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Oil and stocks seem to have bottomed as I suggested last month. Since that March 16th post, stocks are up another 8%, a scorchingly hot run on an annualized basis. Since March 6th the S&P is up over 21%. Meanwhile the price of oil has risen almost 35% since February 18th, not quite two months ago.
More Gains to Come
I continue to expect further gains for both stocks and oil - and eventually for natural gas - but each is a different case. I see stock market gains as a bounce back from an oversold condition caused by the great banking collapse and subsequent recession. More stock price recovery will come before the market is fairly priced for a mildly resurgent economy that most economists now predict for 2010. Businesses are writing off 2009, throwing all their problems into this year’s P&L. Earnings will be awful. But that sets up 2010 for pleasant surprises.
In the short term there may be - should be - almost surely will be - market pullbacks. For that reason I am keeping a substantial amount of powder dry - about 35%. But Thursday’s Wells Fargo earnings announcement was a wake-up call to the market that the banking sector has pulled out of its free fall. Goldman’s coming equity sale and subsequent repayment of their TARP funds should build more optimism for the whole market. So I’d guess any market declines will be limited and not a serious test of the lows of last November.
Of course we will get more bad economic news. G.M. and Chrysler have to complete their dance of death and banks face huge loan losses going forward, especially in commercial real estate. But it seems increasingly clear that the old rule of thumb, “don’t fight the Fed” is still operational. The fact that credit is currently still very tight is actually a positive because you know that it has to become looser over time. The Fed will win. That will be good for the economy and for stocks. Even the downsizing, de-leveraging, and cost-containment of the U.S. auto industry is a longer-term positive for auto profitability and therefore for the economy.
The level of GDP that can be achieved in the recovery will not compare with the fluffy economy of 2007-2008 that depended on vast financial engineering and consumers borrowing to spend instead of saving. I doubt that world is coming back. Nonetheless, in two or three years we might see more robust growth. When that happens the velocity of money will start to expand and the Fed will need to stop easing. Interest rates will start rising and at that point stocks could be in for a rough correction or even worse if inflation worries begin to gain traction. Oil prices may also be rising rapidly at that point, as discussed below. None of that would be great for the stock market. So even if we have a fairly benign stock market for the next 12 - 18 months I doubt stocks will travel back to their previously high levels. In fact stock prices may not reach fall-2007 levels for quite a long time, but that is another discussion.
Right now the economy is a long time away from growing robustly. That scenario seems like a 2011 problem, not one for 2010 - and certainly not a problem in 2009. So on balance there should be more stock market gains I’d guess (and let’s remember all of this is only one man’s best guess) lasting for perhaps as long as the next eighteen months. A rising stock market would also help the economy’s recovery. Eee gads! Not a positive feedback loop!
Oil and Gas
In terms of oil, I see a mild near-term price recovery. In fact, in the very near term oil prices could well turn down and even test recent lows because there is still a huge amount of global spare capacity for oil production no matter how much temporary tightening might come to above-ground inventories. But whether or not a serious a re-test of recent low oil prices happens, I’d be surprised if oil is not above $75 in a year as stronger demand and lower non-OPEC supplies work off the current spare capacity glut. I suspect 2010 may well see an “equilibrium” oil price around $70 - $90. In that price range drilling will be profitable again but OECD consumers will not feel they are being raped. In 2011 and beyond, as discussed below, I believe oil prices will continue on to new highs.
Natural gas is too low at $4 to be sustainable. Inventories are now high and new LNG capacity is threatening to bring in cheap Qatari supplies. But gas wells deplete very rapidly and many drilling rigs have been mothballed until prices are higher. So at some point in the not too distant future I suspect we’ll see the truth of the old trader’s adage, “the cure for low prices is low prices.” In other words, after a long enough period of low natural gas prices supply will diminish enough to bring prices higher. And even demand may respond to low prices to some extent.
The Car/Oil Cycle
I’ve long believed that there is an oil-related basis for the global car-sales cycle we are seeing. Of course the obvious reason U.S. car sales are down over 40% from 16 million to 9 million is the recession . But I would argue that car sales began turning down well before the financial crisis hit and that weak car sales has been an important cause of our economic pain - not just a result of it.
What started the car sales cycle heading down, I believe, was a new and important motivation for people not to buy cars - the fact that car technology is in a significant and rapid transition phase that is related to the growing shortage of oil. Consumers are well aware that a “next generation” car is in the process of coming to market. They’ve known that since oil began selling for over $100 a barrel. They may not have known if the next generation car would be an electric vehicle or a hybrid or a plug-in hybrid. But they damn well knew that in a few years it’s likely that whatever car they buy might now will be fairly obsolete. That knowledge has to be a significant damper to car sales.
Well, now we can pretty much see how the cycle of new car technology is going to play out. The winning technology will clearly be the plug-in hybrid electric vehicle (PHEV). It will probably have some sort of lithium battery although other and newer battery technologies could well become dominant before too long. But consumers are not hung up so much on just what battery will be in the car (though they should care more). Consumers are more focused on the simple fact that the next generation car will be much more dependent on electrons for propulsion and less dependent on oil than any car they can buy today. That is a sea change. As long as they perceive that the “real deal” next generation car is not yet for sale, they will hold off buying cars in great volume.
