The Energy Stocks To Watch When Interest Rates Are Rising

If you have been reading my scribblings over the last few weeks, you will know that I am quite bearish about the prospects for markets in general, including energy stocks and oil, over the next few months. This week's inflation numbers confirmed what I have been saying for some time, and why I am not optimistic right now. The numbers indicated that here in the U.S., we are moving from the first phase of inflationary pressure, caused by jumps in commodity prices due to Covid-related dislocation of supply and a sudden surge in demand, to the second phase, where retail prices climb due to other pressures.

Commodity prices have pulled back and continue to do so, as evidenced by the small drop in the Producer Price Index on Wednesday, but the Consumer Price Index, which measures retail rather than raw material prices, continues to surge. That is because the price increases that resulted from phase one are causing workers to press for higher wages, as evidenced by the rail unions' strike threat and in a tight labor market, employers are conceding to those demands at a higher rate than usual. Add in soaring rent costs and rate hikes making debt servicing more expensive, and any inflation relief that comes from a drop in commodity prices is being more than offset by cost increases elsewhere for manufacturers.

That means that the numbers that the Fed is watching will keep rising for a while, and therefore so will interest rates. It is the rate hikes, not the inflation that are driving markets lower, so relief for investors is some way off.

So, how should we react?

Most people's first instinct in a falling market is to look for "safety", but in this case, that is hard to find. Traditional risk off havens like treasuries and cash are getting hit too. Every rate hike or indication of inflation that suggests them forces yields higher, and therefore the dollar value of bond holdings lower, while cash loses real value in an inflationary environment by definition. The solution is not to think small and short-term, but big and long-term.

That is why now is a good time to invest in companies that have enormous future potential, but that have been dragged down with everything else. This may seem counterintuitive in some ways, but it is how market professionals are taught to think, and it explains why some unlikely names look to have already found their bottoms. Take a look at the two charts below. The first is for the S&P 500 over the last month; the second for EV maker Rivian (RIVN) over the same period…

As you can see, while the S&P is retesting its lows, RIVN is soaring. That is because investors are thinking big picture and long-term and are buying RIVN while it is at a massive discount from where it was a year ago. How else do you explain a surge in such a "risky" stock in such a risk-off environment?

Obviously, that huge spike a year ago was overdone, but while it was way out of whack with where Rivian is right now, it was a result of the enormous potential of the company. Now that investors are looking for stocks that have long-term potential regardless of short-term fear, RIVN is back in vogue.

There are other examples too, but the point is that if, like me, you are worried that the Fed will force us into recession but don't want to lose money by buying bonds or sitting in cash, the best strategy is, in some ways, to take on risk rather than to dial it down. As I said, counterintuitive, but the charts tell the story and now is a good time to buy some things where there is risk, but not necessarily risk related to inflation or rate hikes. RIVN fits that bill.