The current market swoon continues to plate up myriad short opportunities to possibly soak up long losses in other areas of a well diversified portfolio. West Texas Intermediate crude presents a tempting dish. The US priced commodity has settled below $50/barrel on the New York Mercantile Exchange for the fourth consecutive day at Friday’s (21 Dec) close, a string of such closes last seen in August 2017. The price of WTI has fallen steadily after peaking for the year at just over $76/barrel in the first week of October. WTI now languishes deep in bear territory, down over 40% from its October high at $45.42 with Friday’s market close. WTI has another 10% to fall before hitting bottom at $40/barrel, a price level last seen in August 2016.
A bear market in oil creates a strong feedback loop in the greater economy. The Russell 2000, an index of small, largely domestic stocks once viewed as primary beneficiaries of the Tax Cut and Jobs Act (TCJA) in December 2017, is closing in on bear territory, down 17% for the year. The technology-laden Nasdaq Composite approaches correction territory on the year, closing just short of 10% at Friday’s close. From its YTD high in the first week in September, the Nasdaq is in bear territory, down just under 22%. The S&P 500 crossed the correction threshold on the year with Friday’s market close, down 11%. From the Benchmark’s YTD high in the third week of September, it is down just under 18%. Nine of eleven S&P 500 industrial sectors are in correction territory at Friday’s market close.
In the bond world, the biggest high yield group is oil and shale drillers, which make up about 16% of the category and just under 19% of those companies rated CCC or below, according to Dealogic data. The S&P High Yield Dividend Aristocrats Index down just over 5% on the year while the SPDR Barclays High Yield ETF (JNK) is closing in on correction territory with just under a 9% deficit for the year. More concerning, not a single company has priced debt in the $1.2 trillion high yield market to month to date in December. If the feat remains intact through year’s end, the month will create the first placement shutout since the Lehman Brothers implosion and resulting credit market freeze in September 2008.
Figure 1: West Texas Intermediate Crude and the S&P 500
WTI continues to search for bottom through Friday’s market close, opening up a cloud sketch that is almost $10/barrel to the downside between its lead (green line) and base bands (red line), projecting falling prices well into January and likely beyond. WTI is now below the stock sensitive conversion band (blue line), and appears well-placed to fall further as the commodity continues to search out a sustainable pricing floor. Friday's closing prices were last seen in June 2017 (see Figure 1, above). This is a boon for consumers, in part reflected in the week’s sharp 0.4% uptick in consumer spending through the end of November. Consumer spending, which is 70% of total US output, low inflation and the lowest unemployment rate since December 1969—all boost household purchasing power and likely underscores continued economic growth in the New Year.
Investment, however, continues to suffer under the weight of unparalleled uncertainty. Capital goods new orders for durables in the greater economy (excluding the month’s bump in aircraft sales) fell 0.6%, the third such decline in four months. The goods side of the equation is more nuanced. Still, total production ticked to the upside by 0.6% in November, driven by both gas and electric utility demand from the unseasonably cold temperatures across northern and mid-western heating states. Manufacturing output was unchanged for the month while mining output increased 1.7% as oil and gas production continues unabated—at least for now—despite falling market prices. Industry utilization continued to inch toward annual averages stretching back to 1971 while still falling well short of peak averages of the period set from 1988-94.
Fed and market protagonists were close to fisticuffs at mid-week with the release of the Fed’s report card on the economy for the year. The Fed expects the economy to continue its growth in the New Year. The data largely supports the view. From the Fed’s perspective, upside inflation pressures remain tepid while unemployment numbers sit at levels last seen in December 1969. US growth projects out at an above-trend pace of 2.3% in the near- and 2.0% in the medium term through the beginning of the next decade, allowing room for further adjustments of the federal funds rate to more historically consistent levels. These are signals of fairly strong underlying economic fundamentals. Historically, during times of relative economic plenty, Fed’s contents itself with keeping the economy on an even keel by aligning borrowing costs with forward growth. The pursuit provides the Fed with greater flexibility to employ more traditional monetary policy tools to confront the next recessionary cycle—without resorting to extraordinary tools such as large-scale asset purchases that were widely used in the Great Recession of 2007. What really matters to the Fed is material change to the underlying fundamentals of the greater economy that impact price stability and full employment—which defines the Fed’s dual mandate. Market turbulence is not irrelevant, it just falls outside of the Fed’s mandated purview--at the moment.
