Sunday, January 31, 2016

Balancing The Crude Oil Market

One of the most fundamental economic questions about markets and their interworkings surrounds the theoretical concept of an equilibrium. For mathematical economists, the question may seem weightier indeed, but for the run-of-the-mill topographical observer, the phenomenon can play a role in the everyday decisions of an investor and a consumer. Equilibria exist in all systems. One of the most popular may be studied by a physicist concerning pendulums and Newton balls, but to an economist, the forces of supply and demand, price and quantity come to mind. As a quantifiable framework, price and quantity can be shown by two sets of equations and set equal to each other. In the same way, investors can abstractly think about the amount buying and selling going on in the marketplace, knowing that intraday trading is just another method of finding the equilibrium.

Many weaknesses pervade the type of static equilibrium analysis that we employ. Who really knows if the equilibrium that we just calculated will be applicable to the immediate present? There's a Shrodinger's cat kind of evanescence that defines the problem. A mathematician can never adjust his calculations for each immediate change in the economic situation, and a trader will never be able to buy and sell at the right equilibrium because of how fluid the market is. The question I have always asked is: where is the equilibrium in oil price? Is that price given to us my the market? When looking at values determined by large groups of individuals trading, one has to discount (or premium) the sentiment that affects their peers. Just like an auction, each player has a perceived price which he or she thinks is optimal. An investor who wishes to "bet" on the crude oil trend would have to decipher a plausible equilibrium based on the perceived value determined by the millions of other traders out there. So what should that trader base his projections on, his peers' thoughts or the supply and demand forces that come into play? This depends on what that individual thinks is driving daily market fluctuations.

What can be said, then, about the recent performance of the crude oil indicators? This week, crude oil has been on the rise after the early months of January saw some of the lowest prices in recent history. The West Texas Intermediate price has grown about 3.17% in the past five days despite a -12.99% loss for the month. When thinking about supply and demand forces, one might postulate that a significant weekly gain might represent a change in fundamentals where the equilibrium has shifted to show either larger demand or smaller supply. Weekly production estimates show a small drop of 14,000 bbls a day by the end of January. At the same time, the first month of 2016 showed an increase of 20,000 bbls a day from the end of 2015. That's an increase of 0.22% supporting losses of about 13% in price over the span of a month. With these numbers, it would appear that the market has not reached a major consensus on what a plausible equilibrium might be. Increased volatility hinders the ability for traders to find an acceptable equilibrium who might take technical signals as points that provide meaning to a balanced market. There may be more forces that need to be accounted for.


Exchange traded funds became a famous process of securitization that transformed the trading floor. Long and short term traders use the tool to take out bets on certain industries or sectors of the market that appear to have an upside (or downside). There are various ETFs that follow the performance of the commodity price of crude oil. While the trading is not identical, it typically follows the same pattern. There is a fundamental difference between those investing in each asset. If one is buying a WTI contract, he obviously has some demand for oil. Either that or the investor seeks to supply that oil at a certain price. Individuals who have these supply and demand concerns would not trade an ETF in order to solve them. Instead, traders who have a feeling or have noticed a specific trend develop might purchase some of the derivative in order to profit from a movement in price. Here, the individual has less of a stake in the actual supply and demand for the product while focusing on the trend and sentiment surrounding the entity on which the entity is based. The chart above tracks WTI spot price over the past couple months with the performance of OIL plotted behind it. Before 2016, there appears to be no difference between the movement of these two securities. The line that represents OIL rarely deviates from the commodity which it follows. Major deviations only occur at the end of 2015 and the beginning of 2016 as volume spikes and price dips. The arrows point to three major differences in the paths of the two tickers. In all three of these instances, it appears as if the OIL fund overshoots and exaggerates the trends that were in play.

