Be careful what you wish for!
In May of 2015, all the popular averages had tripled off their lows. There was a great clamor among the media and punditry that we needed a correction. A retracement of at least 10% had not happened in 18 months. In August of last year we got the correction, and it was a beauty. The downturn came about, in part, due to a Chinese currency devaluation and falling oil prices (“deja vu all over again”). This kinda reminds me of Greece, the end of Quantitative Easing, the ‘lift-off’ (first increase in short rates in nearly a decade) and the junk bond meltdown. All of these issues continued to pop up, rattle the market, then fade into the background.
Of course, these drops are normal, scary, but seldom the end of the world. Sometimes they become a harbinger of something considerably worse, like 2008. Because of institutional memory, many having experienced that horror show seem to think that the next event of this magnitude is just around the corner. In many respects, that is why the overall cautious, to down-right bearish sentiment has continued to grip many market participants and observers. In the final analysis this prevailing lack of enthusiasm for stocks is a major positive. .
“Bull Markets are born on pessimism,
grow on skepticism, mature on optimism
and die on euphoria.”
Unfortunately, many of the savants offering up investment advice these days have either forgotten about this sage investor, don’t even know of his record or existence; or they don’t care what he had to say, because he was an investor and did not try to game the market with sophisticated algorithms and high powered computers. You know, it is just not relevant to today’s market. On the contrary, I believe legendary investors like Templeton and Buffett (“Be greedy when others are fearful and fearful when others are greedy.”) have it right. As such, this Bull is not close to over, regardless of the potential short-term pain we have to endure.
What are the pressure points?
I guess this depends on how you cypher the health of the US economy, the impact of lower and potentially, prolonged-lower oil prices and the fate of the Chinese economy. As it pertains to the last item, I heard one talker on Bloomberg opine that some are beginning to view the current Chinese economic situation to be akin to Japan 1990. Not sure how they get there, but that is the kind of rhetoric that is out there in the media. By the way, in case you don’t remember, Japan is still out there and we had one of the best decades in the market as Japan began its melt down in the nineties. Remember, too, the Japanese, like the Chinese up until recently, were viewed as a threat to US economic supremacy in the 1980s. They were the power to beat.
Let’s look at the boogiemen that haunted the market last week, starting with tumbling crude prices. Every time the price of oil goes down, the market follows, indicating the market believes demand is shrinking. As we have said before this does not seem to be the case. It is all about Saudi Arabia and their massive overproduction, designed to drive shale oil out of the market and punish their enemies in Russia and Iran. According to the International Energy Agency (IEA), “Early indicators for 4Q15 show growth easing to 1.3 million b/d year-over-year, from a 3Q15 peak of 2.2 million b/d. The resulting annual growth of 1.8 mb/d for 2o15 is led by CHINA, the US, India and – somewhat surprisingly – Europe.” BTW, the IEA 2016 forecast is for continued growth at a 1.2 mb/d. This assumes further slowing in world economic growth, but no Global recession.
Low price is a boon to all who consume oil, a huge tax cut for all peoples that use more petroleum than they produce. But, what about the producers, including the United States?
The impact on energy sector employment.
Yes, low prices will cause painful unemployment in the energy sector, which could damage our economy. What is the risk? According to the Bureau of Labor Statistics, as of December 2015, total employment in the United States stood at 157.9 million. At the same time the oil and gas exploration and extraction segment stood at 184.5 thousand individuals (management and labor). If the entire sector shut down (a ridiculous construct), total employment would be cut a fraction of one percent. Save the very small population who made hay while the sun shined as energy employees, the huge majority of us win big on lower prices. Yet the market still drops like a stone every time oil takes a header. I DON’T GET IT.
I guess one other risk to my bullish stance is the potential of unrest in those countries around the world dependent on oil and gas to balance their budgets. The US is now the number ONE producer, followed by Saudi Arabia and Russia. The latter two, as “The Donald” might say, ‘have not been very nice to us.’ A pox on both of their houses (could be a good Trumpism). I just don’t see how this does not make us stronger in the long-run.
Back to China.
What if things really get bad over there? First of all, they probably won’t. Even though the Chinese government has proven itself to be somewhat inept and ham-handed in their recent attempts to control their equity market, make no mistake they are into stability. They do not need an act of Congress to get things done. Also, remember the slowdown that is in progress was instigated by the Chinese government. Economic policy is not a game of ‘perfect’. It is conceivable the slowdown could be a major overshoot. What happens then? They would not be buying as much from us as they have in the past. What’s the worst case?
According to the US Census Bureau (for some reason they keep track of our foreign trade balances) for the first ten months of 2015, the US exported $106 billion to China. If all our export business with China went away, it would amount to less than a 7/10 of 1 percent hit to our GDP. What the right number is, I don’t know. My call is that it is unlikely that China won’ t continue to grow at some rate; and, that in the unlikely event of the worst case being realized the impact would be de minimis.
Finally, the US economy ‘stinks.’
I continue to hear this or variations on the theme (the economy is weak, the economy is struggling or the economy is ‘expletive deleted’). The only reason that I can come up with for someone saying this would be political, the OUTs trying to make the INs look bad. I guess if you say it often enough, people begin to believe it. There has be a choir of pundits and politicos making this claim since the 2009 bottom, much to the chagrin to those unlucky souls who took them seriously. This was in the face of continually improving economic and market data.
Another term making the round is earnings recession. An earnings recession occurs when you have down earning for the S&P, while the economy (GNP) continues to grow. This is very misleading. According to institutional analytics provider, FactSet, and their November report, “When you remove both the energy sector and those companies whose foreign sales account for more than 50% of sales, the rest of the S&P is on track to rise 10.1% y/y.”
The truth is the economy is doing ok. It could be better, but it does not stink. The recovery has not been as rapid as some other post World War II recoveries, in part because of the hole we had to dig out of, and because we have a totally dysfunctional government providing equally dysfunctional fiscal policy. Globalization has also played a role, too, with the Eurozone pursuing austerity when stimulation would have been called for.
We closed last week with GDP still growing at a 2% clip, unemployment at 5%, the PE on the S&P 500 at 16Xs, super-bearish sentiment and, oh yes, a 2.3% yield on the S&P, all of this vs. 2.11% on a 10-year US Treasury (which does not appear to be going anywhere fast). I like those stats. None-the-less, The Market’s Gonna Do What The Market’s Gonna Do !
What’s your take?
BTW, if you’d like some good extracurricular reading on the topic, check this post out from “Fear & Greed Trader”, “The S&P 500 Drops 6% This Week – ‘Irrationality’ Isn’t Always Associated With ‘Exuberance’ And Euphoria.”
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