FOR investors, there are so many factors to be worried about. The subprime problem was one although it is beginning to fade into the background. Then came bankruptcies and bailouts of the major Western financial institutions.
As the credit markets in turn got hit, many became convinced that the US economy is heading for deep trouble and, in the process, pulling the entire world economy down.
As time went by, the worst fears did not materialise. And as fears subsided somewhat, the surging crude oil price, which was somewhat sidelined, came to the forefront of headlines again.
Along with this, rising inflation and reports of protests everywhere against rising oil prices filled the pages.
So far, the Federal Reserve (Fed) has tackled the subprime and related problems well. As i Capital has repeatedly advised, the subprime and related problem is containable.
It is within the powers of the Fed to prevent the problem from affecting the whole US economy.
The quick rescue of Bear Stearns is a good example of this. Another is the setting up of the Term Auction Facility. However, the surging oil price and its effects on inflation is something else.
At the fundamental level, the current rise in energy prices is not the same as the rise in the 1970s when the oil crisis was essentially due to an unexpected disruption in oil supply.
The impact was sudden and the consumers were not able to adapt to the higher oil price gradually.
This time, the rise is due to strong demand, which although strong and sustained, can only rise by a certain amount per year.
Thus, the current rise in crude oil price has not created the same disruptive effect as in the 70s.
Notwithstanding this, the rise in the last year or so has been more rapid than the prior few years and there is certainly a limit with which consumers can absorb.
In recent times, that limit appears to have been reached, not just in the developing countries but also in developed economies.
Opec has finally recognised that it is getting wealthier at the expense of the billions of poor people and needs to do something effective and fast about the surge in oil price.
At the same time, the oil speculators are recognising that crude oil price may be reaching a temporary point of inflection.
In short, i Capital is of the view that crude oil price is heading for a meaningful correction in the shorter term before resuming its rise eventually.
Such a breather, albeit relatively short-lived, provides plenty of breathing space to consumers, central bankers and policymakers, and can make investors less worried.
More importantly, it also ensures that the rate of inflation does not get entrenched in an ever-rising trend.
i Capital has termed the global economic experience of the last five years as a “cyclical inflation, secular boom”.
Few people have seen it this way and have therefore missed an important aspect of the current economic and pricing environments. This phenomenon is best captured by the chart.
Those who talked about stagflation or are worried about rising inflation have missed the big picture.
The rise in US inflation rate from 1965 to 1982 was a secular trend. The period 1982 to the mid-1990s was a period of disinflation, another secular trend.
However, the days of secular trends are over. From around 1998 onwards, the US pricing environment has become volatile with inflation moving up and down in a cyclical fashion. Recognising and understanding this feature is very important.
This brings us to the expected correction in crude oil price. Should this happen, and i Capital thinks it will, it would reinforce i Capital’s views that the current rise in US inflation rate is cyclical in nature.
At this point in time, i Capital is sticking to this view.
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