Oil Plunge and Janet’s “Considerable” Dilemma

Considerable adjective: large in size, amount, or quantity “Considerable” is the word of the week, as all eyes move from plunging oil markets to the Federal Reserve. This week, central bank officials gather for their last policy confab of the year. With bond buying now done and the economy expanding, the big question is: how might the Fed alter its policy statement to prepare investors for the inevitable increase in short-term interest rates?

Previously, the Fed has said that it would leave rates at near zero for a “considerable time,” but with the labor market improving and the economy gaining strength, there’s a case to be made to shift that language to a word of phrase that might equate to a shorter period of time. Analysts at Capital Economics have turned back the clock by a decade to see what terminology officials’ used ahead of the tightening cycle that began in 2004. “Back then the Fed went from saying that low rates would be maintained for a ‘considerable period’; to the FOMC would be ‘patient’ in removing accommodation; and then to accommodation will be removed at a ‘measured’ pace.”

Here’s how the Fed’s words translated into time:

• Considerable: 6 - 10 months
• Patient: 2 - 5 months
• Measured: one month

OK, so remember back in March when Fed Chair Janet Yellen had that woops moment at her first presser? That’s when she let it slip out that the Fed would raise rates “something on the order of around six months” after QE ended. Since QE concluded at the end of October, something on the order of six months would bring us to April 2015. Conveniently, there is a policy meeting on April 28-29, 2015 so that might be a fine time to start the process.

HOLD YOUR HORSES! The recent acceleration of the oil market sell-off may put a wrinkle on the “considerable” to “patient” exchange. While the 46 percent drop in crude oil from the June highs amounts to about $100 per month savings for US consumers, there are some analysts who believe that crashing oil is the canary in the coal mine for the global economy.

Until the last week or so, most have thought that the oil story was one part increased supply and one part tepid demand, but what if the balance is tipping in the wrong direction? In that case, falling oil has more to do with a big slow down in Chinese, European and Japanese economies than with the growth of U.S. production. In fact, that weakening growth prompted OPEC to predict that demand for its oil will hit a 12-year low next year.

If the world is really slowing down, then can the U.S. remain an outlier of growth for much longer? Investors answered that question with a “NO WAY” last week and sold stocks to underscore the point. After all, if you’re sitting atop healthy gains for the year (the S&P 500 is still up 8.3 percent YTD) and you think the globe is slowing, a reasonable response is to lighten up on your equity positions and see how things unfold. The Federal Reserve may also opt to maintain the status quo on its wording, at least until the first meeting of 2015.

MARKETS: The Grinch stole the Santa Claus rally, at least for a week! Despite seeing the worst week of 2014, the S&P 500 remains within 4 percent of its all-time high.

• DJIA: 17,280, down 3.8% on week, up 4.2% YTD (worst week since Sep 2011)
• S&P 500: 2075, down 3.5% on week, up 8.3% YTD (worst week since May 2012)
• NASDAQ: 4653, down 2.7% on week, up 11.4% YTD
• Russell 2000: 1152, down 2.5% on week, down 1% YTD
• 10-Year Treasury yield: 2.08% (from 2.31% a week ago)
• January Crude Oil: $57.81, down 12% on week (lowest close since May 2009; down 46% from June peak)
• February Gold: $1,190.40, up 2.7% on week
• AAA Nat'l average price for gallon of regular Gas: $2.56 (from $3.24 a year ago)

THE WEEK AHEAD:

Mon 12/15:

8:30 Empire State Manufacturing

9:15 Industrial Production

10:00 Housing Market Index

Tues 12/16:

8:30 Housing Starts

FOMC Policy Meeting begins

Weds 12/17:

8:30 Consumer Price Index

2:00 FOMC Policy Decision/Statement

2:30 Janet Yellen Press Conference

Thurs 12/18:

8:30 Weekly Jobless Claims

10:00 Philadelphia Fed Survey

10:00 Leading Indicators

Fri 12/19:

10:00 State Unemployment

10:00 Kansas City Fed Manufacturing

Will OPEC Decision Halt the Santa Claus Rally?

