Investors getting their arms around oil
By Bob Landaas
One of the key issues that investors are struggling with right now is how much is the price of oil dropping due to the global slowdown, and how much is due to oversupply?
At some point, perhaps when the price levels off, people are going to realize that it’s more a supply issue, not a collapse in demand. They’re going to realize that the global economy is not as weak as people think.
Consider that the U.S. doubled its oil production in the last six years – doubled. Where do you think that oil is going to go? We didn’t double our appetite for crude oil in this country. It’s got to go somewhere.
And if the Saudis and the rest of the OPEC members are digging in their heels, and they’re refusing to lower their production because they don’t want to give up market share, you’re going to get an old-fashioned price war.
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As a trained economist, I’m fascinated. It’s the first time in modern history that oil has gone down during a period of economic expansion. We have never seen this before. Typically, I like to cite chapter and verse about economic events to explain what happened after similar circumstances in the past. None of us can do that in this case.
It’s the same as last year when none of us could say for positive what was going to happen when the Fed was done with the bond-buying program. What impact would tapering have on the markets?
Just one year later, we’re dealing with another unknown unknown in the markets.
None of us can say for positive why the price of oil is going down. So it may take a leveling off in price and maybe a couple of quarters of GDP numbers from overseas to get a good sense that it’s not a global slowdown as much as it is a huge increase in supply of oil at a time when the demand is going down just slightly.
But nobody knows for positive now how much is the global slowdown and how much is oversupply, and that’s adding to volatility in the markets.
I like stocks at current levels. We’re trading at just over 16 times forward earnings, just a tad above average, and profit margins are at record levels.
Typically, what derails markets is higher interest rates. But there is not a lot of measurable inflation out there. And the plunging price of oil and gas pretty much cements that story. Inflation is the least of our worries right now.
A number of years ago, I raised the question, what if interest rates go down and stay down? That’s what is happening.
So we’re in this brand new world of an abundance of labor, an abundance of capital, an abundance of capacity. And the U.S. is doing OK. Not great, but OK.
And it’s important to remember that only 13% of our economy is exports. You contrast that with any of our major trading partners, and it’s just a fraction of their exposure to international trade. That’s not to say we can decouple forever. No man is an island. But we’re much less exposed to foreign trade than Germany at almost 50% of its economy from exports, and China and Japan also more export-oriented. According to the World Bank, only nine nations are less dependent than the U.S. on exports. So we’re somewhat protected that way.
The markets look for an excuse to go up. They look for an excuse to go down. I’m amazed at the resilience of this market. Go back to Sept. 19. That was the day we started selling off last fall. From the peak to the trough, back to the peak, took five weeks. You hardly ever see that.
We went through the same thing in early December, where the markets went down, and two and a half weeks later, we’re back in the races again.
As long as the dollar stays strong, you’ve got this loop of foreign investors going into the U.S. economy because it’s the only growth story in the world. That causes the dollar to go up. That attracts more and more foreign capital, which causes U.S. stocks to go up, and you get that cyclical nature. And that gets hard to interrupt after a while. So I like the stock story this year.
Typically, what ends that party is the Fed.
Typically, what ends the party is you can’t find workers, you can’t find raw materials and you can’t find a place to make your product. And then you go into bidding contests with your competitors, and prices start spiraling upwards, and the Fed comes in and says, “No. We’re not going to let that inflation genie get out of the bottle. Once it’s out of the bottle, it’s really hard to get it back in.” And then the growth story is over.
In terms of what is going to get in the way right now, I think global trade is one.
But I think the $1,000 that every household is saving from lower gas prices could make up for a lot of that global slack. As a result, the projections for 3%-plus GDP growth for this year is enough to fuel corporate profits in the range of 8%-9%. For my money, I’ll take that for the market.
You add it all up, and there are worries out there – but principally outside our borders.
You worry about China. But I think that’s the one country that’s going to be able to turn it around. We’re the biggest economy; we’re growing. China’s No. 2; they’re slowing. But they have the one thing that we don’t have, which is the control of their currency. My guess is they’re going to be able to reignite and grow their way out of trouble. That’ll spill over to the emerging world – the non-oil-producing members of the emerging world.
I’m not so sure about Japan. We’ll see about Shinzō Abe’s ability to stimulate that economy. I’m not so sure about Europe either, with Germany’s reluctance to spend any more money.
So it’s probably going to be a number of months yet before most people get their arms around why the price of oil is really going down. Is it the demand story, or is it the supply story?
My guess is it’s the supply story. People will figure that out, but it’s probably going to take oil stabilizing in price for the marketplace to get a better sense of that.
Bob Landaas is president of Landaas & Company.
(initially posted Jan. 28, 2015)