November 2023 / VIDEO
Moving to a new equilibrium path
David Eiswert explains how the world is now on a different path where inflation creates inflation
Transcript
Recorded 27 September 2023.
So, let's imagine that all the narratives that, so the period from the GFC to COVID, it was a very special period, right, in history. Secular stagnation, no growth demographics, right, debt, all these different issues that people, and that's why we have really low inflation, really low interest rates.
What if it turns out that the reason we had really low inflation and really low interest rates was we had a major shock in the GFC and it put the global economy on a path where really low inflation led to really low inflation, right. So I’ll just give you an example of energy, OK. So if you have really low inflation and the cost of capital is really low, you go out and you dig a bunch of wells and you get a bunch of oil in Texas and you sell it for whatever price you need because your cost of capital is, you know, single digits, right. And what happens to oil price? Stays low, right? What happens to inflation? It stays low. What happens to interest rates, they stay low. What happens to oil, oil drillers? They drill more, right.
And we go through this process, right. So what if that equilibrium path that we were on in that period of time wasn't so much driven by the narratives you hear a lot, it was really driven just by we were stuck in this low inflation creates low inflation. And the reason that I bring that idea up, because COVID was another big shock. COVID was a massive shock.
But the COVID shock very likely could have led us to a different path, right? And we're on a different path. And what is that path is a path where inflation creates inflation. So, energy is the great example. Do we think, does anyone in this room think that the demand for energy is surging right now? China's in a recession. Germany's basically in a recession.
The UK is close to a recession. The US is still strong but not stronger than it was. Why are oil prices going up? Well, look at the economics to drill a well. Go out and try to drill a well. Cost of capital, 15%. Go get workers. No workers, 3% unemployment in the United States, right? Go get a truck. Go get transportation. ESG and a lot of the policies around the world, whether you like ESG or don't like ESG, ESG has clearly led to a degradation of the energy supply chain. So consolidation, equipment companies have gone away. The cost curve for getting oil has gone up. Now what does that mean? That means the price of oil has to be higher to get someone to go out and drill a well. The rig count in the United States is falling every week as oil prices go up. The rig count fell last week. Oil's US$95.
How do you explain it? Like what is it? Why would that happen and how does that lead to inflation driving inflation, right? So it's super interesting, this idea that we could be on a different equilibrium path and why that's so interesting to me as a portfolio manager and I know everyone, all the hotshot portfolio managers, they just say ‘please go back to rate cuts, please go back to just buying tech and I just want to own growth and forget about everything else’, right. You know, I didn't own, so I really didn't own any energy for the whole period that I've run the strategy until now, right, until the last 12 months, we didn't own energy and why?
Because the returns went down every year. Every year you had declining returns, right. And so now you have increasing returns and so now energy is a more interesting, interesting space.
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David Eiswert is a portfolio manager in the U.S. Equity Division of T. Rowe Price. He is the portfolio manager for the Global Focused Growth Equity Strategy, a role he has held since October 1, 2012. Prior to his current role, Mr. Eiswert was the portfolio manager for the Global Technology Strategy from October 2008 until May 2012. He was a technology analyst from 2003 until 2012. Mr. Eiswert is a vice president of T. Rowe Price Group, Inc.