While you were enjoying your Thanksgiving meal, the 12 members of the Organization of the Petroleum Exporting Countries (OPEC) announced that the cartel would hold its output target at 30 million barrels per day. The decision caused a steep sell off in Brent crude oil (the global benchmark) on the ICE Futures Europe. When U.S. markets opened on Friday, investors dumped West Texas Intermediate crude on the New York Mercantile Exchange and futures plunged 10.2 percent to $66.15 a barrel, the lowest settlement since September 2009. Both oil benchmarks are experiencing their worst losing streaks since the financial crisis in 2008, with 18 percent losses for the month of November. As previously mentioned in this space (Peak Oil Pukes), sinking oil and gas prices should help consumers, but the savings has not yet created overall cheer. Last week, the Conference Board said that its consumer confidence index dropped to a four month low in November. But Capital Economics notes “this fall needs to be taken into context alongside the sharp rise earlier in the year.” In fact, confidence is still close to seven-year highs.

What has been driving confidence this year has been the steady improvement in the jobs situation. Through October, the economy has added 2.225 million private sector jobs and 2.285 million total jobs in 2014. The November jobs report, which is due this Friday, is expected to show that the economy added 220,000 jobs. If that happens, 2014 will be the best year for private employment since 1999, according to Calculated Risk.

The unemployment rate is expected to remain at 5.8 percent, which puts it close to the Federal Reserve’s estimate of the longer-term, normal rate of unemployment of 5.2 percent to 5.5 percent. But with wages still up only 2 percent year over year, the central bank is likely to keep interest rates at 0 to 0.25 percent until next year.

Despite lots of energy and attention, the initial reports from retailers about the big holiday weekend may tell us less about the economy than the jobs report. Analysis from the New York Times found that while the holiday season is important for retailers, it “matters only a little bit” for the overall economy. The reason is clear: consumers would spend a certain amount of money in any two months. When stripping out the normal expenditures, “for the last two months of the year, Americans are on track to spend $106 billion more than they would if these were any old months.” Not that you would sneeze at $106 billion, but compared to the $17.6 trillion US economy, it’s not nearly as important as the elusive 3 percent increase in wages that we have seen in previous expansions.

MARKETS: Will investors be treated to a “Santa Claus Rally”? The old Wall Street chestnut predicts stocks do well during the period just after Thanksgiving through the end of the year. Over the past five years, the S&P 500 has gained an average of 2.5 percent during December. But OPEC's decision to maintain current production levels could weigh on energy stock prices, curtail energy company profits and limit the near-term upside in markets.

• DJIA: 17,828, up 0.1% on week, up 2.5% on month, up 7.6% YTD
• S&P 500: 2067, up 0.2% on week, up 2.5% on month, up 11.9% YTD
• NASDAQ: 4791, up 1.7% on week, up 3.5% on month, up 14.7% YTD
• Russell 2000: 1173, up 0.01% on week, up 2% on month, up 0.8% YTD
• 10-Year Treasury yield: 2.17% (from 2.31% a week ago)
• January Crude Oil: $66.15, down 13.5% on the week, down 18% on month
• December Gold: $1175.50, down 1.8% on the week
• AAA Nat'l average price for gallon of regular Gas: $2.78 (from $3.28 a year ago)

 THE WEEK AHEAD:

Mon 12/1:

Cyber Monday

9:45 PMI Manufacturing

10:00 ISM Manufacturing

Tues 12/2:

Motor Vehicle Sales (2014 is on pace to be the best year since 2006)

10:00 Construction Spending

Weds 12/3:

8:15 ADP Private Sector Employment Report

8:30 Productivity

10:00 ISM Non Manufacturing

2:00 Fed Beige Book

Thurs 12/4:

8:30 Weekly Jobless Claims

Fri 12/5:

8:30 November Employment Report

10:00 Factory Orders

3:00 Consumer Credit

Peak Oil Pukes

Remember when energy analysts were scaring everyone with the concept of “Peak Oil”? The theory was that global oil production had peaked and as a result, prices would shoot up to $200 a barrel and the cost at the pump would top $10 per gallon. Flash forward to this past week, when West Texas Intermediate (WTI) and North Sea Brent Crude touched new four-year lows. (The Energy Information Agency provides a good description of the two benchmarks here.) The combination of the U.S. shale boom and weakening Chinese and European demand has pushed down oil prices 30 percent since June. And according to the International Energy Association, lower prices are likely to continue into the first half of next year. Short of a geopolitical flare up, the IEA believe the we are entering “a new chapter in the history of the oil markets.”

The Energy Information Agency said that US oil production reached 8.9 million barrels per day in October, the highest monthly production since July 1986. The agency is forecasting that production will average 9.4 million barrels per day next year, which would be the most since 1972. As a result, the government cut its forecast for global oil prices next year by $18 a barrel to $83. The EIA notes that a $1-per-barrel change in the price of crude oil translates into a change of about 2.4 cents per gallon of gasoline (There are 42 gallons in one barrel, and 2.4 cents is about 1/42 of $1) and so the agency also predicts that the average price of gas will be below $2.94 a gallon next year, a 44-cent drop from an outlook issued a month ago.