Markets take a more anecdotal view of the economy’s growth potential. From current market perspectives, the likely path of monetary policy outlined at last week’s FOMC meeting appears all too dismissive of recent market turmoil—despite the breadth of that turmoil across the equity, commodity, credit and bond markets. Of course, market worries are much more broadly based at the moment than those of the Fed, running the gamut from US-China trade tensions to the increasing use of tariffs in US trade policy to Brexit to facing down a $1 trillion US current account deficit over the near-term to the third partial shutdown of the federal government in the calendar year to date. The realization that $536 billion spent by US companies in the buyback of their own shares through the end of the 3rd quarter on top of another $336 billion in dividend payouts has returned a corrective decline by S&P 500 benchmark—hurts beyond belief. Corporate expenditures on enhanced shareholder programs since the passage of TCJA will rival the cumulative funds spent by the Federal Reserve to right the greater economy under its large-scale asset programs in the immediate wake of the Great Recession of 2007 by the close of the decade at the current pace of outlays. That those shareholder enhancement programs throughout the year were financed by outsized corporate profits juiced by one of the biggest corporate tax cuts and repatriation package of the post WWII era that now stands to wash out of YOY balance sheet comparisons at the turn of the New Year underscores market fears that the year’s outsized growth equation is about to notch down—perhaps considerably—moving forward. Germany, Japan and China have all seen growth decelerate, even contract in the case of Japan and Germany in recent quarters. While the Fed also casts a wary eye on domestic and international events in the political realm, such events still remain peripheral to the Fed’s dual mandate.
And there is the disconnect. It is no accident that almost every asset flavor in the S&P 500 bleeds red ink YTD, with most of those losses being logged in the 4th quarter, as the impact from TCJA on corporate balance sheets begins to wane. December’s market losses alone compare with those incurred in December 1931 during the height of the Great Depression. There are only two other periods of the post-WWII period when such broad-based asset losses were sustained: during the stagflation years of the 1970s and during the Great Recession of 2007. The markets, fancifully, looked toward the Federal Reserve to preserve the unsustainable growth in many corporate balance sheets brought to the fore by TCJA. On the surface, Wednesday’s post-FOMC forward guidance did not provide the answer markets sought. Fundamentally, the US economy remains on a solid footing. And the US current account deficit continues to grow with reckless aplomb.
Sweep away, for a moment, all the political noise generated by OPEC’s latest attempt at curtailing global production, Venezuela’s vanishing production, endless civil strife in Nigeria and Libya, renewed US sanctions on Iran, or even the last minute waivers granted by the Trump administration exempting the forward purchase of Iranian crude by Japan, Greece, Turkey, China and South Korea. Angola’s recent declines in production threaten an encore of the economic dislocation of 2014-16, according to news reports. Through all of this allows the last remaining inconvenient gurgle to percolate to the surface: US crude production continues to expand.
US production hit 11.6 million b/d through the first week in December, the highest level on record. On a YOY basis, US output was in excess of 1.9 million b/d higher. That comes to a YOY annualized growth factor just short of 20%. According to preliminary estimates, US production in August and September topped that of Saudi Arabia for the first time in two decades. Similarly, US production likely outpaced that of Russia in June and August for the first time since 1999. At the same time, US inventory since WTI’s October peak has increased 7.8% through the end of the week ending 7 December.
