Consumer savings are getting tapped …China might be headed toward more lockdowns …oil is in freefall … which should be big for cooling inflation

Another day, another sign of a coming slowdown.

No one is escaping inflation. As you’re well aware, prices have been soaring for more than a year. From gas, to groceries, to rent, there’s been nowhere to hide.

But until recently, the U.S. consumer had a trump card – pandemic savings.

From the beginning of the pandemic through the end of 2021, U.S. households amassed $2.7 trillion in extra savings.

But news yesterday is that Americans are now tapping this savings glut.

From The Wall Street Journal:

Americans are starting to dip into the huge pile of savings they accumulated over the first two years of the pandemic…

Families have tapped about $114 billion of their pandemic savings so far, according to Moody’s Analytics, which analyzed government data.

“Most households have a cash cushion to navigate through the very high inflation,” said Mark Zandi, Moody’s Analytics chief economist. “This is allowing consumers to stay in the game.”

But while it’s good that consumers have this cash cushion, there’s also a potential downside.

***What does “staying in the game,” as Zandi calls it, really mean?

Well, it means that consumers are paying the higher prices for all sorts of goods and services. This keeps demand high, which fuels inflation.

This alone is a problem. But there’s a secondary concern…

These higher prices are being financed with one-time Covid-dollars that won’t be replenished.

So, what happens when this artificial savings glut is tapped out and suddenly the U.S. consumer’s monthly budget – which clearly is already in the negative, if people are dipping into savings – runs smack into inflation-fueled higher prices?

Well, there’s the risk that businesses will face an abrupt gap down in demand, as opposed to a more gradual, tempered decline that would have happened if the U.S. consumer’s continued buying wasn’t (temporarily) enabled by pandemic savings.

In other words, the “healthy” consumer who is still spending today could be revealed as the “financial emperor with no clothes” – or rather, the emperor with insufficient inflation-adjusted disposable income.

But this artificially strong U.S. consumer has good and bad implications.

On the “bad” front, it could mean that corporate-earnings forecasts come in too high later in the year when the savings are gone, leading to pressure on stocks.

But on the “good” front, a pronounced, stairstep decline in consumer demand would help tamp down inflation.

We’re already seeing signs that inflation is cooling – energy prices are coming down substantially. And news out this morning is that rents seem to be topping out.

So, if we add decreased demand for other consumer goods, that’ll be another solid blow to inflation.

As to when the pandemic savings might finally dry up, last month, JPMorgan CEO Jamie Dimon said the U.S. consumer has between six and nine months left of spending power in their bank accounts.

We’ll keep an eye on the data here and will report back.

***Meanwhile, the U.S. isn’t the only country facing slowdown concerns

China’s economy finally celebrated its first month of growth since February, as lockdown restrictions were finally eased in many cities.

Well, there’s a new Covid outbreak in Shanghai that threatens a fresh round of lockdowns.

From Bloomberg:

China’s Covid Zero strategy is being tested anew after a jump in infections across Shanghai raised the specter of another lockdown, while a highly infectious subvariant started spreading in the country for the first time.

Shanghai reported 24 infections for Tuesday, the most in three weeks, with health officials announcing separately on Wednesday that two additional cases were found outside quarantine.

While a small number, the detection of infected people outside isolation and across several city districts raises concerns that the virus could already be spreading widely.

If we look to the Anhui province, the lockdowns have already begun.

From the South China Morning Post:

In southeastern Anhui province, more than 1,000 infections were found from an outbreak that started in late June, with 1.7 million locked down as a result.

Fears of new lockdowns resulted in a selloff in China’s CSI 300 Index earlier this week. Stocks suffered their biggest one-day drop since late-May.

If this turns into a replay of China’s prior lockdowns, with tens of millions of people under house arrest for weeks, all eyes will be on the related demand destruction for global oil markets, which are already under pressure.

***A fresh round of Chinese lockdowns will only add to sluggish demand

Concerns over a recession have been hurting oil investors in recent weeks.

Since its most recent high on June 9, the price of West Texas Intermediate Crude (WTIC) has dropped 19%, down to $98 yesterday. As I write on Thursday, it’s enjoying a nice rally back up to about $103.

Now, if you think $98 is painful for oil investors, get ready for $45 a barrel. That’s what Citigroup is suggesting could happen.

From Bloomberg:

Crude oil could collapse to $65 a barrel by the end of this year and slump to $45 by end-2023 if a demand-crippling recession hits, Citigroup Inc. has warned.

That outlook is based on an absence of any intervention by OPEC+ producers and a decline in oil investments…

It appears Citi has been reading our own Luke Lango.

From Luke’s Hypergrowth Investing issue, back on June 21:

Oil prices are up big in 2022. Everything else – stocks, bonds, cryptos, etc. – is down big.

Russian supply is coming offline. There’s been massive capital underinvestment in the fossil-fuel sector for years. It takes a long time for new supply to come online. Therefore, you’re looking at potential supply constraints for years to come.

I get all of that. That’s why oil prices have soared to 14-year highs.

But, folks, that’s already priced into the market.

Instead of totally expected supply constraints causing a run toward $200 oil, I think you’re going to get unforeseen demand destruction causing a crash toward $40 oil.

Behind this demand-destruction prediction is one thing – a recession.

Luke compares what’s happening now to what happened back in 2007-2008, pointing toward kneecapped demand as the economy tanked. This led to a 70% plunge for oil’s price back in 2007-2008. Luke believes history is going to repeat itself.

Now, as you’ve read in recent Digests, Louis Navellier and Eric Fry remain confident that there’s money to be made in top-tier oil stocks. We’ll be bringing you both sides of this debate.

In the meantime, keep your eyes on today’s rally.

***What we can say for sure is that if oil does continue heading lower, we’ll enjoy relief on the inflation front

With the price of WTIC down roughly 15% from its most recent high, and with the price of U.S. natural gas having dropped about 30% since early June, inflation is headed lower – at least, the market thinks so.

We can get an idea for this by looking at the 10-year Treasury yield.

After having reached nearly 3.50% back in mid-June, it’s been dropping fast. As I write, it’s fallen all the way back to 2.99% as I write.

So, will Federal Reserve Chair Jerome Powell see inflation in the same way as do the markets? And what will that mean for rate hikes?

Yesterday, legendary investor Louis Navellier provided his two cents in his Accelerated Profits market update podcast:

The big question is “how much does the Fed have to raise rates to get in sync with market rates?” Because market rates aren’t going up right now. They’re going down.

[The Fed will] increase by 75 basis points on July 27. And then on September 21, if they do increase by 75 basis points again, that will be the last one. That will get the federal funds rate to 3%.

So, we’ll see if they want to go to neutral or beyond neutral. I think it’s a possibility that on September 21 the Fed is only going to do [a 50-basis point hike] depending on where market rates are.

But that’s it. 

Louis sees no hikes coming in the fall because it’s right before mid-term elections and the Fed doesn’t like to influence elections. December could bring some rate hikes, but Louis is saying it’s not a sure thing.

Wrapping up, between a recession, falling oil prices, lockdowns, and the potential for inflation finally heading lower, I’ll echo what Louis says in his podcast: “fascinating times we’re in.”

We’ll keep you updated on all these stories here in the Digest.

Have a good evening,

Jeff Remsburg