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Michael Bodman
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Michael D. Bodman, M.B.A. I am the principal of Portfolio Economics LLC. My research starts with macroeconomics before proceeding to specific investment ideas. I believe that investment finance is best understood as applied economics. Unlike sell-side analysts on Wall Street, I present complex... More
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Portfolio Muse
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  • American Shale: Falling Oil Prices Boosting Global Growth Prospects

    Crude oil prices have fallen to their lowest level since the financial crisis. Increased oil supplies along with weak demand, due to international economic woes, help to explain what's driving the decrease. Oil stocks have been clobbered in the financial markets. But cost savings from lower oil prices could boost the global economy and the rest of the stock market, outside the energy sector.

    Crude oil prices tumbling

    Since June, crude oil prices have declined by almost 40%, according to data from YCharts. The following graph shows the price of crude for the last six months:

    As of this writing, the national average gas price has declined to $2.64, based on data from the American Automobile Association. Today's average gas price is 29% lower than it was in April, when the average price of gasoline was $3.70. Prices could reach $2.50 in time for Christmas, according to AAA.

    The American shale boom is contributing to increased oil supplies and energy production. The U.S. has become the largest producer of petroleum in the world, according to the Center on Global Energy Policy at Columbia University. This turn of events has vast economic implications.

    Economic analysis

    In the U.S., there are five major macroeconomic consequences of lower oil prices, according to Columbia's Center on Global Energy Policy. These five are as follows:

    • More money is available for domestic consumption, since less money is sent overseas to pay for oil imports. This could lead to an increase in Gross Domestic Product -- as much as 0.3%.
    • Consumers are likely to ramp up spending as a result of lower gasoline costs, similar to what could happen if there was a massive tax cut.
    • Businesses can produce more goods at current prices, since oil related production costs have been lowered for a wide range of companies, from automakers to farmers. As more goods are produced and consumed, overall economic output goes up.
    • Oil production is likely to decline, due to lower prices received in the marketplace for oil and natural gas. This could lower economic growth.
    • Uncertainty over the future of oil prices could create reluctance on the part of some consumers and businesses to make major financial decisions. This could also lower economic growth.

    The basic upshot is that consumers and businesses have lower costs and, thus, more money to save or spend. Oil companies may be suffering. However, businesses outside of the energy sector benefit from lower production costs, as do consumers who do not have to spend as much on gasoline.

    On a global scale, certain countries that rely on oil exports will be negatively affected by the slump in oil prices. Russia, Iran, and Venezuela are particularly dependent on oil exports to fund domestic expenditures. In contrast, oil importing countries will benefit from lower prices.

    The biggest economies in the world are oil importers: the U.S., the European Union, China, and Japan. While the U.S. economy has been improving, the rest of the major economies in the world remain down. Lower oil prices could be just what the doctor ordered to help boost global growth outside the United States.

    Investment opportunities: buy low

    Energy stocks have taken a beating, thanks to the drop in oil prices. The following graph shows the comparative performance of the Vanguard S&P 500 (NYSE: VOO) ETF and the Vanguard Energy (NYSE: VDE) ETF over the past 12 months:

    Many investors are panicking and selling energy stocks while prices are down. This kind of behavior is a natural instinct, but it is not conducive to success as an investor. Rather than following the panic-stricken crowd, now could be a good time to be contrarian and buy low.

    The current downward trend in oil prices will start to reverse at some point in the future. Over time, as oil production declines and economic activity increases due to lower oil prices, there will be upward pressure on energy prices.

    Currently, the Vanguard Energy ETF has a price-to-earnings ratio, a measure of valuation, of 14 times earnings. The Vanguard S&P 500 ETF has a price-to-earnings ratio of 18 times earnings. This means that the energy sector is priced 22% lower than the broad market.

    The Vanguard Energy ETF is a good option for investors seeking broad exposure to the energy sector, as discussed in one of my previous articles on Seeking Alpha. Currently, the Vanguard Energy ETF carries a yield of 1.92% and an expense ratio of only 0.14%.

    The Vanguard Energy ETF is composed of 164 holdings, including oil supermajors such as Exxon-Mobil (NYSE: XOM) and Chevron (NYSE: CVX). By investing in an ETF, investors can avoid the idiosyncratic risk of owning individual energy stocks.

    For those investors who are interested in individual stocks, Schlumberger (NYSE: SLB) is my pick in the energy sector. Schlumberger provides oilfield services to the energy industry with a focus on technology, information, and project management.

    As noted in one of my previous articles on Seeking Alpha, the company has a strong competitive advantage due to: (1) the range of products and services it provides, which creates high switching costs, and (2) the company's global geographic reach, which creates economies of scope. Currently, Schlumberger is trading at 16.5 times earnings, which is lower than the market.

    Risk analysis

    The benefits to consumers and businesses are likely to outweigh the negative effects from lower oil production and uncertainty over gas prices. However, it is possible that the economy could be dragged down along with the price of oil.

    Inflation was low even before oil prices started dropping. There is a risk that deflation could emerge.

    On balance, however, it is unlikely that the U.S. economy will slip into deflationary territory. Based on the last two quarters, the economy is expanding at the fastest pace in over 10 years.

    Conclusion

    Falling oil prices could be the right medicine for what ails the global economy. Practically every consumer and business benefits when oil costs decline. The major exception, of course, is the oil industry.

    Eventually, the commodity price cycle will start to reverse, and there will be upward pressure on oil stocks. In the meantime, the drop in oil stock valuations could be an opportunity to buy into the energy sector while prices are low.

