oil? ebola? the dollar?–why stock prices have been falling

In many ways, stock market commentators have an unenviable task.  At any given moment they have to come up with new and interesting reasons why stocks are rising or falling.   The media gurus’ difficulties are compounded by the fact that most are story presenters who have little understanding of investing and are therefore reliant on sources whose statements are many times influenced by their own private agendas.

After peaking in mid-September, US stocks have fallen by about 7% through yesterday/  This has erased most of their year-to-date price gains, although with dividends factored in the S&P is still up about 4% since New Year’s Day.

Among the current “explanations’ for the fall are:

–a falling oil price.  I don’t think this makes sense.  It would be one thing if world GDP were turning negative and demand were sagging as a result.  The current issue, however, is oversupply, being caused by the rise of shale oil/gas production in the US.

Yes, 10% of the S&P 500 consists of oil-related stocks, many of which are hurt by lower prices.  But, to simplify a bit, the other 90% of the index is a beneficiary.  Lower prices are bad for oil-producing nations in the Middle East, for Russia and for the rest of OPEC.  But they’re great for consumers.

Another point:  today’s production contracts with national oil companies provide that virtually all revenue from oil price increases above a certain level goes to the host country, not to the international oil firm that is developing the petroleum deposits.  Although this has been true for decades, my sense is that many investors still don’t get this.  The dynamic is much more consumers gain/emerging countries lose than the consensus thinks.

–ebola.  More about this tomorrow.  Ebola is scary.  The only model we have for what happens to stocks once investors become aware of pandemic possibilities is SARS.  On the other hand, Doctors Without Borders has been handling ebola patients for many years without a single infection of their own.  In my view, stocks would be way lower than they are today if investors viewed ebola a real threat.

–the dollar.  This is an issue, although almost no one is talking about it. The US dollar has risen against the euro by almost 10% since early May.  In back-of-the-envelope terms, 25% of the earnings of the S&P 500 is sourced in euro.  A 10% fall in the dollar value of the euro means that overall S&P earnings–without factoring in current Euroland economic weakness–will be 2.5% lower than previously thought.  Discounting this outcome would explain about half the recent market decline.

my take:

–technicals.  At the peak a few weeks ago, stocks had already discounted all the S&P earnings growth that’s likely for 2014.  In addition, the market had already also factored into prices, let’s say, a third of the expected earnings growth for the index next year. This is normal market behavior, granted, though, that we haven’t seen “normal” for the better part of a decade.

By September, potential short-term buyers couldn’t justify paying higher prices for stocks.  In addition, euro weakness + a lot of other miscellaneous stuff had put 2015 profits under threat.

We’re now in the process of determining how low prices have to go to bring buyers back.

Looking at past levels where lots of buying and selling has taken place ends up being a surprisingly effective tool for figuring out where buying will emerge again.  Don’t ask me why.  If this rule of thumb holds true, as I read the charts the key levels are 1840-80 (i.e., where we are as I’m writing this) and 1800.

4 responses

  1. I don’t fully understand why the rising dollar/falling euro would have this effect. If 25% of earnings sourced in euros are negatively affected, then isn’t all the earnings sourced in dollars positively affected? As long as more than 25% of the earnings is in dollars, that sounds like a win.

    • Thanks for your question.

      Take Coca-Cola as an example. Let’s say (I’m making the numbers up, but that shouldn’t matter) that in the US the company sells a case of Coke for $5 and makes $1 in profit. In Europe, it sells a case for 5 euros and makes 1 euro in profit.

      A few months ago, a euro was worth $1.39. Now it’s worth $1.26. That change makes no difference to Coke’s US profits. It still makes $1 a case. In figuring the dollar value of its profits in the EU, it used to make $1.39 a case; it now makes $1.26–or about 10% less in dollar terms than it was earning before the dollar fell.

      My experience is that Wall Street reacts to currency movements rather than anticipates them. So I think that professional investors are only now adjusting down their earnings expectations for companies like Coca-Cola that have big European operations.

      Another way of putting the same thing: the stream of future US earnings from S&P 500 companies hasn’t changed; but the dollar value of European earnings is lower.

      A complication (which I was ignoring in yesterday’s post): over longer periods of time, a currency rise acts some what like an interest rate increase, and tends to slow economic activity; a currency decline does the opposite. Personally, I think the dollar rise won’t make that much difference in the US, but it will be a boon to the EU, especially for its exporters.

      You’re right, though, that holders of dollars are now richer than they were before, in that their dollars will go 10% farther in Europe today than they did in the Spring.

  2. CLARENCE ROY-MACAULAY
    Associated Press

    FREETOWN, Sierra Leone (AP) — A Sierra Leone soldier has tested positive for Ebola but he is not a member of, and had no contact with, a battalion of peacekeepers waiting to deploy to Somalia, a government spokesman said Tuesday.

    Meanwhile, Liberia’s transport minister said she was voluntarily isolating herself inside her home after her driver died of Ebola.

    The two situations underscore the precautions being taken to minimize the spread of the deadly disease, and the risks inherent in the movement of people.

    In another example of the disease’s relentless march, Doctors Without Borders said Tuesday that 16 of its staff members have been infected with Ebola and that nine have died. The toll highlights the high risk of caring for Ebola patients even at well-equipped and properly staffed treatment centers.

    Read more: http://www.wtop.com/220/3721819/Sierra-Leone-soldier-with-Ebola-is-not-peacekeeper#ixzz3GB317DEU

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