Oil Prices Should Fall Soon
Since our last newsletter the stock market moved but barely advanced. We had talked about the Russell 2000 and the fact that it reflects more than any other index the perception about the state of the domestic economy. Since that day two weeks ago, the Russell 2000 rose by 3 meager points. The index was rejected from overhead resistance, consolidated for a week, tried again and was able to inch higher. Volume, conviction in other words, was low and market participants always had one eye on the oil markets. Thursday's inventory report for crude oil storage reserves caused spectacular price movements. The report from the Energy Information Administration showed that domestic oil stocks, excluding those held in the strategic petroleum reserve, fell by 8.8 million barrels during the week ended May 23. According to a Bloomberg census, analysts had expected that oil inventories would remain unchanged during the week. The agency laid the blame for the decline on delays in crude oil tanker off-loadings at Gulf of Mexico terminals. There are strict guidelines dictating which tanker shipments can be included in the current report and which must wait for the following week. Because such bureaucratic wrangling often interferes with interpretations of the data, many analysts say that year-on-year inventory comparisons are more insightful than are week-on-week comparisons. Other analysts say that this"delay" was no coincidence and that interested parties had delayed the tankers hoping to cash in on rising prices. Futures prices had been down $2 overnight, jumped by $3 within seconds of the report only to give it all back and end up in negative territory by over $3. Meanwhile, the Commerce Department's second report on U.S. 1st quarter gross domestic product showed a revision from 0.6% to 0.9%. The report will undergo another possible revision before it's finalized, but so far it seems to indicate that the economy managed to avoid contraction in the beginning of the year.
The GDP picture above shows in dramatic fashion how the GDP index tries for dear life to stay in positive territory. Of course what we see in the picture is called"Real GDP" for a reason. The gross domestic product is here not represented in nominal terms but in inflation adjusted terms. Many a market pundit has criticized the way the government reports and represents inflation data. Current official inflation data as measured by the CPI show an inflation rate of 4%. Thus we can assume that the economy grew in nominal terms by about 5% this year. If we assume inflation to be twice as high as some people suggest the economy would have shrunk by some 3%. The second picture above is not adjusted by inflation. It is, however, also reported by the government, in this case the Bureau of Labor Statistics. Initial unemployment claims rose 4,000 to 372,000, and the four-week moving average fell 2,500 to 370,500. This is still a good bit below the 400,000 that would indicate no growth or recession in the economy. This indicator is of course lagging by quite a bit so it may not indicate the current state of affairs but the situation from a month or two ago. Still, at this point in time we should slowly see recessionary numbers coming in. This week's non-farm payroll report may give us some clarity on the employment front. The consumer-led recession may still come upon us, even though at times I have to fight the urge to give in to my doubts about it. I am also still hoping that energy prices may decline substantially from here. If Messieurs Masters and Mauldin are right, a good portion of this year's oil price increases seem to be caused by international speculation. If this is true (which we will find out as usual in hindsight) then the fact that oil could not breach last week's $135 gives me some hope. Doug Kass, a noted short seller who was recently interviewed in Barron's said on 05/23/08 this about oil prices:"There is little doubt that, for a host of reasons, there is a fundamental problem with the balance of long-term demand and supply for energy (and other commodities), but, to me, it is also increasingly clear that speculators have exacerbated the intermediate- and long-term issues in many commodities. At the risk of being slightly premature, I say to the oil longs -- sold to you! -- which is exactly my game plan as I expand my energy-related shorts via a long position in the UltraShort Oil & Gas ProShares DUG and a short in the Oil Services HOLDRs OIH."
Meanwhile the consumer continues to suffer from high energy costs. The first chart above shows you the real ("inflation adjusted") average weekly earnings. Data on average weekly earnings are collected from the payroll reports of private non-farm establishments. Earnings of both full-time and part-time workers holding production or non-supervisory jobs are included. Real average weekly earnings are calculated by adjusting earnings in current dollars for changes in the CPI. You can see the demand destruction that everyone is talking about. No wonder that the consumer is in a lousy mood. The second chart above shows that the University of Michigan consumer confidence index reached a 26 year low. Of course we all know the saying: "Watch what they do, not what they say." In this sense the consumer may feel down and tapped out, but the Commerce Department reported that personal spending and personal income growth each rose 0.2% in April from the prior month, essentially what economists had expected. The March income figure was revised upward by one-tenth of a percentage point. Core personal consumption expenditures also matched expectations last month, ticking up 0.1% compared with 0.2% in March. So it seems that not only the chart above may have reached a low point, but that perhaps the consumer has also reached an extreme from where things can only get better. The optimist in me thinks that it is always darkest right before dawn, at least as far as stocks are concerned. Let us consider a quote from last week's Barron's:"Bill Stone, PNC Wealth Management's chief investment strategist, tracks saving deposits and both individual and institutional money-market accounts to gauge the potential fuel for rallies. The level of available cash, he says, recently stood at about 62% of the total market value of the broad S&P; 1500 index -- down slightly from 65% in March, but still well above the 47% average over the past decade. In fact, the last time cash hit this level was in September 2002. A year later, the market was up more than 12%".
It may be a slow climb up that proverbial Wall of Worry, but the market may have discounted the worst, including a"shallow" recession.