    This post was originally published by Portfolio Muse blog at www.portfoliomuse.com.

    Disclosure: The author is long VDE.

    Tags: SLB, VDE, Commodities
    Dec 10 8:36 PM | Link | Comment!
  • What Are The Underlying Weaknesses Of Today's Labor Market

    The headline unemployment rate has dropped below 6%, according to the latest report from the U.S. Department of Labor. Standing at 5.9%, the official unemployment rate is now at its lowest point since July of 2008. Nonetheless, the Federal Reserve continues to fret about weakness or "slack" in the labor market.

    The headline unemployment rate of 5.9% conceals some basic weaknesses in the labor market. Looking beyond the 5.9% rate, economists are concerned about the labor-force participation rate, the average hours worked per week, hourly wages, and other indicators, according to a recent article in The New York Times.

    These numbers help to explain why people don't feel good about the U.S. economic recovery. At the same time that the unemployment rate is dropping to 5.9%, the labor-force participation rate is deteriorating to 62.7%. Not since 1978 has the labor-force participation rate been so low.

    A broader way of looking at things helps to explain the persistent slack in today's labor market. The picture changes when the unemployment rate includes the following:

    • Total unemployed.
    • Plus all those marginally participating in the labor force.
    • Plus all those forced to work part-time due to economic reasons.

    Based on these factors, the unemployment rate jumps to 11.6%, almost double the headline unemployment rate of 5.9%. No wonder the Federal Reserve continues to be concerned about weakness in the labor market. Until the economy gains sufficient traction to convert part-timers to full-time work, pull in discouraged workers, and mainstream those marginally attached to the job market, the Fed is likely to keep interest rates at historic lows.

    This post was originally published by Portfolio Muse blog at www.portfoliomuse.com.

    Oct 03 8:09 PM | Link | Comment!
  • How To Put Commodities To Work In Your Portfolio

    Commodities are an alternative asset class that can help to diversify your portfolio. Commodity prices are volatile, and investors should have enough risk tolerance to endure the ups and downs of the market. With this consideration in mind, adding an uncorrelated asset class, such as commodities, to your portfolio can help to reduce overall portfolio risk.

    Commodities are generally raw materials, where one unit is just like all other units, according to Iowa State University's Extension and Outreach center. Examples of commodities include soybeans, crude oil, orange juice, cotton, and iron ore. These raw materials are used to create finished goods, such as food, gasoline, and steel.

    Below is a image of agricultural commodities from the year 1936:

    Source: Wikimedia Commons

    In the old days, the market for agricultural commodities was made up of individuals bringing their goods to a farmer's market. Starting in the early part of the nineteenth century, standardized contracts were developed for trading commodities on centralized futures exchanges in faraway cities. The Chicago Board Options Exchange is the largest U.S. options exchange in the United States.

    Options confer the right, but not the obligation, to buy a certain commodity at a specified time in the future, while futures bind the seller to deliver a commodity to the buyer at a specified future date, according to the Library of Economics and Liberty. Futures and options contracts are available for a wide array of commodities.

    Investing in futures and options is complex. Moreover, using these instruments can create federal Schedule K-1 tax consequences, which means extra cost and complexity when tax season arrives.

    A better way to put commodities to work in your portfolio is through equity mutual funds and Exchange-Traded Funds (ETFs). These funds hold a wide range of companies engaged in various activities tied to commodities. Indexes have been created that track commodity-related companies, which facilitates low-cost ETF investing in this alternative asset class.

    Benefits of holding commodities

    A benefit of commodities is that they tend to be uncorrelated not only with stocks and bonds but with each other. Food, energy, and industrial metals are three commodity categories that are relatively uncorrelated with each other.

    Commodities can be used as a hedge against inflation risk. In contrast to stocks and bonds, commodities are real, tangible assets. Owning shares of a commodity-oriented fund is an indirect way of owning real assets. Commodities and other real assets, such as real estate, tend to perform well in an inflationary economic environment.

    Investment ideas

    The Market Vectors Agribusiness ETF (NYSEARCA:MOO) is one of the best food-oriented commodity ETFs. This fund has an expense ratio of 0.55%. The Market Vectors Agribusiness ETF tracks an index consisting of companies selling agricultural seeds, chemicals, and farming equipment.

    Concerning energy, a good choice is the Vanguard Energy ETF (NYSEARCA:VDE). This ETF carries an expense ratio of only 0.14%. The Vanguard Energy ETF tracks an index made up of energy-related companies.

    Finally, to capture the industrial-metals category, the iShares Global Materials ETF (NYSEARCA:MXI) is a good option for investors. The iShares Global Materials ETF has an expense ratio of 0.48%. This fund tracks an index that includes not only industrial-metals companies but also companies engaged in the business of forest products, chemicals, and construction materials.

    Discussion

    Rapid growth in emerging markets over the past two decades has caused a surge in demand for commodities. While economic globalization is being threatened by geopolitical factors, it is likely that the world economy will continue to expand. China is one of the biggest buyers of iron ore used in the production of steel.

    Allocating a portion of your portfolio to commodities is a good way to diversify your investment mix. Scarcity of arable land creates economic forces that are likely to drive commodity prices higher over the long term.

    This post was originally published by Portfolio Muse blog at www.portfoliomuse.com.

    Disclosure: I am long MXI, VDE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    May 18 10:36 AM | Link | Comment!
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