If that holds, consumers will save $61 billion on gas compared with this year. That may not seem like a lot in the context of a $17.5 trillion U.S. economy, but economists say it matters because it immediately gives consumers more money to spend on other things…like holiday shopping!

Before we get too ahead of ourselves with visions of sugar plum fairies and the like, you may wonder if there is a downside to the drop in oil. A recent Sanford C. Bernstein report noted that oil at $80 a barrel makes one-third of U.S. shale oil production uneconomical. If that’s the case, there is a fear that state economies like Texas and North Dakota which combined, account for about half of the nation’s oil production, could take a hit to their energy-dependent economies.

But any pullback on the local level is likely to be outweighed by a more general increase in economic growth. Estimates range from a 0.3 to 0.5 percent bump in fourth quarter GDP from lower oil and gas prices. That might not seem like a lot, but it sure would come in handy for the holidays and kick US growth into a higher gear.

There was one other piece of good news for US consumers: College costs are still rising, but at a slower pace. According to a report from the College Board, tuition and fees for four-year public colleges averages $9,139 for in-state students, an increase of less than 1 percent after inflation (Room and board adds $9,804 to the total bill). In 2009-2010, the annual increase at public institutions was 9.5 percent. Tuition and fees for four-year private nonprofit colleges were $31,231 ($42,419 with room and board), up 1.6 percent after inflation, down from the recent peak in price growth of 5.9 percent in 2009-2010.

The College Board issued a separate report, which found that students and parents borrowed $106 billion in the 2013-2014 academic year from the federal government and other sources, down nearly 8 percent from the previous year after accounting for inflation, and down 13 percent from 2010-2011 peak of $122.1 billion.

MARKETS: With stock indexes at record highs, investors are feeling good. The latest survey from the American Association of Individual Investors found that bullishness spiked to a four-year high of nearly 58 percent. Bearish sentiment, or expectations that markets will fall over the next six months was at 19.3 percent, below the historical average of 30 percent. If you believe that investors are often happiest at the wrong times, this could be seen as a warning… 

• DJIA: 17,634, up 0.4% on week, up 6.4% YTD
• S&P 500: 2039, up 0.4% on week, up 10.4% YTD
• NASDAQ: 4688, up 1.2% on week, up 12.3% YTD
• Russell 2000: 1174, up 0.05% on week, up 0.9% YTD
• 10-Year Treasury yield: 2.32% (from 2.30% a week ago)
• December Crude Oil: $75.82, down 3.6% on the week (7^th consecutive weekly loss)
• December Gold: $1185.60, up 1.3% on the week
• AAA Nat'l average price for gallon of regular Gas: $2.88 (from $3.21 a year ago; longest decline in gas prices since 2008)

THE WEEK AHEAD: Freddie Mac said fixed mortgage rates are hovering near 2014 lows, with 30-year fixed-rates averaging 4.01 percent, down from 4.35 percent a year ago. Will those low rates spur housing activity? We’ll learn more this week, when reports on Housing Starts and Existing Home Sales are released.

Mon 11/17:

Urban Outfitters, Tyson, Agilent

8:30 Empire State Manufacturing Survey

10:00 Industrial Production

Tues 11/18:

Home Depot, TJX

U.S. Senate may vote to approve the Keystone XL pipeline

8:30 Producer Price Index

10:00 NAHB Housing Market Index

Weds 11/19:

Target, Staples, Lowes, Williams-Sonoma

8:30 Housing Starts

2:00 Fed Minutes

Thurs 11/20:

Best Buy, Dollar Tree, Gap

8:30 Weekly Jobless Claims

8:30 Consumer Price Index

10:00 Philadelphia Fed Survey

10:00 Existing Home Sales

Fri 11/21:

Ann Taylor, Foot Locker

Week ahead: Fed Up, geopolitical risk reemerges

The Labor Department said the U.S. economy created 195,000 jobs in June and the unemployment rate remained at 7.6 percent. There was something for everyone in the report. Optimists focused on the fact that employment is trending higher. The previous two months were revised up, bringing total monthly job creation to just over 200,000 this year, ahead of last year’s pace of 175,000. And although the unemployment rate remained steady, it did so by absorbing 177,000 new workers into the workforce. Pessimists will underscore that there are still 11.8 million Americans out of work and the quality of many of the jobs was weak, with 75,000 new positions coming from low paying jobs in the leisure and hospitality industry. As far as the rate holding steady, pessimists note that a slew of part-time workers (360,000), many of whom would likely prefer full-time employment, boosted the workforce. As a result, the broad unemployment rate (unemployed, disgruntled and part time workers who would prefer full-time) jumped from 13.8 percent to 14.3 percent in June.

