Energy Crunch - High Volatility But a Flat Market

September 01, 2022

Another turbulent month is in the books, but compared to last month, we were relatively flat at the end.  Although all the funds were negative, it was reasonable to assume there would be some profit taking while much of the world (and market makers) were on vacation.  Get ready for a more energized Fall as energy prices become a focal point across the globe.  I’m not sure if the media outlets will report the true scale of the crunch that is soon to occur, but the wallets of every consumer have been feeling the inflation dealt by the rise in energy costs.   Depending on the regulatory environment, if the USG decides to backtrack on fossil fuel energy sources to relieve the pain being felt both in the US and Europe there could be a significant uptick in the energy sector which would benefit the funds that track the S&P 500.  However, I believe this is highly unlikely to occur and would take months to be seen.  Rather, the more likely scenario is we continue to enter a period of stagflation where inflation remains high due to soaring energy prices and our economy continues to contract or remain flat-this scenario will keep the markets flat as well.

In this environment, the small cap index will fare worse than the S&P 500 and presents less room for growth.  Smaller companies are less likely to be able to absorb the higher energy prices (economies of scale) and will thus struggle to grow.  International funds, for the most part, are also at risk, especially the funds exposed to Europe and certain parts of Asia.  Europe will face a choice this winter, abandon Ukraine to heat their homes or deal with a thermostat set to 60 degrees and continue supporting Ukraine.  Even if there is “peace in our time”, there is no guarantee Vladimir Putin will turn on the natural gas again. 

In Asia, I am concerned about the increasing hostility Taiwan faces from the PRC.  Taiwan is the absolute center of integrated circuit production.  Without integrated circuits, the highly profitable companies that drive much of the stock market, small cap to large cap, US to international, will be unable to manufacture and sell.  I will be closely watching this scenario unfold, but the mere presence of an island claimed by Taiwan that is only 10km from mainland China may be too tempting for the PRC to take given the significant geopolitical significance of testing the US’s stance on Taiwanese sovereignty.

In short, I am still remaining 100% in the C Fund, and I think there will continue to be strong recession and stagflation indicators.  We will see more volatility, but I think we will see a flat market (+/- 4% monthly) for the next few months and the C Fund is the best place for my investments.  Keep investing!