Since mid-2022, concerns about an impending recession in the United States have been making headlines. However, despite various warning signs and indicators, the U.S. economy has shown resilience over the past nine months.
So, what’s happening? In this blog post, we’ll explore the factors that have fueled recession concerns, discuss the current state of the U.S. economy, and examine whether investors should be worried about a potential recession.
Understanding a Recession
Typically defined as two consecutive quarters of contracting gross domestic product (GDP), a recession indicates a significant decline in economic activity. By this definition, the U.S. economy is not heading for a recession, as GDP grew by 1.3% in the first quarter of 2023.
The National Bureau of Economic Research (NBER) is responsible for officially declaring recessions. Its definition is somewhat vague but emphasizes significant and sustained decline in economic activity across various sectors.
Mixed Economic Signals and Concerns
Mixed economic data has economists divided on whether a recession is imminent.
The Federal Reserve’s projection of low GDP growth for 2023 and successive interest rate hikes have raised concerns about a potential economic decline. A minor banking crisis, resulting in the failures of some financial institutions, also fueled worries.
Moreover, inflation has remained above the Fed’s target, prompting rate hikes that affect corporate investments and consumer loans. As a result, analysts expect negative earnings growth for S&P 500 companies, while a tightened credit market has reduced lending to corporations and consumers.
Meanwhile, the yield curve has been inverted since the middle of 2022, as the yield on 2-year U.S. Treasury notes has exceeded that of 10-year Treasury notes. An inverted yield curve can be problematic as it frequently appears before an economic downturn.
Yet while some indicators have sparked concerns, the current strength of the U.S. labor market and economic activity has divided economists on the inevitability of a recession. In addition, positive earnings, as well as guidance from retailers like Walmart, indicate that consumer spending remains strong.
What Does a Possible Recession Mean for Investors?
While concerns about a U.S. recession persist, the economy’s current state and the labor market’s ongoing strength suggest that an immediate downturn may not be inevitable. However, in the event of a recession in the second half of 2023 or early 2024, investors need not panic. Historically, recessions have been relatively short-lived, with an average duration of around 10 months.
Economic downturns also tend to present attractive opportunities for long-term investors, with the S&P 500 generating an average return of 40% in the 12 months following the market’s low point during a recession. In addition, some stocks, such as Target, Walmart, and Home Depot, have historically performed well during recessions.
Thus, despite the potential risks, investors should take a long-term perspective and consider the historical patterns of economic cycles. Recessions, although challenging, have often paved the way for favorable investment opportunities.
Much like stocks, oil prices have been on a rollercoaster ride recently. Triggered by Russia’s invasion of Ukraine, prices spiked to their highest levels since 2008 this month and then tumbled into bear market territory five days later. (In general, a price drop of 20% from a previous high represents a bear market.)
The recent drop in oil prices is the fastest decline into bear market territory since April 2020. Then, prices fell more than 20% and turned negative in a single day. Yet a dramatic change in oil prices typically doesn’t trigger the same emotional response that a similar change in stock prices would. Perhaps this is because oil markets tend to be even less understood than equity markets.
To put the many headlines you’re likely seeing about oil into perspective, I thought it would be helpful to provide an overview of how oil markets work, why we’re seeing volatility right now, and what this means—or doesn’t mean—for gas prices.
What Is the Oil Market?
There are two primary markets for crude oil: the physical market and the futures market. In the physical market, large producers like Exxon Mobil pump oil from the ground and sell it to processing companies, which then refine it into products like gasoline and jet fuel. A handful of companies act as middlemen, shipping oil around the world through various channels.
Meanwhile, the oil futures market is an electronic financial market consisting of banks, brokerages, and firms that deal in energy. Producers, refiners, traders, and other market participants use futures contracts to lock in oil prices for future transactions. For example, Southwest Airlines uses futures contracts to mitigate rising oil prices and keep costs low for its customers.
In the physical market, private deals between buyers and sellers determine prices. Details of these transactions aren’t widely available, making the physical oil market somewhat murky. Companies like S&P Global Platts publish daily price estimates known as spot prices based on discussions with traders.
The futures market is more transparent. Futures trade on two main exchanges, CME Group’s New York Mercantile Exchange in the U.S. and Intercontinental Exchange in London. The prices of these contracts are widely available.
Types of Crude Oil
Crude oil is graded according to thickness and sulfur content. Light, sweet crude oil is the highest grade and therefore the most sought after, as it is easier and cheaper to refine.
