Looking beyond this corrective phase in the markets we want to spend some time on two investment themes that we believe will increasingly dominate investors’ minds in the coming months and years. The first is the growing political momentum focused on reigning in behemoth technology companies. The second investment theme is energy, which is already underway as we speak. Let’s start with tech.

"Monopolies are inconsistent with our form of government. If we will not endure a king as a political power, we should not endure a king over the production, transportation, and sale of any of the necessaries of life. If we would not submit to an emperor, we should not submit to an autocrat of trade."
—Senator John Sherman

Senator John Sherman was a powerful political figure in the late nineteenth century, whose achievements ranged from helping to redesign the US monetary system after the civil war towards a gold-backed currency to being the principal author of the Sherman Antitrust Act of 1890, which sought to lessen the power and breakup monopolies. Senator Sherman argued that the U.S. should not be ruled by powerful corporations just as we would not be ruled by a king. We are increasingly seeing the power of large corporate technology giants rising to the point where they are drawing the anger from Republicans by limiting free speech on their platforms and from Democrats who are taking issue with their concentration of wealth. Because of this we are seeing more and more anti-trust lawsuits slapped on technology companies both here in the US and in Europe.

Recently, a bipartisan group of U.S. state attorney generals sent a letter to lawmakers last Monday urging them to pass a series of bills that passed the House Judiciary Committee in June to tighten antitrust laws aimed at big tech companies. A few months ago, President Biden signed a new executive order aimed at cracking down on anti-competitive practices. Prior to signing the directive in a speech at the White House Biden said that “Capitalism without competition isn’t capitalism. It’s exploitation.”

This growing regulatory pressure is one of the greatest risks to blindly overweighting the technology giants directly or indirectly through passive investment in vehicles that track the performance of technology-dominated indexes like the S&P 500 or the NASDAQ. This is the reason why we are not overly piling into the technology sector or only buying ETFs that track the S&P 500. Why then do we still have investments in tech and vehicles that track the S&P 500? Bubbles can go on much further than one would expect and it’s these technology giants that are the primary beneficiary of the trend towards passive management and indexing. We are cognizant of the regulatory risk and will decrease our exposure should the backlash towards tech giants start to be reflected in their share prices, but we also want to participate in the passive investment movement driving their prices higher. As highlighted in the first part of the newsletter sent out last week, we have shown that a handful of technology companies are driving the lion’s share of the market’s return this year. We have investments in the sector, but we also are keeping a watchful eye on the exit door should the power of Washington rain down on the technology giants as has occurred in China this year.

Like the US, China’s technology giants have seen their power and control surge over recent years. There can only be one main source of power in China however and China’s President Xi Jinping brought the hammer slamming down this year. Technology companies like Alibaba Group (China’s Amazon), Tencent, Baidu (China’s Google) have seen their share prices fall between 40-60% over the last year as China has brought over 50 regulatory actions against these and other firms for alleged offenses ranging from antitrust abuses to data violations.

Like the 1990s in which the technology sector drove most of the returns, they have done so over the past decade again and there is no sign of a top. That said, given the mountain of political pressure building, it is not a sector we want to overly expose our clients to. While holding a neutral or underweight to this sector where we see risk building, we are increasingly moving towards overweight in another as a separate crisis unfolds.

Revenge of the Old Economy

The dramatic shift away from “dirty energy” to “green energy” has seen large investor capital shift away from resource companies that dominated in the early 2000s towards the FAANG stocks over the last decade. This shift in capital coupled with falling commodity prices has led to increasingly lower inventories and dwindling production capacity. Thus, once demand for commodities picked up after the COVID-induced recession, the supply-demand imbalance caused a dramatic spike. This process and the situation unfolding right now was described by Goldman’s Global Head of Commodities Jeff Curie in an interview with Bloomberg this week: Energy Crisis is ‘Revenge of Old Economy,’ Goldman Sachs Says

The long-term underperformance of the commodity sector relative to the broad stock market led us to make a call a year ago that we were being presented with “A Generational Buying Opportunity in Commodities”, as we highlighted in the middle of our client newsletter last September. One of our largest sector overweights for clients is to the energy sector and we will likely build on that exposure as we believe the current energy crisis will only escalate as the northern hemisphere moves into the winter heating season.

