"Kee Points" with Jim Kee, Ph.D.

  • A Stock Market Rationale
  • High Oil Prices?
  • The Varian Rule
  • Electric Cars

A Stock Market and Economy Rationale

We are just past the half way point for the third quarter, and the Atlanta Fed’s GDPNow estimate for 3rd quarter GDP growth (annualized) is 3.8%. That will change as we move through the quarter, and it is ahead of consensus, but it does beg the question: why would GDP growth – and stock markets for that matter – continue to expand with so much of President Trump’s agenda in flux? One answer is that the upward trend in taxes and regulations that we have experienced in the past few years has come to a halt, and this alone is significant from the market’s perspective. This case has been made by economists like Raguram Rajan of the University of Chicago and by Victor Canto of La Jolla Economics (a Chicago Ph.D). In fact, analyst Jim Bianco counts the pages added to the Federal Register every year (a gauge of regulatory costs) and reports that this year could see one of the largest declines in regulatory actions since the inception of the Federal Register in 1936. Bianco sites a report published by the Competitive Enterprise Institute which argues that the costs to businesses of regulatory compliance exceed those of federal taxes. That’s pretty consistent with prior work done at the Institute for Research on the Economics of Taxation (IRET). Measuring regulatory burdens is notoriously difficult, which is why empirical studies in this area are so few. And most studies are done by think-tanks, which tend to be ideologically driven and often fail to mention some of regulation’s benefits. Nevertheless, the regulatory tone coming out of Washington has changed, and that should impact stocks and the economy in a positive way.

The Case for Higher Oil

With the fracturing of OPEC (Organization of the Petroleum Exporting Countries), the rise of fracking, and the use of alternative energy sources, it is hard to find anyone who doesn’t believe the “lower for longer” outlook for oil prices (currently WTI is at $47/barrel). In fact, many technologists are calling for the demise of the fossil fuel industry in as few as 5-10 years. I am sure most of you have an instinctive red flag that goes up anytime a view of something in the financial markets world is so one-sided. I know it causes me to ask, “Is anyone making a plausible case for higher oil prices going forward?” It turns out there are quite a few.

One comes from the Federal Reserve Bank of San Francisco (FRBSF). Writing in the August 21, 2017 Economic Letter, economists Deepa Datta and Robert Vigfusson point out that the demand for oil from emerging economies like China and India is expected to continue to grow. Demand from China in particular, though it constitutes only 12.2% of global oil demand (2015), accounted for almost one-half of the increase in demand between 2005 and 2015. The demand for oil from China going forward will depend upon both the rate of growth and the energy-intensity of policy choices made by the Chinese government. But the authors argue that even under a scenario of more moderate growth and of less energy-intensive choices, China’s oil demand should still grow by over 30% by 2025.

The Varian Rule

The authors also point to the Varian Rule, named after economist Hal Varian, chief economist at Google and Professor Emeritus at UC Berkeley. If you earned a Ph.D. in economics over the past 20 years you have probably worked through one of Varian’s microeconomics textbooks. The Varian Rule suggests that, “A simple way to forecast the future is to look at what rich people have today; middle-income people will have something equivalent in 10 years, and poor people will have it in an additional decade (FRBSF).” The rule was originally applied (accurately) to luxury goods, i.e. as incomes in emerging economies grow, so should the demand for smart phones, computers/TVs, etc. The San Francisco Fed economists apply the Varian Rule to oil, and argue that as countries transition from low-to-middle-to-high income, consumer demands for all material goods will increase along with or including the demand for oil. They give plenty of evidence from other countries that higher per-capita (per person) GDP results in a sharp acceleration in the demand for oil. The resulting forecasts indicate future oil prices in the $90 to $100 range, so yes, there are plausible cases for higher oil prices going forward!

Electric Cars

Along these same lines, since the main petroleum product consumed in the United States is gasoline (U.S. Energy Information Administration), what about the growth of electric cars? It’s a good question, particularly in light of the exploding demand for them and of statements made by governments like the UK and 12 other international members of the Zero Emission Vehicle Alliance (ZEV), committing to zero emission vehicles by 2050. But at a recent Milken Institute Conference, Fitch Ratings analyst Alex Griffiths ran the numbers on electric vehicles and the demise of conventional gasoline/diesel vehicles, and the results were pretty surprising. Currently, electric vehicles account for about 1% of the 1.2 billion cars on the road. If electric vehicles grow at a compound annual growth rate (CAGR) of 30% per year for the next 18 years, then in fact all the cars sold will indeed be electric cars by 2035. But at that point electric cars will still only be ¼ of global vehicles in use, and fossil fuel burners will have grown to 1.5 billion vehicles. So while electric vehicles will certainly impact the demand for gasoline, internal combustion engines are not expected to disappear in the next 20 years.