West Texas Intermediate (WTI), the primary oil benchmark for North America, is light and sweet because it contains very little sulfur. It is sourced primarily from inland Texas and is one of the highest quality oils in the world. Because the fracking boom has turned the United States into the world’s largest producer, WTI prices are followed globally.
WTI is similar to Brent crude, which they produce off the coast of Northern Europe. Brent is the main oil benchmark for most of the world. It is also very high quality, although it has a slightly higher sulfur content than WTI. Typically, WTI is ideal for gasoline, while Brent is ideal for diesel fuel.
Meanwhile, countries like Canada, Venezuela, and Russia, among others, produce sour crude oil that has a higher sulfur content. Lower-quality crude oil is cheaper to produce but more difficult to refine.
Global Oil Production & Consumption
Established in Baghdad, Iraq in 1960, the Organization of the Petroleum Exporting Countries (OPEC) is comprised of 13 nations that collectively control about 80% of the world’s proven oil reserves. These countries supply roughly half of globally exported crude oil by value. However, this percentage has been steadily declining in recent years. Outside of OPEC, the United States and Russia possess the largest reserves.
The following graphics show the top 10 oil producers/consumers and their share of the world’s total oil production/consumption, according to the most recent data from the U.S. Energy Information Administration (EIA).
In 2020, the world’s top five exporters of crude oil were Saudi Arabia (17.2% of global exports), Russia (11%), Iraq (7.7%), the United States (7.6%), and United Arab Emirates (7.2%). Russia is still a top exporter. However, it’s worth noting that the country’s oil exports by value declined more than 40% from 2019-2020.
In addition to oil, Russia is a major producer, consumer, and exporter of coal and natural gas, as well as the various refined products made from them. According to the IEA, Russia’s fossil fuel industry produced the energy equivalent of 11 billion barrels of oil in 2019.
Currently, Europe and China account for about 90% of Russia’s total exports. Within Europe, dependency on Russian oil and gas varies by country. By comparison, only 3.5% of the United States’ oil imports came from Russia in 2021—the highest percentage in over two decades (but not the highest value).
U.S. Oil Production & Consumption
Since 2008, the value of U.S. oil imports has fallen over 62% due to a surge in domestic production. Currently, about 35% of U.S. supply comes from international partners, compared to about 65% produced domestically.
Meanwhile, U.S. oil exports have increased nearly 3,000% after the United States ended a four-decade-long ban on oil exports, dating back to the Arab Oil Embargo of 1973. In other words, the United States is now less dependent on other countries for our oil and is becoming a more important exporter of oil to other countries.
The United States is becoming increasingly energy-independent. However, it continues to import lower quality oil from countries like Russia to make use of its existing infrastructure. According to Ryan Kellogg, a professor at the University of Chicago, the U.S. spent billions of dollars on its refining capacity in the 1990s and early 2000s. As such, it doesn’t make economic sense to let that equipment sit idle. In addition, domestic production is not yet at the level where the U.S. can stop importing heavier, sour oil from other nations.
What Affects Oil Prices?
Like other markets, supply and demand determine oil prices. Anything that affects either side of this equation can send prices up or down.
Historically, geopolitics have played a significant role in the direction of oil prices as producers jockey for position. In addition, changes in the global economic outlook can affect supply and demand.
Oil prices can also move in tandem with financial markets. For example, it’s not unusual to see oil prices drop when equity markets decline. In the futures market, speculative bets by traders can also influence prices.
What’s Responsible for Recent Volatility in Oil Markets?
In early 2020, demand for oil dropped sharply as Covid-19 cases surged globally. Government-issued lockdowns stopped people from driving to work, grounded airplanes, and slowed the pace of global trade. As a result, oil prices fell to their lowest levels in decades.
Oil prices have been on the rise as the global economy recovers from the effects of the pandemic. However, the Russia-Ukraine crisis exacerbated already inflated oil prices and is largely responsible for the uptick in volatility more recently.
When Russia invaded Ukraine in late February, the price of oil surged to over $110/barrel, a 15% increase from the previous week. Russia is the world’s third largest producer of oil after the United States and Saudi Arabia. Indeed, sanctions on Russian exports and reluctance to purchase Russian oil sent prices upward.
