Drew Angerer
Last Wednesday, in clear tones, Fed Chair Jerome Powell said, “Inflation is running too hot. You don’t need to know much more than that.” He added, “This committee is committed to getting to a meaningful, restrictive stance of policy and staying there until we feel confident that inflation is coming down.”
Yikes! It’s great to speak clearly, but I wish that Mr. Powell had used some dovish language – like “near-neutral” or “data-dependent,” or even smiled a little – but any softening was conspicuously absent.
Naturally, his talks raised recession fears. The Atlanta Fed on Wednesday revised its third-quarter GDP estimate down to a +0.3% annual pace, down from its previous estimate of a +0.5% annual pace.
U.S. interest rates also shot up in response to his words. Currently, some short-term interest rates are at their highest level in over 25 years, as are mortgage rates. There is now a whole generation of home buyers that have never seen interest rates this high, so I suspect that home prices will continue to decline, since inventories are climbing, and homebuyers are shocked seeing the high underlying mortgage rates.
I should add that the National Association of Realtors on Wednesday announced that existing home sales declined 0.4% in August to the lowest rate since May 2020. Existing home sales have declined for seven consecutive months now, as the Fed has very effectively “pricked” the housing bubble that was so strong in early 2022. The Fed is now systematically destroying other sectors of the economy, like auto sales.
The Fed may try to prick the real estate bubble to fight inflation, but last Tuesday, the Wall Street Journal examined the results of a survey of rents and shelter costs and found that housing is a stubborn inflation problem, since shelter costs have been rising steadily – up 0.7% in August after rising 0.5% in July.
Although there is no doubt that the Fed is striving to break the real estate bubble around the country, rents and shelter costs are a lagging inflation indicator, which is why the Fed must raise key interest rates now and then to keep interest rates high for an extended period, until shelter costs begin to cool off. As a result, the soonest we can hope the Fed will reverse its high interest rate policy will likely be late 2023.
Another outcome of the Fed’s policy meeting is that they will raise rates right before the mid-term elections, and that means the House will undoubtedly have a leadership change. The Senate may also have a leadership change. It just depends on turnout and which side is more upset and willing to vote.
Sweden and Italy just shifted to the right, and that could happen in the U.S., too. In the end, all that Wall Street wants is more “gridlock,” and that appears to be much more likely after the mid-term elections.
The Global Impact of a Soaring U.S. Dollar
With Treasury yields surging to multi-year highs – for instance, the 10-year Treasury bond is over 3.7% and 2-year Treasury yields are over 4.1% – the U.S. dollar has emerged as the reserve currency for the rest of the industrialized world. The euro has yielded less than zero for many years, but now it offers close to 1%. Last Tuesday, Sweden raised its key interest rate 1% to 1.75%, while the Swiss National Bank and Bank of England on Thursday raised their key interest rates by 0.75% and 0.5%, respectively. Still, the traditionally strong Swiss franc and British pound both remain weak versus the U.S. dollar. Furthermore, Norway, South Africa, and other central banks followed the Fed and raised key interest rates last week.
A strong U.S. dollar is sending ripples around the globe, putting weaker currencies at risk of devaluation. In my opinion, Argentina will not be the only nation forced to devalue its currency in the next couple of years. Sri Lanka now has acute food and fuel shortages, which caused its people to storm the Presidential Palace and force its President to flee to the Maldives. Lebanon has drafted bank withdraw restrictions, and Pakistan is seeking a bailout from the International Monetary Fund (IMF) after floods devastated a third of the country. Laos and Zambia are also in the midst of a currency crisis and looking for IMF aid.
Another major global inflation threat centers around energy prices going into winter. The EU says it has sufficient natural gas supplies for winter (if it is not overly cold) and is now striving to lock up energy supplies for 2023, when worldwide demand for crude oil rises due to renewed seasonal pressures.
Russian President Vladimir Putin’s behavior remains a wild card that could keep energy prices high as the West continues to try to isolate Russia. Last Wednesday, Putin called up roughly 300,000 reservists and, in a rare address to the nation, said that he was prepared to declare four Ukrainian regions as parts of Russia. Putin said he would defend these regions and implied by “all means.” Putin also told the West. “I’m not bluffing… Those trying to blackmail us with nuclear weapons should know that the tables can turn on them.”
At home, the Biden Administration has depleted the Strategic Petroleum Reserve (SPR) by releasing one million barrels per day for several months, so the SPR is now at its lowest level since 1984. Hopefully, the Biden Administration will begin refilling the SPR during the winter months, when demand is lighter.