Looking at the comparison between OIL and WTI shows a difference between supposed fundamental value and sentimental value. Because one can see more volatility on the sentimental end, it might be possible to classify the current trend as an orientation of attitudes toward the current and future status of crude oil. Equilibrium analysis concerning the supply and demand of the market might be out of focus because of this sentiment-based trend that has apparently emerged. Traders that harness swings of emotion might be more capable of taking profits in this month and the near future, But remember, equilibria are only snapshots of the current desired state of the market. With more news and fundamental change, both the sentimental equilibrium and price-quantity balance will continue to develop. For now, the crude oil might be a little oversold and with a little bit more time, will experience a small rebound as fundamentals come back into focus.

Wednesday, January 27, 2016

The Small-Cap Solution To A Recession

Losses across the globe continue to infest the unnerved prospects for global economic growth this year. Stock markets continue their decline into a bear market which is incomparable in length and magnitude to any major periods of 2015. Despite gains earlier this week, more sliding in major market averages today reconfirms the heavily bearish sentiment that plagues traders and their wallets. The Dow Jones Industrial Average, already down 8.5% on the year, fell -222.77 points (-1.38%) to land below the 16,000 point mark. The S&P 500 following large cap stocks fell a total of -1.09% a trend that has continued through the beginning of January. The Russell 2000 small-cap index dropped a little further at -1.50%. Smaller equities have performed worse than their large cap peers since the March of 2014 in a trend that has set spelled danger for new start-ups and IPOs.

Ratio comparison of S&P 500 and Russell 2000
While advancement from the S&P 500 can typically define a solid bullish trend, a helpful confirmation can be the growth of the smaller businesses behind them. Growth in that sector signals healthy growth in wages and jobs as well as plentiful corporate profits and revenue. Long-term weakness from these equities discourages the creation of new businesses because it shows an increasingly stronger barrier to entry. A bearish trend like the one seen above is enough to scare away potential IPOs and even encourage mergers and acquisitions. In 2015, the economy saw its lowest amount of IPOs and the higher amount of M&A activity. A coincidence? I think not.

Left from WSJ; Right from Renaissance Capital
The performance of small cap stocks should be closely related to the trends in both the M&A and IPO markets. As debt becomes more expensive to fund, smaller companies will carry a larger risk premium which is seen by the gap between the two indices mentioned above. Trading in 2016 has pushed this poor performance to a new high which may mean another year of sluggish IPOs. Companies looking to introduce themselves to the public market will be looking for a period where risky bets are less bearish and capital might be more accessible. Similarly, small companies who want to exit the public market where debt and risk premiums have priced their liabilities too high will look for liquidation in the mergers and acquisition market. For that reason, this year could be another four quarters of a corporate shuffling of the cards. Defaults in industries most affected by the commodity rout may cause consolidation by the largest entities with the ability to weather the storm.

The markets for IPOs and mergers and acquisitions are also affected by the price of money, or interest rates, a popular name used by the Federal Reserve. The same monetary organization concluded a two-day meeting in which major stock market losses raised questions over four more rate hikes planned for this year. Even though labor conditions improved in the past year, the FOMC board recognized that "economic growth slowed late last year" although did not acknowledge a spillover into this year. The statement also downgraded "consumer and investment fixed spending," growth to a "moderate rate" from a "solid rate" mentioned in the December statement. A soft shift in position seems to be a blatant disregard for recession-like symptoms; although, a feigned ignorance could be in place to parry a violent stock market response. The FOMC continues to reaffirm its stance on inflation with little changes to its approach there. On the other hand, comments on job gains were highlighted as an upside to the economy. Neglecting to address the real dangers of inflation and failing to review their 2% policy appear, to me, as the biggest blunders in this report. Although, a surrender to the inevitability of fluctuating energy prices might be a subtle nod to its newfound power on the trading floor. For these reasons, the Fed Funds rate was held at the previous range of 0.25%-0.50% decided in December with a cautious pair of eyes on new data for direction come the next meeting. Futures traders are already placing their bets on the downtrend with the Fed Funds futures price giving a 25% chance of a quarter-point increase in March.

