Tag Archives: economy

is the current equity selloff about oil?

December 12, 2014 By in Energy, Industry Analysis, shale oil, Strategy Tags: , , , , , , , 3 Comments

I’m postponing my 2015 Strategy summary/conclusion on Monday.

 

The price of oil has been steadily declining since June  It’s now below $60 a barrel, after having moved sideways at around $100 from January through early July.

I think the drop is being caused by the fact that supply and demand for petroleum are relatively inflexible in the short term, so small changes in either can cause surprisingly large changes in price.  In 2008, for example, the oil price quickly spiked up from $100 to almost $150 a barrel.   It moved above $125 for a short period in 2011 and again in 2012.

Unlike the prior three surges–caused by fears of supply disruption–the current decline is being created by the steady increase in shale oil output from the US.  In a sense, no one needs all the oil now being brought to the surface.  No one has a place to store the excess.  No producer is willing to cut back his lifting to make room for the extra.  The only mechanism available to clear the market is that the price drops until it reaches a level where buyers are willing to take the risk of increasing their inventories.   Doubtless, commodities speculators of all stripes have been accentuating the downward trend with their shorting activity.

Bad as the price drop has been for oil-producing countries–Russia, the Middle East and Africa–it’s a big plus for the rest of the world.    …yet stock markets are falling on the news.  Why?

–Some market strategists are saying that falling oil prices are being caused by a mysterious–and as yet unseen in other data–falloff in economic activity.  In other words, lower oil is supposedly a harbinger of recession.  Other than for the oil producers, this makes no conceptual sense.  And it flies in the face, at least in the case of the US, of all the economic data we’re seeing–which indicate that the economy is accelerating.

–Others argue that falling oil presages deflation, presumably of the type that has plagued Japan for decades.  Again, other than for oil producers and their banks, I don’t see the problem.  Ex oil companies, no one is going to have less money to spend or to use to repay debt.

–There is a stock market-specific issue, though.  Take the US as an example.  In rough terms, the country produces 13 million barrels of oil a day and uses 20 million.  So it imports 7 million.  The price fall means the country as a whole is keeping about $100 billion a year that was previously going to foreign pil producers.  The loss to domestic producers/gain to domestic consumers is about $200 billion a year.  That money isn’t leaving the country.  It’s just going into different pockets.

In an $18 trillion economy, the whole thing is peanuts, even with secondary effects.

But oil stocks represent 8%+ of the S&P 500 (for the MSCI Global index the proportion is about the same).  So the effect on stocks is much more dramatic.

Energy stocks went down by 10% last month   …and they’ve declined another 5% so far in December.  This has two influences on the market.  The drop in oil stocks themselves depresses the index.  In addition, short-term traders, thinking oil shares look cheap (rightly or wrongly), will short other sectors to buy the oils in the expectation of a bounce.  This arbitrage activity drags the rest of the index down as well.  This is just the way stocks work.

–The fact that we’re close to the end of the year, when many professionals have begun closing down for the year, doesn’t help.  They’ll prefer to sit on the sidelines for now and hunt for bargains in January.

my take

I think the “expert” opinions about possible deflation and recession are silly.  The outsized representation of oils in stock market indices is an issue, but a temporary and minor one, in my opinion.  If anything, I think the oil price fall is a trigger for investors to begin discounting potentially higher interest rates next year.  Some investors may simply be taking profits after a 2014 that has been much stronger than anyone expected.  But declines in December seem to me to imply a better chance of gains in 2015.

 

Shaping a portfolio for 2015 (v): the US

December 10, 2014 By in Portfolio management, Shaping a portfolio for 2015, Strategy Tags: , , , , 2 Comments

a healthier economy

2015 will likely be the first normal year for the US economically for a long time.  The unemployment rate is close to full employment levels; job creation is high–and accelerating; recent signs suggest that wages are beginning to rise.

Wage gains are important for two reasons:

–higher wages imply more consumer spending, which means accelerating economic expansion, and

–the resulting increase in the price level diminishes the possibility of deflation.

alone in growth mode

The EU is, generally speaking, a less dynamic area than the US.  But it is also years behind the US in putting recession in the rear view mirror.  It is still struggling with structural problems–Greece, for example, is flaring up again.

I continue to believe that Abenomics is not going to solve Japan’s economic woes.  So pencil in no growth there.

China is attempting to transition from being an export-driven economy to a doemstic demand-oriented one.  As one would expect, it is encountering tremendous resistance from the export establishment.  This struggle will keep the Chinese economy range bound around 6%-7% GDP growth for a while.  Big numbers, yes, but no acceleration like the US is experiencing.

a lower oil price

I’ve written about this in more detail earlier in this Strategy series.  For the country as a whole, a lower oil price is a plus.

Assuming, as I do, that prices will stay around this level, effects will likely be:

–the biggest percentage change in disposable income for the less affluent,

–diminishing interest in alternate energy sources

–economic, and possible political, troubles for oil-producing countries–Russia, the Middle East and Africa.

