Transcription
This may be the most important chart to understand today. It shows us job growth in the United States and over the course of the last year and a half, the job market has slowed to a standstill. The economy has no longer been adding jobs and in certain months, we've already seen it begun to lose jobs.
But the most important element behind this is that this was what the job market looked like before the war in Iran triggered an oil shock. If the job market was already on the edge of breaking with oil at $60 a barrel, what's going to happen with oil at $95 a barrel? Yes, there is potentially a ceasefire that is currently in the works, but the reality is that oil prices remain 50% higher than they were before the war started, and we have not yet felt the full economic impact that will result from this.
We can take an educated guess at what's going to happen by quickly going back through history. We can adjust the price of oil for inflation to make sure that all of this is comparable. And if we add the US unemployment rate, which is another way of looking at the strength of the job market, you'll notice something quite peculiar. Rises in the price of oil actually often lead the unemployment rate. We can even shift the price of oil forward by a few months to see that it's a very good match.
We know that oil shocks in the 1970s caused multiple severe economic downturns. But this also shows us that the rise in the price of oil preceded the 1990 recession, the 2001 recession, and even the 2008 financial crisis came shortly after a spike in the price of oil. Today, the jump in oil prices is comparable to seven other historical episodes that we've highlighted here. Out of the seven, five were followed by official recessions as classified by the NBER.
In the meantime, the US stock market has been bouncing back considerably over the last couple of weeks despite oil prices continuing to climb higher. Many economists are concluding that this is a sign that the economy is strong enough to weather through the move up in oil and that as long as oil prices don't rise further, growth can remain stable and the stock market can recover. So, let's take a look at that.
Real GDP growth in the United States has been hovering nicely in the 2 to 3% range for the last few years, which is indeed healthy by historical standards. One argument would be that this provides a cushion for the economy before it actually enters any kind of contraction. But this ignores what actually tends to happen at the start of all prior economic downturns. They tend to be sudden. For almost every prior recession in recent history, real GDP growth was actually hovering at around 2% as the downturn actually started. You can see the beginning of these gray lines here mark the beginnings of the economic recessions classified by the NBER. And these actually typically start at the 2% mark, which is where we are today. So in other words, there is no cushion and higher oil prices could absolutely be able to start a recession.
Now, typically oil shocks hit the consumer first directly through gasoline prices raising the cost of transportation and heating, but also indirectly as a result of higher inflationary pressures across all goods and services that require some kind of energy input, which is a lot of them. And given the fact that consumer spending makes up 70% of GDP, it is by far the biggest influence on revenues and earnings of businesses across the economy. So a contraction in consumer spending as a result of an oil shock leads to lower profit margins and so can result in layoffs and start a recession.
So we just need to see if the consumer is already taking a hit as a result of the oil shock. This is what the decomposition of GDP growth looked like before the war started. According to the Federal Reserve's realtime GDP model, approximately 2/3 of US growth was driven by US consumer spending, accounting for 2% of annual real GDP growth. Here's what the decomposition of growth looks like today. We can see that the contribution of consumer spending has gotten much smaller, only accounting for 1% of annual real GDP growth. That means that the oil shock so far has already resulted in a pretty big hit to the consumer.
If we look at the trend between these two dates, we do see that GDP growth that was actually estimated at almost 4% before the war is now down below 2%. Now, to be clear, this is still positive growth. But it's important to remember that we're only a month into the energy shock. Historically, the average length of time between the moment where an energy shock occurs and the moment where a recession actually starts is 4 months. So in other words, each week where oil prices remain high, we believe that increases the odds that consumer spending continues to take a hit and drags economic growth down, potentially pushing the economy into a recession.
Now, this is not just a theory. We're seeing that beginning to get reflected in financial markets in a big way. One of our favorite measures of stress on the financial system has been flashing a pretty ugly signal recently. This is the bond market volatility index, also known as the move index, and it has jumped up considerably recently. We know that bond market volatility only spiked like this in times of high uncertainty regarding growth or inflation. In 2022, when inflation was surging as a result of the oil shock, the move index spiked during CO 19 when the economy was in freef fall. The move index spiked. The same thing happened in 2008 during the great financial crisis. And bond market volatility is one of the most important metrics of health of the financial system and has a huge knock-on effect on the stock market.
We can see that by flipping around the move index and laying on top the valuations of the S&P 500 index as represented by the famous Schiller PE ratio which essentially gives us a measure of how expensive the stock market is based on long-term earnings. The pricing of the stock market is highly tied to bond market volatility. Whenever there is high economic uncertainty, valuations tend to be considerably lower.
Now, if a sustainable ceasefire is implemented and oil prices come back down violently below $80 a barrel, all of this is going to be reversed very quickly. Bond market volatility will cool down and the stock market can resume its bull market. But the point is the current bounce that we are seeing on the market is premature. It is front running a ceasefire that has not yet been confirmed by the energy market and there still exists significant risks to stocks as a result of higher inflationary pressures and potentially a hit to economic growth.
Now that doesn't mean that you should sell all of your stocks and go into cash because cash actually tends to lose its value even more rapidly whenever inflation picks up. But if we really are heading into a period of stackflation, history tells us that there are areas of the market that outperform massively relative to the rest. And we do have real evidence that stackflation is becoming a real possibility as the energy shock is spreading across the prices of raw materials. This is the case, for example, for aluminum prices that have surged recently. You might think that aluminum should be coming down as a result of slower growth. But actually in a stagflationary environment, the prices of all raw materials see significant upside.
We can see that from the 1970s, the last big period of stackflation that the US economy experienced. Aluminum prices skyrocketed during that period despite very low economic growth. We actually think that aluminum is potentially staging a multi-deade breakout similar to what it did in the 1970s. This is a topic, by the way, that we've done extensive research on. And the best way to take advantage of this is to be positioned in stocks that are going to see their profit margins expand significantly as a result of higher prices in these metals. There are two stocks in particular that we think are exceptionally well positioned to take advantage of this.
But it's not just aluminum. We're seeing stagflationary behavior in energy infrastructure stocks. The earnings of these companies have begun accelerating higher recently after a decade of them being stagnant. This is a clear reflection of more sustained inflationary pressures. And again, if we look at what the earnings of this sector looked like in the stackflationary 1970s, it also saw incredible growth with earnings going from $4 per share in 1960, tripling to $12 per share by the 1980s. This was a direct result of the higher levels of inflation witnessed during that period. And again, we think a history is going to repeat, which is why this is another key theme that we've looked at extensively.
It won't be every company within this sector that actually benefits from this. Some stocks are going to benefit infinitely better than others to take advantage of this secular trend. For example, the stocks that we are buying are intimately working with tech companies to capture the infrastructure buildout that is going to take place this decade. So although stackflation is a scary word, you can see there are major opportunities for investors who are willing to look in the right areas and do the research. These are not moments to panic sell and dump all of your holdings, but rather use the volatility in order to position yourself in exceptional companies that are going to benefit from significant tailwinds.
You can access the full premium research report that we've done on these stocks by clicking on the link in the description below. These are probably some of the biggest investment opportunities that I've seen since I started looking at the market. So, I strongly recommend it. Thank you for watching.