The chart below shows that electricity prices are rising. It has increased by about 8% annually over the past three years. Going back to 1955, there were only three other price increases of the same size. The electricity inflation of 1973 and early 1980s was related to rising oil prices due to our relationship with Iran. The peak occurred in 2008 when the price of crude oil briefly reached $150 per barrel and the price of natural gas exceeded $14.
The current inflationary cycle is unique in that it is driven by demand for electricity rather than rising input prices. In fact, the price of natural gas is near a 30-year low of $2.40. Natural gas is the predominant energy source used to generate electricity. To be sure, some of the increases are linked to broader inflation affecting the economy. However, as the chart indicates, some of it is due to growing demand from AI data centers and electric vehicles.
What to watch today
Profits
Economy
Market trading update
As discussed yesterday, the market is in overbought territory after rising to all-time highs on Wednesday. As we mentioned then:
“Although there is no reason for a decline, continue to rebalance as needed to maintain risk tolerance in your portfolio. There will likely be a pullback to retest the 50-DMA over the next few days or weeks, offering a better opportunity to increase exposure.” As needed as the summer months approach.”
From current levels, it would not be surprising to see markets struggle to make further gains without a short-term pullback to the 50-DMA to reset buying conditions. The current deviation from the 50 and 200 moving averages continues to move higher. Although such deviations do not mean that a correction is imminent, they are good indicators to become more cautious about risk-taking, especially when markets are overbought, as they are now. While the number of stocks trading above their 50-DMA is improving, it is still fairly weak, given the current market exuberance.
As we mentioned yesterday, all of this is still bullish but indicates that risk management remains key.
The big problem is small business performance
On Monday, we shared a commentary highlighting how small-cap profit margins have declined rapidly over the past few years while large-cap profit margins are near record levels. Firms with more capital are more efficient with regard to borrowing costs and passing inflation on to their clients. These and other factors help explain some of the variation in irregular fringe.
Another crucial factor is the composition of small and large indicators. As shown below, IT has far greater margins and returns on equity than any other sector.
The first heat map below shows that IT makes up nearly 30% of the S&P 500 index of large companies. The second heat map below shows that IT makes up only about 15% of the IWM Small Business Index. Given the relatively large expansion of margin in IT over the past few years, the composition of large and small indicators helps explain the difference discussed in the commentary above.
Housing starts show signs of weakness in April
April housing starts of 1.36 million came in below consensus expectations of 1.42 million. On an annual basis, it rose by 5.7% on a monthly basis, versus expectations for an increase of 7.6%. Due to the sharp decline in March, the two-month rolling change fell by approximately 9%. Moreover, housing starts have fallen by more than 25% from their peak two years ago. Building permits were also slow, falling 3% month over month compared to expectations for a 0.1% increase.
Even more telling, housing starts typically outpace completions in a strong economy. However, as shown in the chart below from Zero Hedge, the past few months have seen a significant delay in housing starts. This could have a material impact on employment in the construction sector, since housing starts are an important leading indicator of the economy.
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05/17/2024
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