Even though monetary conditions remained easier than what they could have been, the Fed's uncertain tone alienated investors and convoluted the organization's plan for the next couple meetings. Global stocks traded flat in response with the Global Dow up only 0.32 (0.01&). Asian stocks are mixed as they open with Japan and China leading with losses 0f -0.82% and -0.29%. European stocks also traded mixed with slight aggregate gain shown by  a 0.37% increase in the Stoxx Euro 50. The monetary institutions in these markets have already committed to increasing their expansive policy in the face of the global losses. The uncoordinated monetary solution has done nothing but augment the amount of discomfort in the minds of investors which rely heavily on discounting the future. An unclear future can result in capital leaking to safer segments of the market (bonds) as companies deal with shrinking profits. This is the conundrum our financial world faces today, and it can be connected to the performance of small businesses and the IPO and M&A markets. Recessions occur when that one business owner or investor is unwilling to take that risk because of the unsafe business conditions, a feeling that is extremely contagious. The United States, the euro zone, and the major Asian economies cannot emerge from their rut until their individual businessmen make that decision to trust their country's economic health.

Sunday, January 24, 2016

Global Risks from the World Economic Forum

Investors, companies, governments are always looking ahead. These entities devote millions upon millions of dollars of capital towards the resolution of the future because it scares us. We get scared in groups, and that fear feeds other groups because humans have this superficial trust in one other in risky situations. The recent sell-off of the global markets is just one example of our unconscious belief that others may be right. Large-scale reaction to risky and stressful events can also be seen in the surprisingly large approval rating of Donald Trump's suggestion to "ban all Muslim immigration into the United States." All presidential candidates, like Trump, participated in a healthy, indirect discussion of ideas in response to the risks posed by a large migration seeking to disperse themselves among the developed economies. This moratorium on international issues could be represented by an impressive gathering in January, and every January, called the World Economic Forum. Interestingly enough, a large survey in over 100 countries and economies is put together annually to address some of these global risks that cause irrational responses. The migrant crisis and financial trouble are just two of the dangers discussed in the Global Risk Report 2016. For this article, I'd like to discuss some of the ideas and concerns brought up in this report with special highlights of the economic risks that threaten global stability. The report from the World Economic Forum can be accessed at their website here. The 103-page document presents well-written analysis on important social, political, and economic current events and how they may be expected to evolve in 2016. It is not every day that the human population assembles a document listing all the fears and jitters they have, so let's make use of it.

from Global Risk Report 2015
An interesting part of this survey includes the pooled perception of the global risks from thousands of political, social, and economic professionals from countries across the planet. These top five choices are ranked on their likelihood and their impact on the population, and this chart compares the risks to those that were chosen in the past. This figure can be found on page 11 of the document from the link. Some interesting big picture trends to note are extricated by the color-coding system that links each issue to a larger category.