We’re already seeing renewed interest in gas-guzzling cars and trucks in the US.  But also–a good thing, in my view–politicians are beginning to talk about raising taxes on gasoline.  This would provide funds–at least in theory–to repair decrepit roads and bridges.  By encouraging conservation, it would also lessen the long-term economic power of the oil producers.  And it would bring US policies more in line with the rest of the developed world.

rising interest rates

The good economic news opens the door for the Fed to begin to raise interest rates from the current emergency-low levels.  I’ve written about this too in more detail earlier in this Strategy series.

Normalization of rates is a long-term plus.  But rising interest rates will also tend to slow growth a bit, both by raising the cost of borrowing and by rising interest rate differentials between the US and other countries giving strength to the US$.

structural factors

The Internet continues to be an amazingly powerful force of creative destruction in the economy.  No end in sight.

Millennials have surpassed Baby Boomers as the largest segment of the population.  In addition, Millennials will be the chief beneficiaries or rising wages, while Boomers will see their incomes drop as they enter retirement.

my bottom line:  the fact that the US is coming further out of recession is a huge long-term plus, both for the economy and for US financial markets.  Purely from a stock market point of view, however, there are a lot of conflicting variable in the equation for 2015.  And that’s apart from trying to handicap what the markets have already begun to discount.  More about this when I put all the pieces together in a couple of days.

Shaping a portfolio for 2015 (iv): interest rates

December 9, 2014 By in bond market, securities markets, Shaping a portfolio for 2015, Shaping a portfolio for 2015 (iv); interest rates, stock market, Strategy Tags: , , , , , , , , Leave a comment

The Fed has made it clear that it intends to begin the multi-year process of raising short-term interest rates back to normal sometime in 2015.  The agency says it expects to boost the Fed Funds rate from the current zero to around 1.5% by next December.

This is a good news/bad news development for investors.  On the one hand, the economic data clearly show that the US is finally–after six years–coming out the other side of the Great Recession.  On the other hand, rising interest rates are typically not good for securities markets ( a rising return on holding cash makes long-term investments like stocks or bonds look less attractive.).

If the Fed were to begin next April, it would have to do a .25% interest rate increase about every six weeks to get to 1.5% by yearend.  That’s just the beginning, though.  Fed documents indicate that the final goal is a Fed Funds rate of 3.5%.

what history shows

Rising rates are unequivocally bad for bonds.

In contrast, inpast periods of Fed-induced rate rises stocks have gone sideways to up.  That’s because the downward pressure that rising rates exert has been offset by upward pressure from strong-growing earnings.

 four differences today

1.  In past plain-vanilla recessions, interest rate hikes come pretty quickly after the worst of recession is over.  So consumers are just starting to spend (a lot) to satisfy needs deferred during the downturn.  In this case, however, we’ll be six years past the bottom.  Is there any pent-up demand left?    …probably not.  So the typical surge in earnings may be absent.  This is a minus for stocks.

2.  The Fed has been unusually clear  for a long time in publicizing what it intends to do and over what time frame.  Arguably, investors have absorbed this information and already made some portfolio adjustments in advance of the Fed’s actions.  I don’t see this in fixed income markets, but…

3.  The rest of the developed world hasn’t made anything close to thepost-recession progress in that the US has.  As a result,foreign interest rates  either remain at emergency lows, or are even dropping.  Rising interest rate differentials–and a strengthening US$–suggest that international fixed income investors may increase purchases of Treasury bonds, cushioning the fall in their prices.

4.  The Fed is acutely conscious of the repeated mistake that Japan has made over the past quarter-century of trying to return to normal too quickly–and pushing that country beck into recession instead.  Because of this, it’s possible that stock market weakness might cause the Fed to slow down planned interest rate rises.

my take

I think rising interest rates will make 2015 a sub-par year for stocks.  Will “sideways to up” hold true as it has in the past?  I don’t know.  I think a lot will depend on whether the Fed’s commitment to raising rates is greater than its wish to have relatively stable financial markets.  My guess is that stability is more important.

The Fed’s ultimate target for short rates is 3.5%.  I think that’s too high for a 2% inflation world.  I think 3% is more likely.  But let’s keep 3.5%.  Add a 2% real return to that and we get the endpoint for the yield on the 10-year Treasury,  5.5%.  This would imply a price earnings multiple for stocks of 1/.055, or 18x.  Arguably, then, the current multiple on stocks already discounts all the tightening the Fed is setting out to accomplish.

Even I think that the last paragraph paints too optimistic a picture.  What I’ve written may ultimately prove to be correct, but I don’t think the consensus would be willing to put much faith in this idea.