The United States is more insulated from the crisis that other countries—Europe, for example. Still, the shift in global trade flows has caused a lot of market uncertainty over the last month. Indeed, the Biden administration has banned Russian oil imports. However, this most recent price drop was due to the realization that Europe wouldn’t be abandoning Russian oil just yet, easing pressure on the rest of the world’s oil supply for the time being.
The Relationship Between Oil and Gas Prices
Gas prices have also been on the rise due to record-high inflation levels. But many consumers are wondering why the recent decline in oil prices hasn’t affected prices at the pump yet.
Although oil prices influence gas prices, it’s not a cut-and-dry relationship. Retailers set their gas prices based on replacement cost. Therefore, there’s typically a lag between changes in oil prices and changes in gas prices.
When wholesale prices increase, retailers will often take a hit to their margins first to remain competitive with other retailers nearby. Similarly, retailers may hold their gas prices steady despite a lower delivery cost to make up for the margin they lost during the price increase.
In addition, there’s usually a drop in demand when gas prices spike as consumers top off their tanks in anticipation. This slowdown in demand affects when retailers schedule their next fuel delivery—another reason the prices of oil and gas don’t always move in tandem.
What Does All of This Mean for Your Investments?
Though it’s impossible to predict the future, we’re likely to see more volatility as the war in Ukraine continues. And while we’re currently experiencing a particularly painful period as prices rise and our account balances fluctuate, the good news is these things tend to be cyclical. Investors have historically been rewarded for staying the course—especially when it feels most uncomfortable to do so.
If you’re an ESG investor, you will not be participating in the rising stock values of oil and commodities companies due to the supply squeeze. However, I believe the long-term outlook for companies that incorporate ESG practices into their operations is still strong, as I write in my most recent op-ed for CNBC. You can read the full article here if you’d like to learn more.
As always, please feel free to contact us if you’d like to discuss any of this further.
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The following is an overview of the Russia-Ukraine Crisis given what we know currently.
In a speech last night, Russian President Vladimir Putin announced that a “special military operation” would begin in Ukraine. Russian military forces attacked a broad range of targets across Ukraine last night while Russian President Putin vowed to replace Ukraine’s government. Many are worried that Russia’s aggressive stance and wide-scale military attack could potentially spiral into the largest European military conflict since the Cold War.
How Did We Get Here?
When the Soviet Union broke up in the early 1990s, Ukraine, once a cornerstone of the former Soviet republic, was the third-largest nuclear power in the world. Ukraine eventually made the decision to denuclearize, and in a series of diplomatic agreements, Ukraine gave its nuclear arms back to Russia. In exchange, Russia provided Ukraine with security assurances that protected the country from Russian attack.
Russia tested these assurances in 2014, when it illegally annexed the Ukrainian territory of Crimea. Though relations between the two countries have been strained since, tensions escalated in early 2021 when Ukrainian President Volodymyr Zelenskyy pressed President Biden to let Ukraine join NATO.
Putin sees NATO’s expansion eastward as an “existential threat” and has demanded a legal guarantee that NATO will not hold any military activity in eastern Europe and Ukraine. Last spring, he began sending troops near the Ukraine border for “training exercises” and has steadily increased Russia’s military presence near the border.
Many believe Putin is using Nord Stream 2 as a tool to weaken Ukraine and make the EU more dependent on Russian natural gas. If certified, Nord Stream 2 would likely send pipelines across Ukraine offline. This would deprive Ukraine of approximately $2 billion in transit fees from Russia. It would also undermine any previously perceived protection from Russian military action.
The price of oil spiked to a seven-year high following Russia’s invasion of Ukraine. Indeed, it remains unclear what the near- and longer-term impact of the certification delay and a possible Russian retaliation will be on Europe’s economy. Almost 38% of the natural gas used by the European Union last year was imported from Russia, according to Eurostat. Meanwhile, government figures say Russian natural gas accounted for nearly 27% of the energy consumed by Germany.
The Russia-Ukraine Crisis’s Effect on U.S. Stocks
U.S. stocks fell sharply Thursday morning. The Dow Jones Industrial Average fell more than 700 points after the opening bell. Plus, the Nasdaq opened in bear market territory, down over 20% since peaking in November. In addition, the S&P 500 Index has declined just over 11% year-to-date, placing it squarely in correction territory. (As a reminder, a correction is a market decline of more than 10%. Meanwhile, a decline of 20% or more is a bear market.)