On a low-volume day, the optimists won the day, interpreting the report as proof that the economy was improving, but not by so much that the Fed would alter policy before its September meeting. Stocks gained ground, but the bond market was less convinced as 10-year treasury prices slumped and yields increased to 2.72 percent, the highest level in almost two years.

Is this what the rest of the year is going to be like? Since May 22^nd, after Fed Chairman Ben Bernanke testified before Congress and raised the prospect that the central bank could downshift from its accommodative policies if economic data were to improve, investors have been throwing a “Taper Tizzy.” Every day is highlighted by the question, “When and by how much will the central bank taper its bond buying?”

This week, the Fed-funk is likely to continue, after the release of the minutes from the last policy meeting. You might recall that was the meeting after which Chairman Ben Bernanke attempted to soothe investors with more details about the conditions under which the Fed would take its foot off the gas. Instead of the intended calming effect, Bernanke inflamed the situation and volatility spiked across all asset classes.

Taking the Fed at its word, we know that the exit strategy is a work in progress, which will be driven by economic data. Capital Economics sees five stages of the Fed’s exit plans. From an investor perspective, these stages might seem to match Elisabeth Kübler-Ross’ “Five Stages of Grief”:

(1) Taper monthly asset purchases this fall (DENIAL)

(2) End bond purchases completely by mid-year 2014 (ANGER)

(3) Modify forward guidance language included in FOMC policy statement (BARGAINING)

(4) Raise short-term interest rates in 2015 (DEPRESSION)

(5) Begin to sell Fed’s holdings of Treasuries starting in 2017 (ACCEPTANCE)

Regardless of the exact timing and staging, these steps will occur and the quicker investors adapt and accept them, the better off they will be.

For those who were getting sick and tired of the constant Federal Reserve naval-gazing, there is something new to agitate raw nerves: geopolitical risk. In the two years since the Arab Spring, there hasn’t been much discussion of geopolitical risk, which is loosely defined as the risk that an investment's returns could suffer as a result of instability in a country, due to a change in government, legislative bodies, other foreign policy makers, or military control. The situation in Egypt has all of the components necessary to qualify and has already pushed up crude oil prices -- NYMEX crude breached $100 per barrel for the first time in over a year. Thankfully, those increases have not translated to higher prices at the pump yet.

As a reminder, Egypt is not a major oil producer and has been a net oil consumer of oil since 2008. However, its control of the Suez Canal and its proximity to large Middle East oil exporters puts investors on alert whenever there is political unrest. Approximately 2.5 million of barrels of crude oil pass through the Suez Canal or the Suez-Mediterranean (SUMED) pipeline each day. Any disruption to the flow of oil could have ripple effects throughout the region.

Markets: In a holiday-shortened week, stocks benefited from a surprise announcement from across the pond. For the first time, both the Bank of England and the European Central Bank provided investors with forward guidance. Both central banks will maintain their aggressive policies for an extended period.

• DJIA: 15,135, up 1.5% on week, up 15.5% on year
• S&P 500: 1631, up 1.6% on week, up 14.4% on year
• NASDAQ: 3479, up 2.2% on week, up 15.2% on year
• 10-Year Treasury yield: 2.72% (from 2.49% a week ago, yield now at 23-month high)
• Aug Crude Oil: $103.22, up 6.9% on week
• August Gold: $1212.70, down 0.9% on week
• AAA Nat'l average price for gallon of regular Gas: $3.47

THE WEEK AHEAD: Q2 earnings season kicks off this week. S&P Capital IQ predicts earnings to increase by 2.9 percent from the same period a year ago and for the full year to rise by 6.3 percent from 2012.

Mon 7/8:

Alcoa

3:00 Consumer Credit

Tues 7/9:

7:30 NFIB Small Business Optimism Index

Weds 7/10:

2:00 FOMC Minutes

4:10 Ben Bernanke delivers speech commemorating 100th anniversary of the Federal Reserve

Thurs 7/11

Bank of Japan rate decision

8:30 Weekly Jobless Claims

8:30 Import/Export Prices

Fri 7/12:

JP Morgan Chase, Wells Fargo

8:30 Producer Price Index

9:55 Consumer Sentiment