Q3 2021 Recap
A recent story on the Bloomberg news service caught our attention, at first because it struck us as somewhat comical, but as we pondered its implications it became worrisome and even frightful. The headline itself was seemingly innocuous: “A German Power Plant Just Ran Out of Coal.” Having once visited a DC-area Starbucks for our morning caffeine fix only to be told they were out of coffee, our first thought was, “That’s plain silly.” Even more so, this being October, we imagined a crew of lederhosen-clad utility workers hurriedly shoveling briquettes into a wheelbarrow, hauling it to the power plant, firing up the furnaces and clogging merrily off to the nearest Oktoberfest celebration for a stein full of lager.
Now, lest you think we might have done similar imbibing before penning this letter, please bear with us – this tale of unintended consequences does have relevance to today’s global economy and your investments. It turns out that German coal production has been in decline for years, dropping about 45% from 2012 through 2020. And yet, through the first half of 2021, dirty old coal remains the largest source of electricity in the country. The Germans are sharp engineers, as those who drive German cars will surely attest, and we’d bet they’ve been contemplating converting much of their power production to alternative, “greener” fuel sources that could help reduce the impact of coal shortages. Other fuels like, say, natural gas.
It further turns out that several years ago one of Germany’s European neighbors, the Netherlands, announced they were cutting production at their largest natural gas field, Groningen, because they were concerned about earthquakes. It seems that Groningen rests on land prone to seismic instability, and though the Dutch had been one of the main gas suppliers to Europe for decades, they will cease production at the field in entirety next year. Dutch gas generation has fallen more than 70% since 2013 due largely to production caps at Groningen.
Here’s where the silliness turns ominous: Natural gas production across Europe has been in steady decline over the years, thanks in large part to Groningen, even as natural gas dependency reached all-time highs as recently as 2019. That coal-fired German utility may not be so eager to convert to natural gas if there isn’t enough gas to go around. This imbalance has become more pronounced by the rapid and expansive post-pandemic economic recovery with consequences for the globe. Strong worldwide demand has caused natural gas prices on the New York Mercantile Exchange to jump 60% in the last three months alone! A similar price spike in the United Kingdom has led to the bankruptcy of six utility companies there as operating costs grew out of control.
In one of our recent blog posts, we discussed the likelihood that some components of surging post-pandemic inflation may indeed be transitory as the Federal Reserve has stated, but other inflation factors could prove to be longer-lived with more serious consequences. The supply and demand imbalance in the global oil and gas markets suggests fuel prices may remain elevated for some time to come. With the US spending $1.2 trillion on energy, or nearly 6% of US GDP, such cost increases might eventually impact corporate earnings and economic growth.
Though stocks had reached fresh peaks halfway through 2021’s third quarter, worries over inflation and decelerating economic growth combined with new concerns about rising US interest rates, Covid-19’s Delta variant and the solvency of Chinese property developers to send global equities tumbling in September. Despite the late resurgence in market volatility, upward revisions to earnings forecasts helped large US stocks find relatively stable footing, with the S&P 500 eking out a 0.6% gain for the quarter. Foreign stocks were on somewhat shakier ground as developed international equities slipped -0.4% and emerging market stocks tumbled -8.1%. Seasonal factors may have also been a factor in recent market weakness, as September and October tend to be dour months for stock market performance.
Our expectation remains that economic growth may continue to decelerate from its recent pace, but not decline. A slowdown in the rate of growth is still growth, supportive of our positive long-term outlook for the equities markets. While inflation may prove more problematic than many had anticipated, we are encouraged by the strong corporate earnings trajectory. Regarding the fixed income markets, we expect the Fed will be patient and responsive to economic data when rolling out future interest rate hikes so as not to cause bond market disruption.
As always, there are uncertainties to any outlook and surprises may happen. We encourage you to reach out to discuss your portfolio and ensure the mix of assets is appropriate and aligned with your financial goals.
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 FactSet data
Blog commentary and opinions expressed herein represent a snapshot in time and are subject to change. Any discussion or information contained in this blog does not serve as the receipt of, or substitute for, personalized investment advice from Evermay.