At a time when growth US refinery capacity has all but stagnated, production of oil and gas in the Permian Basin has all but soared. More production is now heading for Gulf export facilities dotting Texas and Louisiana in recent years than at any time in the past 50 years. While traders struggle to put a price floor beneath WTI recent declines, Enterprise Product Partners (EPD) is in the final stages of planning a $3 billion oil export terminal off the coast of Texas south of the state’s main oil terminus at the Port of Houston. The narrow water channel connecting the Port of Houston to the Gulf of Mexico is too shallow to accommodate Very Large Crude Carriers (VLCC) that now ply Texas ports with greater frequency in the wake of the recent widening of the Panama Canal. EPD plans an 80-mile pipeline connecting the proposed deep-sea terminal with oil storage facilities on land. The terminal will have a loading capacity of 85,000 barrels/hour, enough to fill a VLCC to its 2 million barrel capacity in a 24-hour period.
It was only in the waning months of the Obama administration in 2015 that the ban on exporting US oil production to world markets other than Canada was finally lifted. Early this month, the US became a net exporter of oil and refined fuels for the first time in decades, according to EIA figures. The US exported 3.2 million barrels of oil and 5.8 million barrels of gasoline, diesel, jet fuel and other refined products. Those exports exceeded combined imports of 8.8 million barrels/day in the week—the first time since at least 1973. By the end of 2019, pipeline capacity connecting Texas Gulf ports with the Permian Basin will come online, overcoming current logistical bottlenecks of bringing Permian Basin production to market while increasing US export capacity and shrinking the remaining spread between WTI and Brent pricing in world oil markets.
Russia is also posting record production numbers on the board since mid-summer, announcing 11.4 million b/d output for the month of October—a post Soviet record. These levels are about 435 thousand b/d above agreed to OPEC levels and about 153 thousand b/d higher YOY. Meanwhile, Saudi production in October was above 10.6 million b/d and between a range of 11.1 million b/d and 11.3 million b/d through November, about 1 million b/d higher YOY.
Amid rising global supply, the demand side of the equation takes on a more tepid hue. Anecdotal evidence from China portends slowing consumer demand across the economy as retail sales plumbed to their slowest levels in 15 years last month, according to government statistics. Factory output lagged to a three-year low as the summer’s stimulus programs launched by the government have had a smaller impact on growth than anticipated. A three-day Central Economic Work Conference has recommended tax cuts rather than the issuance of debt to fund further infrastructure-related growth in targeted urban areas. The report underscores the continuing challenges emanating both domestically and from abroad which could exert downward pressures on growth moving forward. Chinese car sales for the year are poised to show their first annual decline since the 1990s as subsidies have been removed on many vehicle purchases, causing sales volumes to drop. Further consumer confidence declines resulted from deep declines in equity shares on mainland stock exchanges, accentuated by growing trade tensions with the US.
China is also moving forward with efforts to eliminate gas-powered public transit across the country. In Shenzhen, taxes and buses will be fully electric by year’s end, which has attracted a lot of stimulus funding from government sources at both the local and national levels. While subsidies for the purchase of standard vehicles has largely ended, generous subsidies for the purchase of electric cars remain in place, saving millions of barrels of oil.
Here in the US, production estimates of diesel, which is a leading indicator of economic activity for the transport of goods and services to end users in the greater economy, fell just over 10% since the beginning of the 4th quarter and just under 7% YOY through the end of the week ending 14 December. Gasoline supplies fell 3% for the quarter but are up just over 1% on the year for the period. Meanwhile, crude oil supplies are up 8% for the quarter and just over 1% on the year.
Equity markets around the world now mostly flirt with correction territory while underperforming economic fundamentals are more the rule rather than the exception. US markets, long the exception to the trend, have joined the fray as the 4th quarter draws to a close. With perceptions of uncertainty in global markets running rampant, economic slowdown could easily become a self-fulfilling prophecy. While investors should be scouring the markets for opportunity amidst the debris, markets appear to be more concerned with just how much more selling will hit exchanges in the days to come while laying blame for the resulting plumes of dust from the unwind of leveraged positions gone bad.
Meanwhile, the supply side for oil will likely continue to outstrip demand further depressing prices in global markets for the foreseeable future.
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