Market Outlook – 15 March 2005(A)
This past fall the price of a barrel of oil set a new record above $55, and after a brief respite we are close to those sky-high levels once again. Yet the economy is growing, and inflation is running at only 3%. For many of us who were both alive and out of diapers during the oil crises of the 1970s, this is a puzzling set of events. So what is driving the increase in energy prices, and what are the economic, social and market impacts?
Energy consumption has been rising steadily for at least 200 years, so what is perhaps most surprising was how low and stable prices were from the mid-eighties until quite recently. Then a confluence of factors sent energy costs to the stratosphere, including September 11th, the Iraq war, and global economic recovery. But perhaps the decisive factor has been the evolving nature of developing countries with large populations, most notably China.
Between 1990 and 2001, total energy use increased by 16% in industrialized countries, but by a whopping 56% in the developing world. Populous countries, including China and India, have crossed a wealth threshold that is leading to an explosion in the production and sale of consumer goods. Automobile sales in China have risen by as much as 35% in some years, reaching five million units in 2004.
Our country has gotten so rich that, for many people, the increase in energy prices just doesn’t matter that much anymore. Yes, people are spending $8 billion more a month at gas stations than they were three years ago, but at the same time overall retail spending has risen by more than double that much. Gas station sales represent only 8% of overall retail sales, even with the higher prices. Rising energy prices have had little overall impact on our affluent society, but have put yet more pressure on working people and the poor.
One would hope that rising prices would lead to more conservation, but economic and population growth is swamping the impact of more-expensive energy. Worldwide emissions of carbon dioxide, the greenhouse gas most responsible for worrisome trends in global warming, are projected to increase by over 50% between 1990 and 2025, according to estimates by our own Department of Energy. Yet the policies to control energy demand are straightforward and well within our grasp. Greg Easterbrook has estimated that five years after raising average efficiency standards for new cars and light trucks by 6 miles per gallon, we would be conserving about 850 million barrels of petroleum per year – equal to what we import from the Persian Gulf states on an annual basis.
With little overall economic cost to the run-up in energy prices, the most tangible financial market response has been to raise the value of energy-company stocks. In the last five years technology company shares have declined in value by 65%. Meanwhile, the S&P 500 energy index is up 75%. Just in the first couple months of 2005, energy stocks have risen 20% in an otherwise flat market. At Trillium Asset Management Corporation, our clients’ portfolios have participated in this price rise. While not excluding the energy sector altogether, we actively avoid the most egregious actors in the industry, and are engaged with some of the more progressive companies such as British Petroleum and Royal Dutch Shell.
Beyond the dramatic move in energy company stocks, markets have been bouncing around in 2005 with no clear direction. Given the ongoing strength of the economy, reasonable market valuations, and the lack of inflationary pressures, we expect stocks to continue their recovery and outperform bonds during the remainder of the year.