Originally published on Reno Gazette’s website http://www.rgj.com/story/money/business/2015/01/07/robert-barone-stock-prices-worry/21424791/
Intellectually, we all know that the equity markets can be volatile. It is a question of whether or not we can control our emotions, especially during market sell-offs. As of last Tuesday, the S&P had fallen for five straight sessions, something we haven’t seen for a year. Some pundits have proclaimed the end of the bull market. Take this with a grain of salt – remember: major bear markets occur when a recession is imminent. No recession is on the horizon.
Wall of worry
The markets are worried (again) about a Greek exit from the Eurozone, which, if it were to occur, would likely mean a default on their government issued debt. If the exit is allowed, this would be a major shock, but it would mainly impact European banks who hold most of the Greek debt. Nevertheless, equity markets worldwide would probably react poorly. Ultimately, however, there doesn’t appear to be any major linkages from Greece to the U.S. But, because it would impact Europe, it is a disruptive and worrisome issue.
Some of the recent economic data disappointed the markets – mainly because the markets expect the next set of monthly data to be higher than the last set. Retail sales (example: autos) did grow at a very robust 4.26 percent annual rate in November, and vehicle sales through year end have continued to be strong. The markets, however, were disappointed by a drop in both of the ISM December indexes (manufacturing from 58.7 to 55.5 and non-manufacturing from 59.3 to 56.2 (>50 means expansion)). Both of these numbers are still solid.
In fact, the 59.3 reading for November for the non-manufacturing index was the second highest in the series’ history (series began in 2008) only exceeded by that of last August.
The slight downdraft in the manufacturing index is likely due to a stronger dollar and a softer international economy which impacts exports, and to the port slowdowns in Los Angeles and Long Beach which created parts and materials shortages and impacted some production schedules. Still, the ISM indexes, at these levels, have historically been associated with real GDP growth of about 4 percent.
The price of oil
The falling price of oil is clearly worrying U.S. equity traders. The price has now fallen to under $50/bbl, and it may go even lower. Wall Street hates uncertainty, and the downward march of oil prices is unsettling. But, consider the following:
•Whenever Wall Street gets involved, volatility rises. Like the gold market where paper gold ounces are 92 times greater than real physical gold ounces, there are many times more barrels of oil in derivative and futures paper contracts than there is in potential production. When a sell-off starts, it cascades. I suspect that after the speculators are exhausted, the price will stabilize, and even rise moderately.
•Today’s oil production is based on that $100/bbl price. Once a well is operating and producing, it makes no sense to take it out of production; the heavy costs are up-front while operating costs are minimal. It will take months for production to fall. That will occur as existing wells produce less over time and no new wells are drilled. So, once a near-term price low is reached, it will likely rise gradually.
•While there is pain in the oil and gas sector and likely a recession there, the benefits to U.S. consumers overwhelm the negative impacts of this sector which only accounts for about 2.5 percent of gross U.S. output.
•For every 1 cent drop in pump prices, U.S. consumers benefit by $1.5 billion on an annual basis. According to AAA, the average price of regular unleaded in the U.S. was $2.194/gallon on Jan. 6, down 34 percent from $3.317/gallon a year earlier. If prices get to $1.50/gallon from the $3.70/gallon peak in 2014, American consumers will have $330 billion of discretionary income to spend on other things.
•Who gets hurt? While there is pain in the oil drilling industry, the main impact is on the oil exporting nations. To name some: Russia, Saudi Arabia, Iran, Iraq, Libya, Venezuela. Most of these are OPEC – they have used oligopoly pricing to inflate prices for four decades. Not much sympathy will be forthcoming from oil consumers. And any resulting political turmoil in most of these countries is not likely to have much impact in the U.S.
We need to worry about the temporary impact a Greek default might have on equity prices. Meanwhile, the U.S. economy continues to trend higher. Rapidly falling oil prices are due to speculative derivatives and futures contracts on Wall Street. This will pass, but a return to $100/bbl oil is not anywhere on the horizon. U.S. and world oil consumers are the big winners; oil exporting nations are the big losers. Except for Greece, few near-term worries.
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee. Robert is available to discuss client investment needs. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of the company, 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.