  • For the events that were considered most likely in the past up to 2016, two different categories dominate the list. From 2007 to 2010, most of the world saw economic risks as the most likely to occur in the given year. Over half of the risks chosen in these years pointed to asset price collapse, slowing production, or oil shocks. Obviously, this trend was caused by the financial crisis that left a lot of professionals questioning their conventional finance knowledge. Because of this large-scale panic in the economy, central banks were handed the problem and forced to come up with a solution. From 2011 to the current year, environmental risks have trumped the other categories in being the most likely to occur. In this period, ecological issues account for over half of those chosen with climate change and concerns over water supply looming in the minds of participants. This trend shows a global shift in perspective from profits to social good that may have been helped along by the flopping of the financial sector. While global warming dangers have been evident since the early 21st century, the emergence of eco-economics is challenging mainstream business models in favor of those that recognize natural capital as a legitimate resource. A refocus on environmental assets could lessen the importance of regular capital and profits.
  • While economic and environmental issues reign supreme as the most likely, there is one category that barely threatens us at all. Participants in the survey only chose technological risks three times in all the years listed. The year 2007 was the only year where one of these issues made the top three. The absence of the fear of technology may rest in its increasing familiarity. A new generation is not pioneering new and ambiguous fronts in this field but instead already firmly grasps its capacity and dangers. The world is no longer growing up into technology but growing up alongside it. Older generations may still see technology as something that is new and developing, but the generation that will control tomorrow realizes that the other issues listed in the survey will be solved with technological breakthroughs and innovations that are being welcomed in both the developed and emerging economies of the world.
  • Just as technology risks are rated as most unlikely, so they are rated as least impactful. There is no doubt that innovations and changes in this category have large impacts, but people seem to fear their risks less. A similar sentiment could have been found in the early 2000's when technology stocks were inflated to prices that didn't reflect their fundamental value. Then, and perhaps now, the human population concentrate on the positivity that radiates from technology while failing to recognize the vulnerabilities networking and automation can create. As the world becomes entrenched with newer gadgets and acclimated to the a globalized networks, the underbelly of computerization may be easier to identify. Instead of sci-fi movies attempting to warn against the dangers of a robot invasion, the Global Risk Reports of the future may provide the caveats we need. 
  • While technology issues failed to make the impactful list, 8 of the last 10 most impactful risks have been economic with "fiscal crises" and "asset price collapse" as the most popular choices. Many more economic risks crowd the 2nd-5th choices for these years as well. Ever since the financial crises and even before then, wariness over the economic systems has been augmented by more complication to the system that rules our money. In the 1990's, the U.S. government allowed a lot of deregulation and globalization to occur which set the stage for the interconnectedness that plagued the financial system when things crashed. During that time (often called "The Great Moderation"), financial crises in the developing Asian countries where assets and currencies constantly collapsed. Financial trust, amidst the fiscal crises of the last thirty years, has migrated to the central banks and their leaders. Investors have increasingly placed importance on the policies and statements coming from the largest monetary institutions in the world. Interest rates have transcended the role of pricing money to a barometer of economic health. The trend of economic risks as the most impactful supports the transfer of trust from private institutions to central banks as fear and doubt continues to linger.
  • The idea that economic problems are often antecedents to social instability is a commonly held principle. The trend of economic risks in the early years has already been identified in both the likelihood and impact surveys, but the current, and developing, pattern of the early 2010's has been defined by the societal category. Four of the last five most likely risks have been societal issues. In addition to being the most likely, societal issues were chosen most often in the impact survey over the past two years. These social maladies that are listed among the global risks are reactions to poor living standards in areas pervaded by major conflict. Some examples would be water shortages in the Middle East as well as the migration crises in Syria. Solutions to the economic enigmas of the developing world were as success as some would hope. The financial crisis exacerbated the globalized poor while geopolitical issues prevented any real cooperation over environmental and societal concerns. This is why global citizens are turning from financial solutions and embracing events like the Iran nuclear treaty and the green Paris agreement. Just as these issues are defining the dynamics of the new generation, so they are majorly affecting the 2016 election in the United States where Democrats and Republicans leave economic decisions behind for the Middle Eastern conflict and assessment of income in
These are just a few of the trends that can be extrapolated from the perceptions about the likelihood and impact of the various global risks. The next section that I want to turn to on this report is labeled "Economic Growth 4.0" on page 16. The authors, in this section, focus on the economic weaknesses pointed out by participants in the survey. Ranking as the most likely and most impactful, "fiscal crises in key economies, asset bubbles, and structural unemployment and underemployment" were the most identified risks. The losses from the major developed markets show the fear and weakness that threatens the interconnected financial structure that prices fixed income, equities, and bonds (both corporate and sovereign). Underneath all of these issues, the continuation and deepening of the energy shock have forced inflation to a nonexistent level and confused central banks. Energy prices were actually selected as the 5th most impactful in this year's survey as major oil exporting countries threaten to bog down the global economy. The dangerous atmosphere created by deflated Brent and WTI crude prices and sluggish capital can be attributed to the amount of debt floating around on balance sheets of private companies and government accounts. The report cites a comment from the IMF in which they estimated a total of $3 trillion of overborrowing and a debt-to-GDP ratio increase of 26% in between the years of 2004 to 2014. In 2015 alone, emerging markets added around $120.5 billion worth of debt to their portfolios despite an uncertainty surrounding interest rates. These high levels of debt were created at a time when energy prices were higher and interest rates were near; the reversal of these trends could mean higher risk premiums on bonds. Currently, U.S. 10 year Treasury bonds are trading near their low 2.00% yield despite the Federal Reserve's plan to increase the Fed Funds rate. Corporate debt could get pricier if a slowdown continues throughout 2016, and sovereign debt premiums could widen as well. Debt-littered euro zone countries could face monetary crises with a devaluation of their currency as well as their government bonds. Greece is just one already urgent example of countries that spend in order to preserve social welfare and stability. While those policies were favorable to the populations, the long run consequences of heavy spending eventually overcome the expensive public goods. Instability in France has already become a concern as President Hollande declared an "economic state of emergency in the country." All of these concerns summarize major downside risks that pervade the global economy, but we haven't even mentioned China.

