Oil price rise ignites new inflation impulse

NVIDIA has been the best performing component of the S&P 500 index this year, with a total return of 197.8 per cent up to the end of September.

After that blistering run, the chipmaker – widely seen to be at the epicentre of the rise of artificial intelligence – now has a market capitalisation north of US$1 trillion.

Only two other S&P 500 index component stocks managed to chalk up triple-digit percentage returns during the same period: Facebook’s parent company Meta Platforms returned 149.5 per cent, while electric vehicle maker Tesla returned 103.1 per cent.

The S&P 500 index returned 13.1 per cent.

Do you know what the best performing S&P 500 index stock since the beginning of 2022 has been, though? Here’s a hint: It isn’t a technology stock.

It’s a company called Constellation Energy – a nuclear power producer that was spun out of another energy company and added to the S&P 500 index early last year. It delivered a total return of 164.6 per cent, versus the S&P 500 index’s total return of minus 7.4 per cent.

There were six other energy-related components of the S&P 500 index that chalked up triple-digit returns during the period: Marathon Petroleum, Occidental Petroleum, Hess Corp, ExxonMobil, Schlumberger and Valero Energy.

All but two of the 10 best performing S&P 500 index stocks since the beginning of 2022 were from the energy sector.

How did Nvidia perform during the same period? It was the 32nd best performer among S&P 500 index stocks, with a total return of 48.1 per cent.

Like many big technology-oriented stocks, Nvidia declined during most of 2022 – as the US Federal Reserve and other major central banks tightened monetary policy to address surging inflation stoked by post-pandemic supply-chain bottlenecks and the war in Ukraine.

Nvidia bottomed out in October last year, along with the S&P 500 index. At that point, the Fed was hiking rates by 75 basis points each time while the 10-year US Treasury bond yield had climbed above 4.2 per cent.

Many energy stocks seemed impervious to this rapid monetary policy tightening, though. Shares of Chevron, ExxonMobil, Occidental Petroleum and Schlumberger rose through 2022.

As headline inflation abated in 2023 and the Fed slowed the pace of its rate hikes, the big technology-oriented stocks took off again – few more so than Nvidia.

With its strong financial performance and the excitement spurred by the launch of ChatGPT in November, Nvidia’s stock more than recovered the ground it lost in 2022.

Yet, it hasn’t been quite enough to put it among the very best performing S&P 500 index stocks since the beginning of 2022.

Another inflation impulse

This ebb and flow of US stocks through 2022 and 2023 could be instructive, as rising oil prices threaten a resurgence in inflation while economic activity continues to surprise on the upside.

The US Bureau of Labor Statistics said last month that the headline consumer price index (CPI) for August 2023 was up 3.7 per cent over the preceding 12 months. This was higher than the corresponding increase for July of 3.2 per cent, and June of 3 per cent.

On a month-on-month basis, the US CPI for August was up 0.6 per cent. This was sharply higher than the 0.2 per cent increase in July and June.

The energy component of the CPI in August surged 5.6 per cent month on month, versus an increase of 0.1 per cent in July and 0.6 per cent in June. Within the energy component, the petrol segment was up 10.6 per cent month on month in August.

This fresh inflationary impulse could be problematic given the continued strength of the US economy. While the US Federal Open Market Committee (FOMC) maintained the target rate for the federal funds rate at 5.25 per cent to 5.5 per cent in September, it raised its projections for economic growth.

The September median projection for GDP growth by FOMC meeting participants was 2.1 per cent for 2023 and 1.5 per cent in 2024. This is significantly higher than their median projections back in June of 1 per cent for 2023 and 1.1 per cent for 2024.

Their September median projection for the federal funds rate by the end of 2023 was unchanged from June, at 5.6 per cent – which implies one further 25-basis-point hike. Their projection for the federal funds rate by the end of 2024 was 5.1 per cent, higher than their projection in June of 4.6 per cent.

The market seems to be accepting the idea that interest rates will stay higher for longer.

The 10-year US Treasury bond yield has been climbing since March, and is now at 4.8 per cent – a level not seen since 2007, before the onset of the global financial crisis that sparked the Fed’s quantitative easing policy.

While some investors may see this as an opportune time to hunt for bargains, I would tread carefully. We may yet see higher long-term bond yields, and continued pressure on interest rate-sensitive stocks in the months ahead.

Inflation impact in Asia

The Straits Times Index (STI) has performed better than the S&P 500 in the face of tightening monetary policy around the world, with a total return of almost 12 per cent since the beginning of 2022.

One reason for this outperformance: The STI’s largest components are not technology stocks, but banks – which benefited from rising interest rates. DBS returned 13.6 per cent, OCBC returned 25.4 per cent, and UOB returned 16.7 per cent.

Then there were Keppel Corp and Sembcorp Industries , which delivered triple-digit percentage returns on the back of value-unlocking initiatives and bullishness in the energy sector. Keppel returned 125.5 per cent, while Sembcorp returned 167.6 per cent.

Rising interest rates were hard on Singapore-listed real estate investment trusts (Reits), though. Only one Reit within the STI achieved a positive return since the beginning of 2022: CapitaLand Ascendas Reit , with a total return of almost 4 per cent.

The worst performing Reits within the STI were Mapletree Pan Asia Commercial Trust and Frasers Logistics and Commercial Trust – with total returns of minus 21.3 per cent and minus 23.2 per cent, respectively.

Will recently announced increases in transport and utility prices stoke domestic inflation? Probably.

Yet, the larger story here is that bus and train fares are being raised by only 7 per cent – well below the maximum allowable 22.6 per cent.

The Public Transport Council said it will defer the remaining 15.6 percentage points to future fare review exercises, and sought an additional subsidy of S$300 million from the government.

The bus and train sectors receive annual operating subsidies of more than S$2 billion.

Subsidies and price controls are among the tools that some Asian governments use to shield their economies from rising energy costs.

Of course, these economies would need to have robust current accounts and fiscal positions in order for their currencies to avoid depreciation pressure – a daunting prospect given the strength of the US dollar since the beginning of 2022 as interest rates increased.

Last week, The Business Times reported that Nomura sees the Philippines and Indonesia as being among the most vulnerable economies in the region to rising oil prices. At the other end of the spectrum were Indonesia, Malaysia and Singapore, which Nomura noted have current account surpluses and sufficient fiscal space to support fuel subsidies.

It will be interesting to see if the recent rise in oil prices prompts the Monetary Authority of Singapore to take any action when it releases its policy statement this week.