Why Equities Still Look Good
Earnings (E) are growing faster than prices (P). In the past, price-to-earnings (PE) ratios were higher than now because earnings are rising very fast. The result is higher prices at higher quality. I expect this to continue through the rest of this year and into next year, even with current market weakness. The tech sector is seeing heavy selling, but energy shows strength.
Exxon and Chevron Earnings
Exxon Mobil (XOM) shares rose 2% in the morning after beating expectations, and are up about 50% so far this year. Profits are surging - almost 200%. Both Exxon (XOM) and Chevron (CVX) are posting a massive jump in profits.
Exxon (XOM) is the fifth largest oil producer in the world. As a country it would rank number five, ahead of China, Iraq, and Iran. Chevron (CVX) is the eighth largest producer in the world. Both are fully integrated, with heavy production, including a lot from the Permian Basin. In a tight market for diesel and similar products, their refineries can earn larger profits.
Demand will stay strong for a long time. The Middle East situation does not fix itself overnight on pricing because inventories have been drawn down heavily. Even if the Middle East and the Strait of Hormuz are resolved fairly quickly, rebuilding inventories takes a while. That keeps a strong bid and demand signal for both companies while they earn large profits.
Oil Prices and the Transport Bottleneck
WTI is above $104 a barrel. Brent crude is above $117. There is new military activity in the Middle East, including a strike on a tanker in the Strait of Hormuz.
Oil is still getting through. Last week flow was back up to an average of 16 million barrels a day, the level seen before this conflict started. It takes about 6 weeks to go from tanker to gas tank, so prices have not fallen yet. The reason prices are high is a transportation problem, not a supply problem. There is plenty of oil; the issue is traffic. That kind of problem can be fixed fairly quickly.
Can resolution be sure to come soon, since earlier predictions failed? Earlier this year the flow was not 16 million barrels a day; now it is. Regardless of what the IRGC says about closing the Strait of Hormuz, ships are getting through. More oil comes through, the distillates and byproducts need some working through, but the market just needs time to catch up.
Inflation and the Fed
The way I read oil levels: $60 WTI is stimulative, $80 is about right, $100 is inflationary, $120 is recessionary. At $100 there is some inflation pressure, which is why the Fed is paying attention. The Fed had one rate increase, and maybe another is coming.
Diesel prices, more than gas, are pushing this inflation. A rise in diesel today shows up in core inflation tomorrow more than anything else. I am not worried about it in the longer run. Looking 3 months out is one thing; looking 12 months out is very different. The current situation is temporary and driven by transportation. It gets resolved reasonably soon, then takes about 6 months for everything to settle. Within the next 6 months, these prices likely come down.
