The continuing, seemingly unwarranted concerns about oil prices, a triple witching event (stock index futures, stock index options and stock options expire the same day) which always roils the market coupled with year-end tax selling and portfolio adjustments on the part of institutional investors, made for an ugly Friday market. Oh yes, and just being a Friday when traders like to go home flat (neutral or no positions on the books). It was not a happy day.
No matter how you spin it, the media and punditry cannot be content with a happy ending. After last week’s non-reaction in the bond market to the first increase (i.e. lift-off) in the Fed Funds rate in nearly a decade, something they felt would derail the economy, nothing happened. In fact, as we had forecast in an earlier piece, longer-bond prices went up, yields down … a positive outcome. They have now refocused themselves on the new/old worry: recession, signaled by falling commodity prices, which they equate to falling worldwide demand. Of course, they fail to point out recessions are normal economic phenomena. They usually come about due to excesses in the economy that need to be worked out. They generally are not associated with the end of the world. Recessions are oft predicted by the so-called experts, but seldom seen.
The current energy/materials rout is a correction of these industries building too much capacity to satisfy Chinese growth, that was running at 12% to 14%. This was unsustainable and has been intentionally slowed by the Chinese government to a lesser, but more reasonably sustainable rate. Importantly, China is still growing. Also, as it pertains to energy, demand continues to grow despite comments to the contrary.
According to the International Energy Agency, 2015 demand for crude oil increased by 1.8 million barrels per day. They are estimating in 2016 that number will increase another 1.2 million barrels per day. This 2016 number has been decreased recently to adjust for possible economic softness in 2016. That forecast reduction, in part, has been taken in response to potentially higher interest rates softening world economies. No, the major culprit here is not demand, it is Saudi Arabia, trying to retain market share, flooding the market with supply, to knock down rapidly rising production in the US. This also works to punish many OPEC rivals, as well as, Russia and Iran. Again, this is not a demand slowdown issue. The very low prices are all about an oversupplied market.
Finally, the energy and materials sector of the S&P 500 index carry a combined market capitalization weighting of less than 10%. If both industries went completely out of business tomorrow (highly unlikely), it would represent a 10% correction to the index. Assuming their demise was due to a low-pricing environment, the other 90% of industries would be in the catbird’s seat until, of course we needed to replenish those assets. This will eventually happen. Main point: these low prices are a boon to all but the producers and service companies, no matter how hard the media spins it the other way.
Over the past few days, I have heard pundits using the word “tightening” in reference to the recent quarter-point bump in the Fed Funds rate. Folks, this ain’t tightening. The cost of money did go up a little. For example, if you are a prime rate borrower, your annual interest payment on a $1000 face value loan would increase by $2.50. The prime rate is currently 3.5%. For future reference or perspective, the prime rate reached an all-time high of 21.5% December 19, 1980. It was 9% March 22, 2000 and 8.25 June 29, 2006. After surviving all this, 3.5% does not look so bad.
If they really wanted to tighten, the fed would let the $3.5 trillion in Treasuries and mortgage-backed securities that they purchased during QE begin to roll off. This, they indicated they would not do. Easy money looks like it is here to stay for some time.
Jeff Saut’s “rip your face off” rally prediction
I respect Jeff Saut, Raymond James’ Chief Investment Strategist, despite his less-than-genteel descriptor of a major potential liftoff in stock prices. We are very oversold. Because of the very narrow market we’ve experienced over the past year (pass the F.A.N.G.s please), the general avoidance of value stocks and the flight from energy and energy-related stocks (a bloodbath), investor sentiment is in the tank. Saut thinks we are in for a major market move on the upside. I concur. His comments are in the link above.
So, why do we feel so bad? It may be the constant negativity in the media and not the facts that are present in the real economy. Also, I think in the market, feeling so bad is a precursor to feeling really good.
What’s your take?
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