Your personal situation continues to be the most important factor to consider. Are you in a recession-sensitive job? How sensitive is your income to interest rate-related factors? Increasing your level of savings may be appropriate.

Changing the investment mix of long-term investment programs is not recommended, as these declines are the best opportunity to acquire shares at lower prices. In the meantime, interest and dividends from existing holdings are reinvested, providing an additional benefit while we wait for improvement.

Now some talk about oil:

Any legislator threatening operating oil and gas companies with windfall profit taxes is trading long-term benefit for short-term gain. Much of the oil industry recorded losses last year. Adding a tax will not help reduce prices or encourage ongoing investment.

The US was NOT energy independent under the Trump administration. We never produced enough oil to meet domestic demand. We were producing natural gas in excess of our needs, but that gas couldn’t be used to fuel vehicles, meaning we still needed to import oil and refined gasoline. Lower oil prices prior to 2021 also led some producers to cease production.

Thousands of permits for production have been approved since President Biden’s election, but most of that happened before the inauguration. The oil industry has been forced to prepare for opposition to drilling and exploration, given the harsh rhetoric employed by the president during his campaign.

Oil companies are dealing with the same labor shortages as the rest of the economy. Even if higher prices lead producers to increase activity, and they will, finding enough workers to do the job remains a challenge.

A greater emphasis on environmental factors by many large investors has led to HALF of the upstream investment in oil and gas versus 2014. Current oil prices are the result of many factors, including the pressure on pensions, investment firms, and others to divest themselves of fossil fuels.

50% of US electricity is produced by natural gas. For good or ill, we need continued investment in oil and gas to keep our economy functioning.

Q: How about some good news?

A: Interest rate increases will bring us to a more “normal” level, improving the rates on savings accounts and other safe options. It will also give the Fed room to respond when we do enter a recession (whenever that is).

Yields on new bond investments will be more attractive as well.

Current market expectations are incorporating bad news, allowing for potentially positive surprises to the upside. There is a feeling that it’s all bad news, and it certainly isn’t. The economy is open and much of it functioning at pre-pandemic levels. We are in a better place than we were one year ago.

This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results.