Market volatility was present throughout January with no calming so far in February. We saw a 565-point intraday slide on the Dow on Jan. 20; then a few days later, the market closed up nearly 400 points! As February began, the Dow gave back most of that 400-point gain only to regain nearly half of it last Wednesday after another rollercoaster ride (376 intraday points). On Friday, the jobs report was +151,000; while it missed Wall Street estimates, it was still strong enough to scare the market into thinking the Fed would tighten again in March (not likely!) So, more downside volatility (-212 for Friday and -261 for the week).
- So far, everyone is at a loss to explain why falling oil prices would/could trigger an equity sell-off. Aren’t lower energy prices good for the economy?
- It appears that we are still in correction mode. Is this a buying opportunity? Or is this the beginning of a bear market as a recession approaches?
The correlation of equities to the oil price
There are very few explanations as to why falling oil and equity prices have become so highly correlated. Economist David Rosenberg appears to have a reasonable one.
Over the 40-plus years of OPEC, there has been an epic and historic wealth transfer. Nearly all of the producers in the cartel ended up with so much money that they developed massive sovereign wealth funds. These funds now hold 54 percent of the value of the world’s equities.
According to Rosenberg, the slump in equity prices is not due to falling oil prices being negative for the world’s economies. He says that it is possible that falling equity prices reflect “the run down in sovereign wealth fund reserves,” cashing these in to finance their fiscal deficits. “In other words, the tight link between oil and equities is more fund-flow related than any nefarious message on global growth.”
The falling oil price has caused real pain for America’s oil industry, which has now become the swing producer, a role usually assumed by Saudi Arabia. But because it has taken much longer than anyone could have forecast for America’s and the world’s daily oil production to decline, the intense pain is now also being felt by some OPEC producers. At current prices, 90 percent of global oil production is uneconomic, and therefore unsustainable. Small members Ecuador and Venezuela have been asking OPEC to restrict supply; so far, their voices have been ignored. But sooner or later, OPEC (or market forces) will make the modest supply cuts that will push the oil price back toward $50. When that occurs, all of the anomalies associated with the weird attachment of asset prices to the price of oil will disappear.
Just a correction?
Market negativity abounds – and volatility results. The latest fears have to do with corporate debt. We are told that corporate leverage is at a 12-year high, and credit rating agencies have downgraded more corporate issues than at any time since ’09.
The trouble with this line of thinking is that it begs the real question – can corporations afford their debt? As someone who often looks at corporate balance sheets, it is very evident that over the past seven years, corporations have spread their cheap debt out over several decades, so they are, for the most part, insulated from rising interest rates. The scare also ignores the strength of corporate balance sheets, most of which have record levels of cash, cash equivalents, and other current assets. As for credit rating agencies’ downgrades, realize that manufacturing is weak and the oil patch is faring far worse – why are rising credit downgrades so surprising? Let’s not dismiss this out of hand, however. Moody’s said that their downgrades are now spreading to non-energy sectors. So, it is best for fixed income investors to stay away from the high-risk, high-yield markets.
Meanwhile, real Q4 GDP came in at a paltry 0.7 percent growth, taken down by rising imports and falling exports (due to the strong dollar), and shrinking inventories. The picture painted is one of deteriorating economic growth. What’s missing? The positives!
- Q4’s average monthly employment growth was 279,000. We’ve rarely seen quarters this good in the post- recession period
- January’s official employment growth was 151,000. The unemployment rate fell to 4.9 percent (first time with a “4” handle in eight years!). Construction jobs grew 18,000, retail by 58,000, and, surprise surprise, manufacturing added 29,000! Monthly earnings grew at a 9-plus percent annual rate and the workweek expanded
- The dollar weakened significantly during the past week; this is good for exporters, multinational corporation earnings, and dollar denominated emerging market debt, and it also causes oil prices (in terms of dollars) to rise
- So far, corporate earnings have been decent: U.S. banks, Johnson & Johnson, Procter & Gamble, Coach Inc., McDonald’s, 3M, and Ford (best earnings ever!)
Conclusion
There are lots of scares on U.S. and global growth in the financial markets. While the underlying fundamentals have retreated, they are nowhere near recessionary levels. That doesn’t mean that the current market pain won’t continue. Volatility is likely until OPEC decides to restrict supply or free-market oil production (i.e., U.S.) falls. Investors who look beyond OPEC’s lunacy, which will end, may best be served over the long-run.
Robert Barone (Ph.D., Economics, Georgetown University), an advisor representative of Concert Wealth Management, Inc., is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, Inc., a Registered Investment Advisor. Dr. Barone is available to discuss client investment needs. All accounts welcomed. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources that Universal Value Advisors believes to be accurate and credible but makes no guarantee to their complete accuracy. A more detailed description of Concert Wealth Management, Inc., its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.