July 2022 may have represented a turning point, with indices rallying significantly in the last weeks of the month. Investors are convinced that the end of the tightening cycle has been reached with the US heading into recession, expecting the Federal Reserve to start reducing rates in May 2023. We hold non-consensus expectations about the immediacy of rate cuts, given that inflation is likely to be sticky. We see increases in rent, for example, which are a secondary effect of the tightening financial conditions given an insufficient supply of housing stock. One of the goals of the Fed has been to slow housing appreciation and they have been successful so far. However, less affordable housing pushes more consumers into multifamily and single-family rentals. In May, the average new lease on a market-rate apartment in New York City increased 25% year over year to $4,000 for new leases. In Dallas, new leases in Class B apartments rose 19.6% in the second quarter. Tightening financial conditions won’t increase the stock of new housing. We are more concerned with stagflation reducing the purchasing power of most Americans. At least we are better off than Western Europe. It will be more difficult in Germany this winter if heating bills increase by 300% or in the UK, where energy expenses are forecast to consume 28% of a typical family’s household budget.
In listening to earnings calls of various shipping companies, we saw the push and pull of momentum versus value. We reviewed four calls ranging from container shipping lessors to dry bulk to product tankers. In each case, the results were excellent, but in four out of four instances, the stocks finished down from their highs after their earnings announcements. The market believes these are peak earnings, with falling shipping rates to follow over time. On the other hand, by any financial measure, the stocks are cheap, and the fundamentals are improving. It is a dilemma, with one’s outlook determined by one’s investing time horizon. We still feel there are opportunities in many markets, although container shipping will have to climb a wall of worry in the next 12 months if we do enter a global recession.
Oil seems to have peaked in early June at $122.15 per bbl. (Brent), with prices having fallen by 12.0% to $107.53 at the end of July, Usually, market projections of peak pricing assume significant demand destruction from weaker economic activity. We are more concerned about supply challenges, given that the world’s marginal barrels of oil are coming from the US Strategic Petroleum Reserve. After releasing 146 million barrels or approximately 1.0 million barrels per day from the SPR over the last year, US crude commercial inventories are still 17 million barrels lower than they were in July 2021. If the SPR releases end in October as scheduled, global inventories will continue to be below five-year averages going into peak seasonal demand. To the extent that energy prices start rising again, it may impact inflationary expectations. Looking back to December 2021, investors were worried about many issues but inflation and a major energy shock due to the Russian invasion of the Ukraine were not among them. We remember markets in 2021 rallying each time Jay Powell declared that inflation was transitory. Given his current claim that the neutral Fed Funds rate is 2.00% to 2.50% and our belief that he is wrong again, capital preservation continues to remain one of our foremost objectives in 2022.