Stunned And Confused

| About: The United (USO)

What stuns and confuses me is the new (or continuing) mantra on Wall Street that higher oil prices are good for stocks and the economy. No matter how hard I try to rationalize this thought process, I cannot make it work... except in one case. That is in the case that fear of a deflationary spiral, where higher trending oil (and other commodity prices) indicate inflation is taking the upper hand. To be fair, we have had several spells over the last few years, where concerns about deflation or disinflation have roiled the markets. But as the economy continued to muddle through and grow with modest inflation, these concerns appeared to abate.

Two misguided reasons on why higher oil prices are a good thing

  1. LOW OIL PRICES COST JOBS in the energy sector. This is true, and it is usually where the analysis stops. But let's look a little deeper. According to John Kemp, Reuters London, since October 2014, oil & gas extraction and allied industries have lost 100,000 jobs (off a base of 538,000), "U.S. oil, gas industry sheds 100,000 jobs in slump: Kemp" - Feb. 4, 2016. Kemp also points out that during that same period, according to the Bureau of Labor statistics, the economy added more than 3.5 million jobs in other sectors. A corollary to job loss in the oil & gas industry would be job losses in the general non-energy community (butchers, bakers, etc.). This is an area where I do not have clear information. Obviously, there was collateral job loss in the boom towns that exploded in the hot shale venues like the Bakken and the Permian Basin. Again, I would point you to the fact that during this same period, the economy added 3.5 million new jobs in other sectors. I am satisfied that this number swamped job losses due to falling energy prices. Ergo, although those who lost employment because of falling oil were victims, the economy did just fine.
  2. Falling oil prices are symptomatic of worsening global economic conditions and a slackening in demand. Wrong again. Worldwide energy demand has continued to grow (according to the International Energy Agency) during the entire period mentioned in the Reuters article above. It may not have grown as fast because of the economic retrenchment in China, but it grew. So why the falling prices? It was a supply glut brought on by the shale oil revolution in the U.S. and the Saudi Arabian response - opening their spigot to push prices lower and quash the shale revolution. The Saudis had as secondary goals hurting Russia and muting the benefit Iran would receive returning to the world oil market. Of course, Iran did exacerbate the glut. Ergo, the price collapse on crude had nothing to do with demand. It was all about oversupply.

This is not the first time I've made these points on kortsessions.com.

You may want to refer to:

"... , I have it from a reliable source that the sky is falling - SELL!" -2/7/16

"What's so bad about cheap oil?" - 1/19/15

Another way to frame the positive side of low oil prices

I'll start with a negative as it pertains to the market: in the short term, it hurts the level of S&P 500 reported earnings. This is part of the reason that we've been in a so-called earnings recession the past 6 quarters. Beside the weight of a strong dollar on corporate profits, the energy sector has been losing money.

Now the good news. According to Bespoke Investment Group, LLC, energy only represents 7% of S&P 500 market capitalization. The other 93% of companies in the market cap of the S&P are probably, in one way or another, energy consumers. That 93%, plus every other company or person on the planet that consumes energy, are beneficiaries. This is a tremendous tax cut on the world economy that did not have to make it through Congress. It is disinflationary!

I would imagine if the current trend in oil price continues that the media and pundits will throw up their hands in horror saying, "OMG! These rising oil prices are going to choke off our fragile recovery". They will be tripping all over themselves, dripping with negativity, uttering the "R" word. Again, the bears will be having it both ways - falling oil prices are bad, rising oil prices are bad. And I will continue to be stunned and confused.

I would like to conclude this week's post with a few words about valuations

THEY ARE NOT SET IN A VACUUM!

I am not one to try to reinvent the wheel. When I see something really good, I like to pass it on. This post came in from one of my regular reads on Seeking Alpha, Chicago-based money manager Jeff Miller. His piece, "Weighing the Week Ahead: Will the market embrace and stronger economy?", especially the section on valuation in a time of rising rates, I believe to be definitely worth your consideration.

Watch for -

The Brooklyn Investor compares bonds and stocks over a long period. The analysis reveals the shortcoming in measures like the Shiller P/E, which consider neither interest rates nor inflation.

Signing off... Maybe not stunned, but still probably confused.

How about you?

The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.

About this article:

Expand
Tagged: , , Market News Article
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here