It is not the prospect of a global recession some say is lurking as evidenced by the recent sharp drop in crude oil prices. As I have said before in kortsessions, I simply don’t buy this. Lower oil prices are a huge benefit to for everyone on the planet not involved in production or supporting the production of crude oil.
What does bother me is the unforeseen consequences of the continual, intentional over-production of crude oil by Saudi Arabia and the cavalier attitude they have taken on their policy. This is evidenced by statements like, “Why should we cut? Why?”–Ali Al Naimi, Saudi Oil Minister. This statement was made December 11, 2014, as the price of West Texas Intermendiate closed below $60/barrel. As of this post it was $48.36.
“Why should we cut?”
Because you are destabilizing an already unstable world!
In particular, Russia, which is already reeling from sanctions leveled on their incursion into the Ukraine, needs (according to BloombergBusiness Week) “$100 per barrel (to sustain itself): Its budget loses $2 billion for every dollar it drops below that price … ” We are below $50 today and the Russian economy is severely wounded. Like a wounded animal, these low oil prices might drive their fearless (somewhat unpredictable) leader to lash out with other military diversions to move the Russian public’s attention away from their economic woes.
And Russia is not the only potential hot spot. Others include Libya, Egypt, Iran, Iraq and Venezuela … all unstable and potentially able to turn their maleficence back on the Saudis. Bottom line: I think in their attempt to exert economic punishment on Russia and Iran, retain market share and shut down the U.S. shale oil boom, the Saudi’s are playing a dangerous game of ‘chicken’, where they could unleash dangerous consequences on a regional and, maybe, global basis. This is what worries me and I’m not sure the market, with its constant short-term focus, is even close to this worry.
What is your opinion?
A parting shot at economic weakness
Here is on last thought for those still worried about the equation: Falling Oil Prices = Global Weakness and a falling market. Ben Levinsohn’s Streetwise column in this week’s (1/12/15) Barron’s (“Plunging Oil: What the past tells us”) makes a pretty good case to the contrary.
Plunging Oil: What the Past Tells Us
Oil price plunges in the past haven’t been bad for stocks. Since 1984, oil has seen three similar drops, and each time stocks traded higher a year later.
In Ghostbusters, Bill Murray and his crew of paranormal investigators listed signs suggesting that the end of the world was near that included everything from fire and brimstone to cats and dogs living together. With a reboot of the hit film in the works, you have to wonder if they’ll now include $50 a barrel oil on that list.Some in the market seem to believe they should. Last week, the price of a barrel of crude dropped below $50 for the first time since the financial crisis, and that caused all kinds of consternation, with the weakness in oil said to be pointing to a global economic collapse. As a result, the Standard & Poor’s 500 index fell each of the first three days of the year, the first time that’s happened since 2005.The only problem: Just as there’s no proof that ghosts actually exist, there’s little evidence that tumbling oil is bad for the stock market—or for the U.S. economy. In fact, the very opposite might be true.Now don’t get me wrong: The plunge in oil shouldn’t be taken lightly. At the end of last week, a barrel of crude changed hands at $48.36, less than half of what it had traded for six months ago, among the fastest drops of the past 30 years. In the U.S. alone, oil’s precipitous drop has had a sizable impact on expectations for corporate profits: Analysts have cut their fourth-quarter earnings forecasts for S&P 500 energy stocks by more than a quarter since the end of September, while total S&P 500 earnings forecasts have come down by more than 7%.The good news, however, should outweigh the bad. Citigroup economist William Lee notes that the U.S. still gets about a quarter of its oil from overseas, so lower oil prices should benefit the economy to the tune of $140 billion, while every household should have an extra $1,400 or so to spend. No wonder, then, analysts expect consumer discretionary stocks—companies like Walt Disney (ticker: DIS) and Home Depot (HD) that benefit when Americans have extra cash to spend—to post record earnings in 2015.But here’s the thing: Such plunges haven’t been bad for stocks—or the U.S. economy, for that matter. Since 1984, oil has experienced three similar drops, and each time the S&P 500 traded higher 12 months later. In 1986, for instance, oil plunged 46% as the oil embargo of the 1970s spurred conservation and new production, ultimately leading to a supply glut. Did the plunge in oil prices bring down the U.S.? Far from it. Real gross domestic product grew at a 2.9% clip, while the S&P 500 gained 15% that year. Evercore ISI’s Ed Hyman calls that year “a good road map for the U.S….We doubt [oil’s decline signals] the beginning of a major deterioration in the economy or equity markets.”Don’t bet on a rapid rebound in oil prices, however. Many observers act as if it’s just a matter of time before oil trades at $100 again. But a look at history shows just how extreme that is. Consider: From 1982 to 2002 oil generally traded in a range between $20 a barrel and $40 a barrel, with the top end only being hit during the Gulf War in 1990, when the supply of oil from the Middle East was under a direct threat. In fact, that $40 oil was enough to send the U.S. spiraling into recession.BUT SOMETHING HAPPENED IN 2002 that would change how the market thought of oil—and pushed the price of crude to previously unprecedented levels. That something was China. From 2001 through 2006, its rate of growth nearly doubled, from 6.6% to 12.4%, as China entered a so-called supercycle as it rapidly modernized its economy. Double-digit growth in the world’s second-largest economy, however, is now a thing of the past—and with it one of the forces that drove oil prices ever higher.The price of oil also got a boost from its use as an “investment.” The easiest way to bet on rising oil prices is with futures contracts, and the number held by speculators increased 17-fold from 2002 through 2014’s peak in crude prices. And despite the rapid decline in oil, the number is still 10 times higher than it was at the start of the period, notes Gluskin Sheff economist David Rosenberg. “Those were the forces driving $100 oil,” Rosenberg says. “It was never going to be sustainable.” And it probably won’t get there again—at least not for a very long time. Rosenberg suspects that oil will eventually settle into a range between $40 and $60 a barrel.With that in mind, and with many investors digging through the wreckage searching for bargains in a beaten-down energy sector, BMO strategist Brian Belski warns against moving too quickly. His reasons: Slowing profit growth and dwindling free cash flow makes the energy sector, he says, “a classic value trap. We recommend that investors proceed with extreme caution.”Otherwise, a feel-good story could quickly morph into a horror show.The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. 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