Energy Stocks, US Wage Growth & Inflation

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Energy Stocks, US Wage Growth & Inflation

Two “Data” topics today:

#1: Three reasons to look at US Energy stocks here, even after the run they have had recently:

First, analysts’ earnings estimates look too low to us:

  • S&P is showing a $30.51/share estimate for the large cap Energy sector in 2022.
  • That is essentially the same as what the group earned in 2018 ($30.61/share), when oil prices averaged $60 – $75/barrel until prices fell apart (with everything else) in Q4.
  • If oil prices can remain above $75/barrel next year, and they show every sign of doing so with a still-recovering global economy, then the Street is too low.
  • From 2011 – 2014, when WTI prices averaged around $100/barrel, the S&P large cap Energy sector reliably earned $43 – $45/share. Even if the sector has modestly less earnings leverage now, $39-$40/share is still within reach (+30 pct higher than current estimates).

Second, large cap Energy (using the XLE exchange traded fund as a proxy) has an attractive dividend yield and payouts should only increase as oil prices hold steady/climb:

  • Current yield on XLE: 4.3 percent, annualizing the most recent quarter’s $0.59 dividend payout.
  • That is better than the usual suspects in terms of high dividend payout groups: large cap Utilities (3.2 pct), Consumer Staples (2.7 pct) and even Real Estate (3.1 pct), for example.

Lastly, and contrary to popular belief, near term oil demand is not expected to decline despite the growing global popularity of electric vehicles or alternative energy sources. Here are the US Energy Information Agency’s latest projections for global liquid fuels supply and demand through 2022 (note the 2022 forecast shows a complete recovery in demand relative to 2019):

Takeaway: we understand the traditional Energy industry is not everyone’s cup of tea, but consider the fact that the entire sector’s weighting in the S&P 500 (2.8 percent) is only 1.6x Tesla’s weighting (1.7 pct). We have no problem with TSLA’s valuation; it is the “future”. We do, however, think the “present” (in the form of Energy sector valuations) is mispriced relative to the most likely future path for the global economy and commodity prices. It is a contrarian opinion, to be sure, but it continues to make sense to us.

#2: Ahead of Friday’s US Jobs Report, let’s check in on US wage growth with 2 datasets: the one that gets most of the attention, and the one we think is actually useful in terms of understanding the intersection of wage growth and structural inflation.

First up is the attention-getter: the annual percentage growth in average US hourly/weekly earnings, shown here in red/blue. The August readings were similar, at +4.3 percent versus last year. The data since March 2020 has been very choppy as the makeup of the US workforce shifted dramatically during lockdowns and then reopening. About the only useful thing we can say about current US wage growth using this data is that it seems to be settling out at about 4 percent, a figure modestly higher than the 3.3 – 3.6 percent during the latter stages of the last expansion.

Now, here is the data we think helps connect US wage growth to structural inflation, which is the market’s chief concern at present. It shows wage growth for production/non-supervisory workers back to 1965 – far more information than is available in the hourly/weekly wage dataset. As noted in the graph, 1965 – 1980 saw persistent wage gains (going from 4 pct to 9 pct). Whether that “caused” inflation in the 1970s/1980s or was merely a function of it is somewhat beside the point; the two clearly ran in tandem. Since 1983, however, wage inflation has trended in a reliable band between 1.5 – 4.5 percent and is predictably cyclical within each period of economic expansion (I.e., between each set of gray recession bars).

Takeaway: history shows wage growth needs to be persistent across at least several years and through an economic cycle before we should worry about its effects on inflation. That’s what happened in the 1960s/1970s, and the post-1983 period shows just a few years of 4 percent wage growth is insufficient to spark lasting inflation. This won’t stop investors fretting if we do get a hot wage growth number on Friday, of course. But the historical connection between wages and inflation says we need more than just a few months of still-wonky data to truly support those concerns.

Sources:

US EIA September 2021 report: https://www.eia.gov/outlooks/steo/report/global_oil.php