Relief Is on the Way

by: Jack Miller

The cavalry bugles can be heard in the distance, relief is on the way. In recent days, consumers have been pleased to spend $20 less on a tank of gas, but the gas that will sell for $2 per gallon is just entering the far end of the pipeline. A few weeks from now, consumers will be pleased to save $40 per tank (20 gallon tank). The sound of other bugles, telling the story of relief can be heard. It is not just the price of gasoline that is coming down.

A friend in the plastic business mentioned that his company posted a huge price increase in July. At the time, oil was trading around $145 per barrel. My friend admits that his company will hold up prices for as long as it can. The company needs to rebuild its balance sheet before adjusting to the current price. The decline from $145 to $62 is a 57% decrease in his company's prime raw material. Inflation is on the way down!

The 5 year EU Bund has dropped from 4.75% to 3.25% since June! The cost of 5 year EU money is down 32% in 4 months. South Korea just lowered its short rate by the largest move ever. Rates just went from 5% to 4.25%, a 15% decline in one day. The news media is talking about how this recession might last three years but the big drag on the economy, housing, just saw its first year over year sales increase in 30 months. Home sales were up 5.5% in September and up 1.4% year over year. The percentage of homes in foreclosure is falling fast because the foreclosed homes are being dumped on the market rapidly. The banks want these properties off their books. The short term effect is the final drop in average home prices even while prices rise in most communities.

It is worth repeating that based on price moves that have already happened, the average household is going to reduce its spending on fuel, including transportation fuel, by $4,800 per year. Include the savings to the consumer from price decreases of other raw materials and the average household will spend $12,000 less in the next 12 months. This $12,000 increase in the family budget will not be taxable income, it is more like found money.

This cycle was unusual in that the economy stayed very strong even as consumers were pounded mercilessly by higher prices. Now that the higher prices are dissolving, the consumer is going to see times like the 90s, after the last real estate recession. I remind you that after the bottom was made, Best Buy (NYSE:BBY) went up 1,400% in less than 3 years.

For some time I have recounted the events that occur during an economic slowdown. Three of the key things expected: 1) a drop in commodity prices, 2) a decline in bond rates 3) a sharp turn around in bank stocks. So far, we have seen 1) a steep drop in commodity prices followed by a minor bounce which lasted for a couple of weeks and then a resumption of the decline, 2) a significant decline in bond rates in the US followed by a minor bounce during which stubbornly high EU Bund rates finally rolled with passion, and 3) we saw a significant V bottom in bank stocks followed by a "correction". Pretty soon, the pace of bank consolidation will pick up and prices will rise.

As of Monday morning in London, the financial sector is off 5.8% while the Energy sector is off 6.1% and the Basic Materials sector is off 8.5%. Keep in mind that the EU will not benefit as much from lower fuel prices as will Americans. In the EU, there is much more use of mass transit, but in both countries the sharp decline in fuel prices is just beginning to make its way to consumers. RELIEF is on the way.