A Tug-of-War Between The Bulls and The Bears

By David B. Armstrong, CFA | Jun 13, 2016 | Weekly Market Commentary

I’m seeing, reading and hearing a lot of back and forth between people on where this market is heading and frankly, there are a lot of data that are supportive of both camps. People who are beating the bull drum have been highlighting the restrained investor sentiment, fair valuations, the improvement in the U.S. Dollar that is supportive of better earnings in the future and the still growing, yet tepid, economy. Bears, on the other hand, are underscoring that valuations may be strained by poor earnings outlook, China drama, the Brexit (Google it since I’m not getting into it in today’s blog) and the U.S. election spectacle (I’m DEFINITELY not getting into that – people are getting beat up for just having an opinion these days!).

So what do I think? Well, I think both sides have valid concerns, but I come down on the side that the current outlook for growth outweighs concerns that a bear market is around the corner.

For now.

We will eventually have a recession and that will coincide with a larger market pullback, but as I’ve been saying for a while now, the usual data suspects that pop ups prior to a recession are simply not rearing their ugly heads a this time – there is no over-confidence, over-spending or over-borrowing, no severe interest rate increases and no commodity spikes.

For some background, be sure to see my last economic update video where I go over some of the bigger reasons I see things in a more positive light and address all those ugly heads.

I think the last few weeks have been very interesting because while there has been a mix of economic news and certainly some increased global risk, the markets appear to be rather…dare I say…resilient. Despite concerns such as the recent U.S. labor market, which I discussed in last week’s blog, the upcoming BREXIT vote, and doubt surrounding future Fed policy, stock prices have not sold off.

We will always need to withstand the near-term risks. While it’s true that the market has rallied hard since mid-February, the medium-term and long-term position for equities remains upbeat in my mind…especially if we see the progress in corporate earnings that I’m expecting.

Oil

Oil remains a big factor in the economic outlook and for earnings. There are a ton of different ways to look at this but here is a basic, elementary thesis…when things are cheaper to make and ship because oil prices are low, that’s good for earnings. Someone with a Ph.D. in Oil may have a more complicated thesis, but I think mine is kinda sound.

Let’s start with gasoline.

The price of regular gasoline across the U.S. bottomed at $1.73 per gallon in mid-February. While the price has risen off that February low, data reveal the average price over the Memorial Day weekend was $2.34. That’s still a pretty sweet price relative to the last few years.

If you are like most people, you’ve noticed that gasoline prices predictably rise during the spring. There is a seasonal aspect in the gasoline price equation.

That said, taken in perspective, gas prices are still looking pretty good. The chart below is from Charles Sherry. The green line is 2015, the red line is 2016 and the blue line is the 2000-2015 average.

The biggest determinant in the price of gas is the price of oil.

Duh – right? Here is the deal. About 42% of the price of gasoline is determined by the cost of oil, and oil prices have nearly doubled since bottoming in mid-February. Oil is currently hovering roughly around $50 per barrel.

So the natural question is, “What’s pushing the oil prices higher?” Well since there are several different factors, I’m going to focus on some of the big ones.

1. U.S. gasoline consumption is currently up year-over-year. There is also data showing that there are year-over-year increases in key emerging markets like India and China.
2. In addition to consumption, there have been some supply disruptions. Libya, Nigeria, Venezuela and Canada come to mind. Canada had that huge fire and Libya, Nigeria and Venezuela have, well, Libya, Nigeria and Venezuela stuff going on.
3. Then there is the U.S. oil production that is expected to fall by 700,000 barrels per day this year as lower prices limit drilling/fracking.
4. Finally, don’t forget about the U.S. Dollar. Oil is priced in dollars when sold around the globe. The recent dip in the dollar is interconnected with rising oil prices.

However, even given all that, supply disruptions could diminish and with oil near $50 per barrel, we could see fracking production stabilize (and even rise?). Both of those situations could put a cap on prices.

I realize that seasonality could reaffirm itself during the fall, but for now, higher prices have been a plus for the suffering oil industry and it has contributed to the rally in stocks. This in turn helped to calm anxiety in the junk bond market.

The bottom line? We are well off the bottom in prices but the current prices are still rather acceptable.

Quick Tips for Success Right Now…and Always

Just a few quick thoughts to help you frame a construct for success given where we are right now:

1. The single greatest weapon an investor can wield is patience.
2. Curb your emotions since the markets have none – they are merely a reflection of collective emotion.
   1. If you are looking for excitement, go take a weekend out in Vegas.
   2. If you are looking for drama, go binge watch a season of the Kardashians.
3. Follow a principled strategy – chasing things you wish you had when you didn’t have them will only cause problems.

Have a great week – call with questions.

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