Looking at the charts below, you can clearly see how we got here as the developed world has consistently reduced its production (and, hence, availability of inventories) of fossil fuels, which leads to price spikes and higher inflation when renewables can’t meet current demand.

Euro zone inflation hits highest level in 13 years as energy prices soar (CNBC)
Euro zone inflation hit its highest level in 13 years in September, as the bloc battles surging energy costs. Headline inflation came in at 3.4% last month, according to preliminary data from Europe’s statistics office Eurostat. This was the highest level since September 2008 when inflation stood at 3.6%. It comes after German consumer prices rose by 4.1% in September — the highest level in almost 30 years. The rise has been driven higher by surging energy prices, deepening concern among policymakers. The front-month gas price at the Dutch TTF hub, a European benchmark, has risen almost 400% since the start of the year. What’s more, this record run in energy prices is not expected to end any time soon, with energy analysts warning market nervousness is likely to persist throughout winter.

Since 2007, according to BP’s Statistical Review of World Energy, the U.S. has cut its coal production by 55%, Germany by 56%, and the U.K. by 90%. We’ve even seen a reduction on the reliance of clean nuclear energy since the 2011 Japanese Fukushima nuclear meltdown. Japan has cut its nuclear energy consumption by 82% since 2011, while Germany has cut its consumption by 46%. Nuclear consumption here in the U.S. and the U.K. has remained steady while China’s nuclear consumption has grown by 298% as part of a concerted effort to shift away from coal and reduce air pollution. In terms of natural gas, since 2007, China has grown its production by 229%, the U.S. by 82%, while Germany has cut its natural gas production by 73% and the U.K. by 53%.

Considering dramatic cuts to production and consumption of nuclear, coal, and natural gas, Europe and the U.K. are leaving themselves at the mercy of Russia and the U.S. to help meet their needs and both regions better pray for a mild winter this year or the recent price spikes in energy could get a lot worse.

To give you an idea of the scale of the energy crisis, look at the following chart of natural gas prices from around the world rebased to 100 a year ago. Natural gas prices in the U.K. are up 638% over the last year, up 628% in Europe, up 455% in Asia, and up 99% in the U.S.

Source: Bloomberg, Financial Sense Wealth Management

The U.S. has an abundance of natural gas as technological improvements in the energy sector have seen rising production. The abundant supply of natural gas in the U.S. has prompted the energy sector to build liquified natural gas (LNG) terminals for export across the Atlantic Ocean. As the U.K. and Europe have shifted away from fossil fuel production, they have become more reliant on the U.S. for their supplies and rising exports of U.S. LNG (shown below) have pushed prices higher here in the U.S. as well.

Source: Bloomberg, Financial Sense Wealth Management

Because of the exponential rise of U.S. LNG exports recently, natural gas storage levels (solid black line below) are running below their seasonal average (dotted line) and not quite near our 5-year seasonal low (orange line). However, continued shortages abroad and further exports of U.S. LNG coupled with a cold winter could push U.S. inventories towards their seasonal lows.

Source: Bloomberg, Financial Sense Wealth Management

When supplies of natural gas are low, electric utilities often switch towards using coal as a fuel source. The problem is, coal production and consumption have plummeted in recent years given the shift away from dirty energy sources and so coal will not be a savior to high energy prices this winter. Current U.S. coal inventories used for electricity are at a 30-year seasonal low and low coal supplies are leading to spikes similar to what we see with natural gas.

Source: Bloomberg, Financial Sense Wealth Management

Unfortunately, low inventories are also present in other energy commodities like gasoline…

Source: Bloomberg, Financial Sense Wealth Management

And crude oil inventories:

Source: Bloomberg, Financial Sense Wealth Management

The S&P 500 peaked at the beginning of September and it remains to be seen if the pullback is over. It is quite common to have at least one to several 5% pullbacks each year (we had a 10% pullback last September and 9% pullback last October) and yet we haven’t had even one this year. We would not be surprised to see stocks pull in further into October and is why we have a bit of a cash buffer to take advantage of a market decline. We do not believe the bull market has ended however and so we would view any correction as a buying opportunity and will be looking at increasing broad market exposure as well as exposure to the resource sector should an opportunity arise. Further exposure to resources will help hedge against escalating energy prices as we head into winter.