Capital Markets Update #19

The global price of oil today and the US labor market in 2022 share a critical concept in common – one American government institution holds a significant amount of power to control the independent variable.  To be clear, if the overall economic outlook is the dependent variable, the independent variable would be the critical input which manipulates the dependent variable.

Throughout 2022, seemingly every economist under the sun called for a recession given the perceived systemic risk of runaway inflation, coupled with a likely dose of soon-to-be rising interest rates.  Our contrarian view, at the time, was founded in what we saw as an almost moral and political certainty that a Fed-induced recession was entirely untenable.  The Fed’s complete control over the independent variable, that being the Fed Funds rate and associated messaging, underwrote our short- and medium-term confidence in the economic outlook. In effect, the Fed could jab at inflation with messaging, land heavy blows with large rate cuts, then take a breather and let the dust settle.  Then go again, if necessary.  The combination of messaging, rate cuts and strategic pauses turned out to be a more deft suite of tools than the “blunt instrument” rate cuts are often perceived to be.  In many ways, the equity market narrative today has been taken hostage by a similar perceived systemic risk, defined by prolonged exposure to high oil prices leading to material demand destruction.  While the risk of widespread demand destruction as a result of high oil prices is undoubtedly concerning, no doubt plenty of grey area exists between now and then, especially for the US economy.  Thus, we believe markets have learned from experience and take note of the similarities extant within today’s murky economic outlook and what we experienced in 2022.  Much like the Fed in 2022, the President has an incredible amount of control over today’s critical independent variable (in this case, oil prices).  For instance, he likely has the power to compress oil prices by say 25% with a tweet plus some follow-up action.  He’d probably suffer politically, but the President could literally cut some deal with Iran tomorrow and walk away.  Would things go back to normal? Probably Not.  Would oil prices plummet and the market move on?  Probably so.  Markets have colloquially dubbed this power the “Trump Put” and its real.  Ironically, this power has nothing to do with Donald Trump as an individual and everything to do with US global physical and economic influence. 

We recognize there are plenty of countervailing facts to contend with here.  In no world is it logical that WTI is up 47% YTD and the S&P 500 is up 4% YTD. Furthermore, US Government control of the independent variable does not account for the sum total of this asymmetric performance.  It’s important to note that, according to a 2021 report by the EIA, US energy intensity, or total energy consumed per unit of GDP created, is down by roughly 50% since 1983.  Timely fiscal stimulus, by way of increased tax returns, will help the American consumer weather this oil price shock.  It helped that the global oil market came into 2026 running a 4MM BPD surplus (IEA).  We can’t underscore enough how important S&P 500 earnings forecasts of 13.1% YoY growth in Q1 2026 and 18.6% YoY growth by YE 2026 are to the overall bullish thesis (Factset data).  But, our contention is no single factor is more important to today’s sustained market optimism than the reality that one institution, which holds the US economy and populace as its client, can unilaterally change the deleterious paradigm with a moment’s notice.  We saw the Fed wield this power quite effectively in 2022, and, to a certain extent, we experienced this power again in 2020/2021 via extraordinary stimulus.  A historical 10-year chart of the S&P 500 will support the fact that equity and credit traders are right to be gun-shy of building a material short thesis against the American economy.  Furthermore, the mere announcement of a ceasefire (which doesn’t even solve the oil problem) on March 30th has driven the S&P 500 to 13.5% gains in a month – our point exactly. 

Anyways, we spend time highlighting this point as we believe it’s important to appreciate and understand the role the US government now plays in the broader market narrative.  Between the executive branch and the Fed, the US government has developed an almost hegemonic power to move markets, throw floors under sinkholes and prop-up industries.  In many ways, these innovations, really born and bred in the post-GFC economic fallout, but perfected (if you want to call it that) by recent administrations, represent a new feature of American global economic power.  We’re not going to take a view on what’s right or wrong here, our view is it just sort of is, so we have to account for it.  However, if harnessed properly, America’s ability to reliably control the independent variable could be the unseen tailwind which drives price trends monotonously upward over decades to come.