Lower Prices, More Buying

Inflation Ticking Down  

November core CPI was released this week and continued to show progress at 4% y/y growth from the 4.1% figure a month ago. Importantly, the 3-month annualized rate is now 3.4% vs. the 4% reading in the first half of 2023.     

While progress has been made on inflation, the stickier parts of the composite like medical services and shelter have kept inflation at an elevated level. Used car prices have also been elevated, although with wholesale prices coming down, we expect retail prices will follow.   

Breaking down the November inflation data between goods and services shows lower goods prices and continued elevated services inflation. An example of this: U.S. consumption of food at home increased 1.7% – the fifteenth consecutive month of deceleration. Food away from home rose 5.3% and has outperformed at home for the ninth consecutive month. This supports the idea that the services side of economy remains healthy; it’s important to remember that services account for 70% of U.S. consumption. 

Chart 1: Core Consumer Price Index Trend ¹ 

Chart 2: Consumer Price Index Trend ² 

Even though the headline figures remain higher than the Fed’s ideal, the economy is making progress and has seen a cyclical peak for both core and headline inflation. In addition, the 6-month annualized core PCE, which is the measure the Fed watches closely, is up 2.5% – significant progress towards the Fed’s goal of 2%.   

The lower inflation, 15% drop in gasoline prices, resilient consumer and continued strength in the economy (the Atlanta Fed tracker is at 1.8% for 4Q GDP) supports a soft-landing thesis, as we’ve called for.   

Energy Deals Accelerate Despite Elevated Rates  

M&A year to date has fallen 19% y/y, at $2.6 trillion. One bright spot has been the activity in the energy sector; deals in this industry are up 70.6% y/y with a total value at $372.2 billion. There are only two other sectors that have posted positive y/y M&A activity – basic materials, up +32% y/y, and utilities, up +60.5% y/y.³  

Energy security is a growing concern due to underinvestment and increased geopolitical weaponization. Compressed valuations within the energy sector have made consolidation more attractive for buyers. The Energy Select Sector SPDR ETF (XLE) is currently trading at a 10.6x forward price-to-earnings multiple, compared to the S&P 500 (SPY), which is trading at 18.5x. The oil and gas sector has been the most active in M&A year-to-date and has accounted for $240.8 billion in transactions out of the total dollar figure of $372.2 billion. The oil and gas sector specifically can be valued by looking at the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). This ETF is currently trading at an 8x forward price-to-earnings multiple, which is cheap compared to its 10-year average of 14.9x. The major oil companies have taken advantage of these low valuations and have done the buying.  

Exxon Mobile (XOM) completed the largest deal, acquiring Pioneer Natural Resources (PXD) at a $68 billion valuation; Chevron Corp. (CVX) acquired Hess Corp. (HES) in the second-largest transaction for $59.4 billion; and Occidental Petroleum (OXY) announced the acquisition of CrownRock LP for $10.8 billion.⁴ 

The M&A activity is a departure from the last several years when the major oil companies chose to return their strong free cash flow to shareholders through buybacks and dividend increases. While many continue to deploy their cash in this way, the fact that they’ve added acquisitions as of late shows just how attractive the valuations have become. But it is worth watching: the reason the sector outperformed in 2020-2022 was the strategic change (more buybacks, dividend increases and production discipline), which now seems to be reversing.   

Buyback Bonanza  

One theme year-to-date has been the strength in buybacks. It shows that companies feel their stocks are undervalued. It also speaks to the enormous strength in overall free cash flow. Year-to-date, across the NYSE and the NASDAQ, total commitments to buying back stock totaled near $360 billion.⁵ The biggest buyback came from tech giant Apple (AAPL), which has committed to buying back $90 billion worth of company stock.⁶ Taking the second spot is Chevron Corp (CVX), which has committed to buying back $75 billion worth of its shares.⁷ Generally speaking, investors respond favorably to these share repurchases, as seen by the performance of the S&P 500 Buyback Index (SPBUYUP), which is up over 12% year-to-date, outperforming the S&P 500 Equal Weighted Index (SPW), which is only up 9.6% year-to-date. This buyback index measures the performance of the top 100 stocks with the highest buyback ratio in the S&P 500 (SPY).⁸  While M&A is lower year-to-date, we expect companies to continue to look for opportunities while using their cash for other shareholder returns. 

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Sources

1. FactSet (chart). As of December 11, 2023.
2. FactSet (chart). As of December 11, 2023.
3. FactSet (chart). As of December 11, 2023.
4. Bloomberg. As of December 10, 2023.

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