Will High Gas Prices Hurt this Economy?

Filling up my pickup used to take $40, now my wallet is deflated by $75. I hear the same cash sucking sound when my wife fills up her vehicle. Granted we don’t drive the most fuel efficient vehicles, but our monthly budget for gas has gone up at least $200. Ouch! That’s not pocket change, and Americans on a fixed budget or those who are already living beyond their abilities, are going to feel the pinch.

At some point, gas prices will hurt the economy and push us into a recession. Gas at $4 per gallon certainly hurts; but it isn’t enough to cause a recession by itself. The price of gasoline accounts for only 4% of personal consumption. Some price increases can be absorbed into the average family’s budget.

Higher fuel prices cost us more than the direct cost of filling up at the pump. The higher cost of fuel is imbedded in everything that we buy. If the products you are buying are shipped, and practically everything is, a portion of the purchase price is for transportation.

Clients of mine that have been following my advice over the years to keep their debt low and to actually save for large purchases rather than using credit, are better able to weather this storm. Those who have not, will need to make some direct trade-off. There is only so much money to go around.

Don’t expect the rest of the world to feel sorry for us. We have 3% of the population and we consume 25% of the world’s energy resources. The unfortunate reality is this: we now have some competition (China) for the world’s resources. This competition is driving up the cost of oil. For some strange political reason, we refuse to use the resources we have available right here in the good old USA. We are spoiled and don’t want to get our own hands dirty, but we want others to supply their oil to us at a cheap price.

It’s time for the bloated US consumer to go on a diet. (Starbucks has been successful in convincing many consumers to spend $35 for a gallon of coffee.) But like the diet I have been on for the past six months, it only works if I change some of my longstanding behaviors. The first few weeks of my diet, I was one grouchy fellow. I would still like to go back to my nightly feeding at the ice cream trough, but I know that I can’t get away with it anymore. Likewise, the US consumers need to change some patterns of behavior on how we use oil and gas.

But don’t confuse going on a diet with going into a recession. Earlier in 2008, it was beginning to look like a recession was a real possibility. We have come to terms with the sub-prime housing issues and the economy has still been resilient. The weaker dollar makes our goods and services cheaper oversees, which has been a positive offset.

Gasoline at $4 a gallon won’t kill this economy by itself, but it is another pressure point. If enough other negative events occur, like a disruption in the oil supply or even some other large economic negative occurrence, it could easily add up to too much. At some point too much is just too much.

So what are some smart things you can do to protect yourself? Here are a couple of thoughts:

If you can’t beat them, join them. Maybe some of your portfolio should be positioned to take advantage of higher fuel costs. If fuel costs are eating up your home budget, you can help regain some of that money through extra investment earnings. Vanguard has a wonderful energy fund. Returns have averaged over 17% for the past 15 years and even 35% for the past five years. It does have a high minimum balance of $25,000, so it is only appropriate for portfolios of $250,000 or more. Another option is to simply purchase an Energy Sector Exchange Traded Fund (no minimum) as a hedge against higher inflation. This Exchange Fund buys only energy stocks, and they buy an equal representation of all stocks in that sector.

With oil prices increasing everyone’s budget, your portfolio should be positioned more toward defensive value stocks vs. growth higher risk investments. Properly balanced portfolios need both kinds of stocks, but I have always built a bias into the portfolio toward conservative large blue chip investments. I

nvest in China. China, and even Asia in general, are competing with the US for oil. The growth of Asian countries has been tremendous and I believe it is a trend that will continue for many years. These markets can be volatile. So they aren’t for the faint of heart, but the returns can be generous. For example, one fund I have been using for clients earned 65% in 2006 and 75% in 2007. For the first part of 2008 it is down 13%. For the past five years the average return was 35% and for the past ten years it was 17%. In addition to investing overseas in the Asia market, I am currently researching investing in a fund that specializes in the Middle East. These types of investments should only comprise a small part of your portfolio, but they can help enhance your overall returns.

With the pressure from fuel costs, inflation overall is beginning to raise its ugly head. Don’t get caught in long term bonds, which lose their value as rates go up. Also, don’t keep your money in CDs and money market funds that are currently averaging 3% or less. Inflation alone was over 4% in 2007, plus you have to pay taxes on the earnings. Most people are going backwards trying to be safe and they don’t even know it. You might not be able to control the cost of gas at the pump, but you can position yourself to win. You don’t have to be a victim.

Ron Dickinson CPA, CFP®, MPA-tax