Why I Am Not Worried About The Market

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Includes: CEW, DBC, EWH, EWZ, FXI, KBE, SLX, SPY, USO
by: George Kesarios

Summary

Oil prices, China and the fact that commodity prices are this low are nothing to fear.

And the reason is, all of the above are a function of supply and demand. And the past several years there has been more supply than usual.

However oversupply does not mean a lack of demand. Demand is just fine.

Coupled with the fact that U.S. loan defaults are at record lows, I see very little reason for concern, even if global growth stalls a little.

Market analysis Many analysts and financial commentaries point to low commodity (NYSEARCA:DBC) prices, slower growth in China (NYSEARCA:FXI) (NYSEARCA:EWH), and low oil (NYSEARCA:USO) prices as something that will might be detrimental to markets.

Personally I do not see many problems, and all the above are also positive in a way.

I do not prescribe to the theory that low commodity prices are a proxy for slower world growth. I mean one percent here or there is not the end of the world, and in my mind, how high or low iron ore (NYSEARCA:SLX) is or oil is not a function of global growth.

The IMF recently lowered its forecast for global growth for the third time in less than a year. The fund in now modeling global growth at 3.4% for 2016, and 3.6% for 2017, or about 0.2% than its previous forecast. If you ask me, no big deal.

Yes lower commodity prices are the reason for the hammering of Brazil (NYSEARCA:EWZ), but that's only because Brazil does not have a diversified enough economy and depends too much on commodities. It's not because of lower commodity prices.

And as far as lower oil prices, one thing is sure, it's not because of lower demand. Both the U.S Energy Information Administration and the International Energy Agency have charts that show demand for oil up year after year, and also predict that oil demand will increase in the future.

Let me tell you why oil prices are this low. A few years ago crude caught everyone by surprise and reached as high as $140 a barrel. So everyone decided that the simplest way to get rich, was to invest in oil and gas. So hundreds of billions of dollars went into exploration and production over the next several years.

Study upon study, and forecast upon forecast, called for oil to go to the moon over the next decade. So everyone thought that levering up on oil and gas would not be a problem, because as long as oil was above $80 or $100 a barrel (as everyone said it would), they would still get rich.

But at the margin, there was more oil the market can absorb, so prices went down a little. And then with the shale revolution, even more oil came on the market. That's when Saudi Arabia thought enough was enough for shale, and decided to bite the bullet for several years, keeping OPEC production high so as to bankrupt many U.S. shale producers. And so far this strategy is working.

And this is what I think will happen with oil. Many producers will go out of business, and tens, if not hundreds of billions in loans will be written off. And then, stronger producers will pick up assets on the cheap, production will go down again, and prices will go up again.

In other words, lower oil prices are not a function of global growth, but a function of supply and demand. And because the nature of people is to get rich by any means possible, as soon as possible, everybody overkilled on oil and gas.

So the problem is not demand, but oversupply. In fact just today Reuters tells us that "Iraq flooded a massively oversupplied oil market with record output last month."

I am sorry folks, but oversupply is not the same as a lack of demand. I do not see a problem because the market is oversupplied.

Now let me tell you what is going on in China. China has a credit bubble (about 50% of all loans are non performing like Greece), has invested hundreds of billions in real estate that no one will buy, and is a country where people have speculated their life savings in the stock market, and in many cases have lost it all.

This behavior has nothing to do with world growth folks. It has to do with malinvestment practices, speculative commodity fever and a country that is more corrupt than Greece.

Eventually the Central Bank of China will have to print trillions to clean up the mess, and all those who thought that the Renminbi (NYSEARCA:CEW) is a cheap currency, will be proved wrong.

So commodity prices, oil prices and China have nothing to do with global growth in my opinion. And even if they did, the fractional downward revision to global growth that the IMF predicts, does not explain the tumble in commodity prices, the hammering of Brazil or tumbling oil prices. If you want to blame it on something, blame it on human nature, market forces and the fact that we do not live in a perfect world.

So commodities, oil and China aside, there is one more reason why I am not worried about the state of global affairs or U.S. markets. And that is, that every major crisis over the past 20 years or so, has had its roots in the U.S. banking system (NYSEARCA:KBE).

Please take a look at the charts below:

US Nonperforming Total Loans for all Banks Chart

US Nonperforming Total Loans for all Banks data by Charts

S&P/Experian Auto Default Index Chart

S&P/Experian Auto Default Index data by YCharts

S&P/Experian Consumer Credit Default Composite Index Chart

S&P/Experian Consumer Credit Default Composite Index data by YCharts

S&P/Experian First Mortgage Default Index Chart

S&P/Experian First Mortgage Default Index data by YCharts

Please note the following:

  • Non-performing loans at all U.S. banks are at comfortable low levels and still coming down.
  • Auto loan defaults are close to 1%, near all time record lows
  • Consumer credit defaults are also at record low levels
  • And my favorite chart, the First Mortgage Default Index, is also at record low levels.

What all these charts mean is that the quality of credit of U.S. banks is very good, and U.S. bank balance sheets are in excellent condition. Especially as far as first mortgages are concerned, please note that the problems of 2008 started when everyone was buying a second home to flip and make a fast buck.

You cannot do this today, because banks will not let you do it, because you actually need to have real income and a down payment to get a loan these days.

So in my mind, if the banking sector does not have a problem, the market does not have a problem. And when the market does not have a problem, my only worry is excessive speculation and if the market is overpriced.

Click to enlarge

Source: WSJ

Now the current P/E of the S&P 500 Index (NYSEARCA:SPY) is about 21. While this is not cheap, the market is not a bubble either. More important, the 12 month forward P/E of the market is estimated to be about 15, which is where the long term average is. In fact, with interest rates this low, this might even be considered cheap.

Does this mean the market cannot correct?

Of course the market can correct. In fact, markets can correct for no obvious reason whatsoever. I am not saying that there might not be a correction like the one we have witnessed recently.

But do I think the S&P can go to 1000 points? No. Do I see a major recession? No. Do I think if China grows at 3% the world will end? No. And do I think that markets will crash if global growth falls to 3%? No.

Bottom line

Based on the data above, I do not see a major problem for U.S. markets, along the likes of the sub-prime days era. I also do not see anything on the global horizon that might have a similar impact.

One day we will have another recession, and there will also be another world financial accident. Currently however, there is nothing on my radar screen that makes me believe that a financial storm is coming, and markets are going to crash.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.