It’s not unusual for geopolitical and other external events to shock financial markets. Yet historically, stock volatility has been temporary following such events. In fact, since World War II, stocks were higher three months after a geopolitical shock. And following about two-thirds of those events, they were higher after only one month. The chart below helps illustrate this point.
What Does the Russia-Ukraine Crisis Mean for Long-Term Investors?
While volatility is always unsettling, it’s not unusual given the many uncertainties this conflict creates. We don’t know how this will play out, nor do we know how long it will last. However, we are likely to see more volatility in the near-term. Nevertheless, there are a few aspects of the current situation that may help ease your anxiety.
In the United States, the median stock market drawdown due to geopolitical shocks was -5.7%, according to data from Deutsche Bank. Moreover, these drawdowns tend to take around three weeks to reach a bottom and an additional three weeks to recover. On average, the market was 13% higher from the bottom 12 months after.
The U.S. economy remains relatively strong, making us more resilient to broader economic repercussions. It may be worth noting that the last crisis in Ukraine in 2014 had little impact on the U.S. economy. That said, it’s unclear if the current crisis will change the Fed’s plan for increasing interest rates.
Volatility often provides investors with the opportunity to purchase stocks at discounted prices, which can boost long-term investment results.
In general, I don’t believe external events like the Russia-Ukraine crisis warrant dramatic changes to your long-term investment plan. Historically, investors who stay the course during periods of uncertainty ultimately reap the benefits. I have no reason to believe this time will be different.
I’ll be monitoring the situation closely and will keep you updated as appropriate. As always, I’m here to support you if you have any questions or want to discuss your financial plan in more detail.
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The CARE Act signed into law on March 27, 2020, is a 2 trillion package of aid to individuals and businesses to ease financial distress due to COVID-19. It’s an over eight hundred page bill, so there are lots of details. Over a series of blog posts, I’m going to describe the provisions that will have the most impact on individuals and small businesses.
To start, I’ll describe the stimulus payments to individuals provision.
In general, individuals will be entitled to $1200, while joint filers will receive $2400 and taxpayers will receive $500 for each child under the age of 17. The payments are not taxable. Limitations and phase-outs depend on income (AGI- adjusted gross income) as follows:
The rebate will be reduced for taxpayers whose AGI exceeds:
$75,000 for individuals $150,000 for joint filers $112,500 for Head of Household
For each $100 over the applicable threshold, you lose $5 of the rebate until it goes to zero, which means that once you hit the following AGI, you don’t get a rebate:
$99,000 for individuals $198,000 for joint filers $136,500 for Head of Household
The above numbers are based on the AGI from your 2019 tax return, or if that return hasn’t been filed yet, your 2018 return. If your income was higher in 2018 or 2019 than you anticipate in 2020, when you file 2020 taxes, you will get the rebate.
PLANNING TIP: If your income is lower in 2019 than in 2018 and you haven’t filed 2019 taxes yet, it would be a good idea to do so as soon as you can. It’s not clear how soon the rebates will go out.
You don’t have to apply for payment. If the IRS already has your bank account information because you have a direct deposit of your social security check or tax refunds, the money will go there. Otherwise, the IRS will mail a check. If your payment gets misdirected somehow, you will get a paper notice in the mail letting you know where the payment went and in what form. If that doesn’t work, you will have to contact the IRS using the information in the notice.
PLANNING TIP: If you know the IRS doesn’t have your most current address and you expect a rebate, you can file Form 8822 to have your address updated.
This month I was honored to be asked to be part of the inaugural CNBC Digital Financial Advisor Council. The council was conceived by Jim Pavia, formerly editor of InvestmentNews and now digital editor at CNBC.
Jim’s mission as a journalist is to educate the public about personal finance and the importance of long term planning. This council is unique in that it is made up of working independent financial advisors (not talking heads) who are meeting with clients regularly and helping to guide them through all the complexities of personal finance from building a diversified investment portfolio, to creating a workable budget, to retirement planning. The ultimate goal is to provide investors with straightforward, informative and relevant content that is transparent, timely and useful.
The 20 council members all have expertise in comprehensive financial planning and investment management but also have particular specialties such as divorce planning, women’s financial issues, wealth psychology, healthcare, life-threatening illnesses, and business-planning. Several of the members are well-known researchers and thought leaders in the financial community and add a breadth of knowledge and experience that is invaluable.
You can benefit from this brain trust by logging into the “FA Hub” on the CNBC Site and checking out recent articles and videos.
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