My starting out point is that interest rate rises will make next year a volatile one for stocks.  Without positive influences from earnings growth or foreign money flows, rising rates have the power to push US stocks down by, say, 5% in 2015..  At the same time, I think that good stock and industry/sector selection will enable investors to generate positive portfolio returns.

the ever-expanding Black Friday

November 21, 2014 By in Current Market Thoughts, Industry Analysis, Retail Tags: , , , , , Leave a comment

For at least the past couple of weeks the Promotions tab of my email inbox has been stuffed with a gazillion Black Friday promotions.  In the bricks and mortar world, Wal-Mart (WMT) has announced that this year its Black Friday period will last for 10 days (today is day one).  [The term “Black Friday,” by the way, originated in Philadelphia, according to the Visual Thesaurus, as a police description of the extra work they had to do on the Friday and Saturday after Thanksgiving.]

In the years immediately after the Great Recession, retailers, led by Wal-Mart, began to try to push the traditional start to the holiday shopping season forward from Friday to Thanksgiving Day itself.  The theory hat lent urgency to this endeavor was that times were bad and consumers had little desire or ability to do extensive shopping.  Therefore, the first merchant to make a sale would do well; retailers who held back would find consumers’ wallets already empty.

What investment significance–if any–does the move of Black Friday from the week of Thanksgiving to the week before the  holiday have?

My take:

–I don’t think this is a sign of overall economic fragility, as it was several years ago.

–I do think, though, that spending on big-ticket items like housing and autos has left consumers with less cash for other items.  This is a normal pattern worldwide, including the US prior to the crazy bank lending spree that led to the financial crisis.

–WMT’s customer base is skewed toward the less affluent.  The company is facing increasing competition from dollar stores, as well as, I think, a rejuvenated Target.

–I suspect that there’s a Millennials/Baby Boom element to the promotional environment, with physical stores positioned to serve the latter–so that those retailers are competing in a no-growth arena.  One interesting (to me, anyway) aspect of the WMT promotion is that Black Friday prices are available today, but only in the stores, not online.

–My inbox bloat may just reflect my online shopping habits and have no further significance.  Still, any online merchant has the ability to avoid using the blunt instrument of price reduction and use couponing or customer-specific pricing to drive sales instead.  The idea is at least as old as dynamic pricing for airline tickets.  The practice is likely much more widespread than I care to believe.

My conclusions:

Most important, I don’t think signs of an increasingly promotional holiday season are a red flag either for overall US consumer spending or for the stock market.

Personally, I’m looking more for Consumer Discretionary names that are online or Millennials-oriented rather than physical store/Boomer plays.  No surprise there  …in the eternal struggle between Concept (growth) and Valuation (value), I’m normally going to be in the growth camp.  There will be times when valuation trumps potential.  I don’t think now is one of them, although I have noticed that for the first time in years WMT has begun to outperform.  If anything, this suggests to me that the holiday shopping season may be better for everyone than I’ve been thinking.

 

 

online shopping continues to evolve

October 27, 2014 By in economics, Industry Analysis, internet, Retail Tags: , , , , , , 1 Comment

Three studies reported in the press this year about the behavior of online merchants have caught my eye.  They all call into question what I think is the consensus belief that online shopping is not only faster and simpler than going to a bricks-and-mortar store, but that it’s cheaper as well.

–the first concluded that the price Staples showed to an online customer varied with that customer’s location.  More specifically, price depended on how close the physical stores of rival office supplies companies were.

–the second concluded that Amazon has been raising its prices  this year, to the point where for some things AMZN is now 10% more expensive than Wal-Mart and 5% more than Target.

–the third, covering 16 popular online merchants and noted last week in the Wall Street Journal, found that:

—–Travelocity charged users of Apple mobile devices to access its site $15 a night less for hotel rooms than everyone else

—–Home Depot showed cheaper items to shoppers using a desktop than those coming to its site via laptop, tablet or phone.  The difference averaged about $100.

—–Cheaptickets and Orbitz charged on average $12 less to customers who logged into their sites than those who didn’t, without alerting people to the savings.

—–some sites seemingly experimented with pricing by randomly offering customers higher or lower quotes.

my take

Some of this is a little weird–like why an iPhone user should get a discount (I would have thought the pricing would go in the other direction).  A lot parallels the traditional practices of bricks-and-mortar retailing.  Using a phone or tablet is apparently the equivalent of driving up to a sore in a limo and expecting a bargain.

The emergence of the same in online retailing signals a significant maturing of the medium.  We’ve left the early days where to make profits grow it’s enough just to get more traffic.  The game is now all about finding the highest price that will convert browsers to buyers, thereby maximizing the profit per transaction.

We all know some variable pricing happens, both in online and bricks-and-mortar retailing.  But as potential customers become more aware that it occurs a lot more online than they had thought, and as they learn the signals they need to send to get a lower price, the tricks merchants now employ will become less effective.

A so-so economy will accelerate this adjustment process, with negative implications for online-only retailers, I think.