The S&P 500 set a new closing low earlier this week, while the Dow Jones Industrial Average sliced through its November low more than a week ago. The broader market averages continue to react to weak data on the US economy, and energy commodities and related stocks are taking their cues from the same basic fundamentals.
As I pointed out in the most recent issue of my free e-zine Pay Me Weekly, It’s Still the Economy http://ezines.kci-com.com/link.php?M=1363390&N=5890&L=4491&F=H , the only indicators within the Index of Leading Economic Indicators (LEI) showing signs of life are money supply and interest rate spreads. Neither ultra-low interest rates nor the fastest growth in money supply in a generation form the basis for a durable economic recovery. We absolutely need to see strength coming from other corners of the economy.
Some of the November-through-January rally in the S&P 500 and in most energy-related stocks was driven by optimism surrounding the fiscal stimulus bill signed into law by President Obama last week.
This bill might provide some stimulus for the economy toward the end of 2009. But check out the chart below from the last issue of my subscription based service The Energy Strategist http://ezines.kci-com.com/link.php?M=1363390&N=5890&L=83&F=H .
Source: The Energy Strategist, Congressional Budget Office
The media has reported the value of the bill to be about USD787 billion, but that figure is really just the Congressional Budget Office’s (CBO) estimate as to its long-term impact on the US budget. Far too many people assume that all of that cash will hit the US economy immediately upon passage of the bill; this is a total fallacy.
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The chart above breaks the American Recovery and Reinvestment Act of 2009 (the Act) down into two components, tax breaks and spending. The chart further shows exactly when the stimulus is projected to impact the economy. When reading the chart, keep in mind that the government’s fiscal year (FY) ends on Sept. 30; FY2009 would end Sept. 30, 2009.
Roughly USD185 billion of the package is projected to hit the economy this fiscal year, while the peak year for the stimulus will be FY2010, with about USD400 billion. Broadly speaking, tax provisions will be among the first to have an impact and are heavily weighted in the first two years of the CBO projection. The spending provisions have a bit longer tail and will continue to impact the budget significantly out through FY2014.
In other words, the maximum stimulus impact of this massive spending bill may not impact the economy until after a tentative recovery takes hold.
But amid all this gloom and the uncertainty in Washington, there are a few positive signs. Chief among them is that after a series of large builds to US crude oil inventories, inventories appear to have stalled. Even more interesting are the demand figures that the Energy Information Administration (EIA) releases alongside its weekly inventory stats.
According to the EIA, over the past four weeks US total petroleum demand is off just 0.8 percent over the same period a year ago. Demand for gasoline is shrinking at a far slower pace than it was late last year.
Source: Energy Information Administration
The chart above shows the four-week change in motor gasoline demand on a year-over-year basis. This data can be volatile from week to week, and other considerations, such as weather, can heavily skew the data.
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Valuations for energy-related stocks are the lowest they’ve been in more than 15 years.
The S&P 500 Energy Index is cheaper today than it was when oil and natural gas were trading at a third of current levels.
One oil and gas E&P is trading so low, two of Europe’s majors are salivating over its prime reserves they can now snap up on the cheap.
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However, it’s fair to say that the year-over-year decline in US gasoline demand hit its nadir in October/November and since that time has been improving. Although it’s by no means a certainty, this could well be the first indication that the American consumer is responding to lower energy prices by bumping up consumption of gasoline. This is also reflected in the large drawdown in gasoline inventories reported this week; gasoline inventories are at or below average levels even though crude stocks remain bloated.
Another factor supporting this view is that although both car and sport utility vehicle (SUV) sales are declining on a year-over-year basis, SUV sales are no longer performing any worse than sales of small cars. In other words, consumers’ preference for smaller, more fuel-efficient vehicles has waned since last summer.
If these trends continue heading into the summer driving season, this would begin to push crude higher yet again. If demand does stabilize I also expect supply to once again take center stage.
OPEC Secretary General Abdalla Salem El-Badri recently stated that of the 150 projects planned in OPEC countries for completion within the next four years, 35 have been delayed until after 2013. Crude oil prices of USD70 to USD80 are required to encourage new investments in production capacity, and the longer crude stays depressed the more supplies will fall. And supply doesn’t turn on a dime; when demand does stabilize, falling supply spells a rapid run-up in prices.
A second factor to keep an eye on is the action in the global currency markets. Check out the chart of the US dollar/Japanese yen below.
Note just how closely the yen/dollar exchange rate correlates to the path of global equity markets. The reason is simply that the yen was the funding currency for the carry trade--traders took advantage of Japan’s low interest rates to borrow money in yen to invest elsewhere. The unwinding of the carry trade involves selling assets priced in other currencies and buying yen to pay off loans. The unwinding of carry trades is essentially a deleveraging process--a negative for stock and commodity markets
When the carry trade unwinds we should expect to see the yen lose value against the US dollar. Because the chart above shows how many yen make a dollar, a rising line suggests a weakening yen.
It’s clear that the yen strengthened sharply against the dollar as the global credit crunch took hold and traders unwound their carry trades. But that trade has now reversed, and the yen is moving sharply lower against the dollar again. If this continues it would suggest that the negative effects of the carry trade are beginning to abate.
A final potential catalyst for commodity prices late this year and into 2010 is a resurgence of inflation. Many investors are puzzled by the fact that US money supply continues to grow at a record pace, yet inflation is declining, and there’s a very real risk of outright deflation this year. I’ll examine the economics behind this phenomenon at some length in this week’s issue of my free e-zine Pay Me Weekly.
Also, be sure to visit our free blog At These Levels http://ezines.kci-com.com/link.php?M=1363390&N=5890&L=179&F=H in coming weeks. I’m a frequent poster on the site, which allows me to provide up-to-the minute commentary on the broader market, energy prices and the economy. We’ve also added a new Twitter feature, which allows me to post quick comments about the market or breaking news on the go.
Be sure to check out all the new features.
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