More Gains to Come
I continue to expect further gains for both stocks and oil - and eventually for natural gas - but each is a different case. I see stock market gains as a bounce back from an oversold condition caused by the great banking collapse and subsequent recession. More stock price recovery will come before the market is fairly priced for a mildly resurgent economy that most economists now predict for 2010. Businesses are writing off 2009, throwing all their problems into this year’s P&L. Earnings will be awful. But that sets up 2010 for pleasant surprises.
In the short term there may be - should be - almost surely will be - market pullbacks. For that reason I am keeping a substantial amount of powder dry - about 35%. But Thursday’s Wells Fargo earnings announcement was a wake-up call to the market that the banking sector has pulled out of its free fall. Goldman’s coming equity sale and subsequent repayment of their TARP funds should build more optimism for the whole market. So I’d guess any market declines will be limited and not a serious test of the lows of last November.
Of course we will get more bad economic news. G.M. and Chrysler have to complete their dance of death and banks face huge loan losses going forward, especially in commercial real estate. But it seems increasingly clear that the old rule of thumb, “don’t fight the Fed” is still operational. The fact that credit is currently still very tight is actually a positive because you know that it has to become looser over time. The Fed will win. That will be good for the economy and for stocks. Even the downsizing, de-leveraging, and cost-containment of the U.S. auto industry is a longer-term positive for auto profitability and therefore for the economy.
The level of GDP that can be achieved in the recovery will not compare with the fluffy economy of 2007-2008 that depended on vast financial engineering and consumers borrowing to spend instead of saving. I doubt that world is coming back. Nonetheless, in two or three years we might see more robust growth. When that happens the velocity of money will start to expand and the Fed will need to stop easing. Interest rates will start rising and at that point stocks could be in for a rough correction or even worse if inflation worries begin to gain traction. Oil prices may also be rising rapidly at that point, as discussed below. None of that would be great for the stock market. So even if we have a fairly benign stock market for the next 12 - 18 months I doubt stocks will travel back to their previously high levels. In fact stock prices may not reach fall-2007 levels for quite a long time, but that is another discussion.
Right now the economy is a long time away from growing robustly. That scenario seems like a 2011 problem, not one for 2010 - and certainly not a problem in 2009. So on balance there should be more stock market gains I’d guess (and let’s remember all of this is only one man’s best guess) lasting for perhaps as long as the next eighteen months. A rising stock market would also help the economy’s recovery. Eee gads! Not a positive feedback loop!
Oil and Gas
In terms of oil, I see a mild near-term price recovery. In fact, in the very near term oil prices could well turn down and even test recent lows because there is still a huge amount of global spare capacity for oil production no matter how much temporary tightening might come to above-ground inventories. But whether or not a serious a re-test of recent low oil prices happens, I’d be surprised if oil is not above $75 in a year as stronger demand and lower non-OPEC supplies work off the current spare capacity glut. I suspect 2010 may well see an “equilibrium” oil price around $70 - $90. In that price range drilling will be profitable again but OECD consumers will not feel they are being raped. In 2011 and beyond, as discussed below, I believe oil prices will continue on to new highs.
Natural gas is too low at $4 to be sustainable. Inventories are now high and new LNG capacity is threatening to bring in cheap Qatari supplies. But gas wells deplete very rapidly and many drilling rigs have been mothballed until prices are higher. So at some point in the not too distant future I suspect we’ll see the truth of the old trader’s adage, “the cure for low prices is low prices.” In other words, after a long enough period of low natural gas prices supply will diminish enough to bring prices higher. And even demand may respond to low prices to some extent.
The Car/Oil Cycle
I’ve long believed that there is an oil-related basis for the global car-sales cycle we are seeing. Of course the obvious reason U.S. car sales are down over 40% from 16 million to 9 million is the recession . But I would argue that car sales began turning down well before the financial crisis hit and that weak car sales has been an important cause of our economic pain - not just a result of it.
What started the car sales cycle heading down, I believe, was a new and important motivation for people not to buy cars - the fact that car technology is in a significant and rapid transition phase that is related to the growing shortage of oil. Consumers are well aware that a “next generation” car is in the process of coming to market. They’ve known that since oil began selling for over $100 a barrel. They may not have known if the next generation car would be an electric vehicle or a hybrid or a plug-in hybrid. But they damn well knew that in a few years it’s likely that whatever car they buy might now will be fairly obsolete. That knowledge has to be a significant damper to car sales.
Well, now we can pretty much see how the cycle of new car technology is going to play out. The winning technology will clearly be the plug-in hybrid electric vehicle (PHEV). It will probably have some sort of lithium battery although other and newer battery technologies could well become dominant before too long. But consumers are not hung up so much on just what battery will be in the car (though they should care more). Consumers are more focused on the simple fact that the next generation car will be much more dependent on electrons for propulsion and less dependent on oil than any car they can buy today. That is a sea change. As long as they perceive that the “real deal” next generation car is not yet for sale, they will hold off buying cars in great volume.
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