The EV Revolution is Sputtering, Threatening to Slow the Entire Economy
The Wall Street Journal recently published a great article (“Electric-Car Demand Pushes Lithium Prices to Records,” September 21, 2022), which explained why the Biden administration’s transition to electric vehicles (EVs) has created long waiting lists that are frustrating buyers, since prices are being increased substantially while they wait. Many buyers are now wondering if they can still afford an EV.
The Journal reported that EVs are in such short supply that they account for only 6% of all new vehicles sold. Although Ford (F), GM, and VW Group (OTCPK:VWAGY) all expect to rival Tesla (TSLA) in EV sales, they are hampered by insufficient supplies of critical parts, especially lithium-ion batteries. For example, Ford wants to double production of its F-150 Lightning but must employ a worldwide task force scouring for batteries.
Even though Ford signed a supply deal with CATL, it will take several years for CATL to build its U.S. battery plants. Ford even warned potential car buyers last Tuesday that its supplier costs will be $1 billion higher than expected, and up to 45,000 trucks and SUVs must be stored this quarter waiting for key parts.
In the article, the Journal reported that lithium prices are now about $71,000 per metric ton, up from less than $10,000/ton at the end of 2020. The Journal also highlighted Sociedad Quimica y Minera De Chile (SQM), which I have recommended and hold in managed accounts, as the best-performing lithium stock.
Finally, the Journal article said that California’s tax on lithium extraction is expected to delay the startup of new lithium mines. I find it ironic that California, the most pro-EV state, is now impeding new lithium production by taxing it! So far this year, lithium prices have risen by 119% (and +610% since 2020) as supply chain woes continue to impede the auto industry’s EV components and semiconductor chips.
Speaking of supply chain issues, I should add that LG Energy Solutions recently completed a new battery plant in Ohio, but this plant is only supplying GM, which is way behind in throttling up its EV production, despite 90,000 orders for its new Hummer EV. I was in Alabama last week and Mercedes opened a new battery plant next to its manufacturing plant, but initially, this new plant was assembling lithium-ion battery packs modules that will eventually be outsourced by the end of the decade.
An acute shortage of lithium, nickel, and cobalt is unquestionably hindering EV production. The Journal also reported recently that Tesla is considering pausing its plans to make battery cells at its Berlin factory in order to qualify for U.S. EV and battery manufacturing tax credits. The Journal article said that Tesla is considering shipping the equipment destined for battery production in Germany to the U.S.
The new tax credits from the Biden Administration’s green energy bill include a $35 per kilowatt-hour (kWh) credit for each U.S.-produced battery cell. The bill also affords $10 per kWh for domestically produced modules, and additional assistance for companies making raw and intermediate battery materials in the U.S. Overall, these production tax credits could offset more than a third of the cost of EV battery packs, provided the rechargeable cells are made and packaged in the U.S. Tesla recently dropped application for European Union aid, so it appears it may be gearing up to make its battery cells in the U.S.
Speaking of EVs, our family’s Audi e-tron still has not recovered from surgery after six weeks and only 23,095 miles and three years’ use. Specifically, after the service crew dropped its battery pack, the cells that had to be replaced worked, but other problem cells materialized. As a result, more cells from LG Energy Solutions (formerly LG Chem (OTCPK:LGCLF)) now have to be replaced. Frankly, I am lucky the Audi e-tron is still under warranty and has an 8-year warranty on its battery back. But some EVs are just costly toys for driving around town, since I would hate to get stuck on a long road trip with an electric car that failed!
The excitement about Porsche’s IPO in late September is helping to lift the overall stock market. The demand for the initial $9.4 billion in stock being sold in the IPO is now grossly oversubscribed, so the stock is now expected to surge post IPO. Since I recommend VW Group and hold the stock in many managed accounts, shares of Porsche will tentatively be distributed this Thursday, September 29th. The exact details of VW Group’s Porsche share spin-off will be released shortly.
I should add since Porsche has high operating margins, massive brand loyalty and it has been assisting VW Group’s EV transformation, it will undoubtedly be compared to Tesla on a market valuation basis.
Currently, Tesla is trading at 53 times estimated 2023 earnings, but Tesla still gets lots of EV tax credits, plus they have not yet had to pay any U.S. taxes. I should add that Porsche will initially electrify its iconic 911 via a hybrid model that will compete with its Porsche Turbo S model, so that its fastest-performing sport cars will be utilizing electrification in the upcoming years. I think Porsche is a great company making great products, so I would not be surprised if Porsche soon trades at Tesla-like valuations.
Navellier & Associates Inc. owns Ford Motor Co. (F), and Volkswagen Ag. (VWAGY) in managed accounts. We do not own General Motors (GM). Louis Navellier and his family own Ford Motor Co. (F) and Volkswagen Ag. (VWAGY) via a Navellier managed account. He does not own General Motors (GM) personally.
All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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