By James Neals, CFA®
Vice President & Portfolio Manager, Optimize Financial Group
“Don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.” - Robert De Niro in Heat
I learned a slightly different lesson about “heat” during my first summer job working at a full-service gas station. A few times a day, “head office” would call and tell us to either raise or lower the price. We quickly discovered that lowering the price meant getting absolutely hammered with customers, while raising it meant considerably more time to “chill.” So, naturally, price increases were executed with the precision of a high-frequency trading desk, while price cuts required considerably more… committee discussion. Eventually, we expanded our corporate malfeasance by simply turning off the lights at the pumps so customers would assume we were closed. Looking back, perhaps we were simply early adopters of modern energy-market pricing. And that may be the story of diesel today: prices go up quickly and come down rather reluctantly.
The diesel crack spread has moved above $100 per barrel versus a normal $15–$30 range, and unlike gasoline, diesel is embedded in the cost of almost everything that moves: freight, agriculture, construction, and manufacturing. That makes it a much bigger inflation problem, but also creates an interesting setup for markets. Diesel is effectively a tax on economic activity: if these elevated costs persist, eventually they should weigh on demand and growth. For bonds, that creates an important counterbalance to today’s inflation shock. Yields have already repriced sharply, meaning investors are being paid substantially more to own duration. If the diesel shock ultimately slows the economy and inflation rolls over, today’s pain can become tomorrow’s bond opportunity. And for equities, any eventual moderation in diesel prices would provide relief to corporate input costs.
And that brings us back to Heat: when you feel the heat around the corner, don’t get emotionally attached to the trade that got you there. For bonds, the opportunity is that yields have already repriced dramatically; the 10-year recently reached 5.20%, creating substantially more income and potential price appreciation if growth eventually absorbs the diesel shock and yields retreat. For equities, a cooling energy complex would eventually ease one of the biggest input-cost pressures facing businesses. In other words, the heat is real, but markets have a funny habit of pricing the fire before they price the smoke clearing.
3 Things We’re Watching This Week
- Higher yields are not necessarily a problem for equities when they are driven by stronger growth. The current rise in Treasury yields reflects a shift toward a higher equilibrium, with stronger potential growth and a higher neutral rate helping offset some of the valuation pressure from higher discount rates.
- The main risks are rate volatility and global spillover. The recent rise in yields came alongside a sharp increase in the MOVE Index, while higher U.S. yields are also pulling global yields higher. So far, however, the stress appears largely contained within rates, with limited spillover into foreign exchange and equity volatility.
- What we’re watching: Whether rate volatility begins to spill into FX and equity markets, and whether higher U.S. yields continue to push global borrowing costs higher.
- Why it matters: The key distinction is why yields are rising. Stronger growth can support equities despite higher discount rates, while a broader rates shock could create a more significant headwind for risk assets.
2. S&P 500 Poised for Record Margins Despite Energy Hit
- Corporate margins remain surprisingly resilient despite higher energy costs. S&P 500 operating margins are projected to reach new highs, with strong profitability in energy (particularly refining) helping offset rising input costs elsewhere in the index.
- AI-driven growth and productivity are providing another buffer. Technology and AI-related sectors continue to support aggregate profitability, while recent research points to increased operational efficiency and productivity. Consumer staples and industrials are seeing more pressure from higher input costs, but it has not yet become broad enough to overwhelm the index.
- What we’re watching: Whether higher energy costs begin to spread more broadly through corporate margins, or whether productivity, energy profitability, and AI-related earnings continue to absorb the pressure.
- Why it matters: Corporate margins are an important transmission mechanism from higher energy prices into equities. Continued resilience would suggest companies are absorbing the energy shock better than initially expected.
3. The Boring Minivan Is Getting Hot With American Parents Again -
Americans are increasingly choosing practicality over status. U.S. minivan sales reached 281,000 through August, up 8% from the same period last year, even as total new-vehicle sales declined. Minivans offer similar utility to SUVs at substantially lower prices, making the value proposition increasingly attractive.
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Higher fuel prices are reinforcing the trend. Four of the six minivans available in the U.S. are either hybrid or fully electric, while the customer base is expanding beyond young families to empty nesters and consumers using vans for recreation, pets, and equipment.
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What we’re watching: Whether the minivan resurgence becomes a durable shift in consumer preferences, and whether automakers respond with more hybrid, electric, and higher-end offerings.
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Why it matters: The resurgence is a useful read on household behaviour in an inflationary environment. Consumers appear increasingly willing to trade status for utility, lower operating costs and value.
Disclaimer: This report is for informational purposes only and does not constitute investment advice. Please consult with your financial advisor before making any investment decisions.