On page 17 of the Global Risk Report, the authors discuss China's economic status as one of the largest factors influencing global financial health in 2016. Both of the sell-offs in August of 2015 and the beginning of 2016 have been reactions to Chinese asset crashes or sluggish productivity data. The Asian behemoth is now the largest economy in the world accounting for just over 16% of the world's GDP which rivals only the United States. Because of its roles as both an importer and exporter from/to most developing and developed countries, even small changes in the supply and demand can disrupt global market equilibriums. Take oil for example. OPEC, which exports a lot of their heavy crude to East Asia, has been forced to sell at a much lower price with diminishing demand under industrial slowdowns in China. At the same time, the Chinese yuan continues to be devalued by weakness. President Xi has coined a new term for China's condition to inform the world that the manic growth is over. He calls it the "new normal" where "the economy will be based on fewer exports and investments and more services and consumption." Basically, Xi wants his country elevated to the developed status, and this desire can be seen by the Chinese government's push to make the yuan a designated "reserve-currency" by the IMF. He also warns that China's growth rate is not below 7% because of weakness, but because the new normal represents a transition to a service-based economy with a slower growth rate. There may be a reason to believe him too. The Global Risk Report cites an IMF source again that claims the Chinese construction sector has been operating with incredibly high levels of leverage, "a ratio of total liabilities to equities that exceeds 250." While debt like this was sustainable before, the new normal will not sustain rapid growth and capital flow on such a high level. This is exactly why Chinese stocks are experiencing a reality check of considerable magnitude. So what should the rest of the world, that has been relying on China's 10%+ growth rate, do to fill the gap? Central banks might elect to stimulate more, but I would do nothing. These trepidations are necessary to the business cycle and the rest of the global economy. China's growth definitely overheated while wearing out an underdeveloped financial industry. The report mentions the problem of "face worsening asset quality and non-performing loans" which will need to fail in order to solidify the economic development that has been beneficial. One might think of it as letting subprime investments go just as subprime loans could have been allowed to fail. Once again, debt reemerges as the core of the problem. There are tranches of debt that represent the different quality of the risks that are being taken. Chinese investors will soon find out that their risky bets will no longer be supported. Once the Shanghai Composite finds its bottom, look for stronger, flatter, gradual growth to begin. A cleanse might also include a witch hunt with weak companies and weak investments weeded out of the good ones. The "new normal" may be more of an understatement on the global scene, pertinent to only the domestic Chinese economy. With commodity prices nearing their bottom and debt purchases being condemned, perhaps a spark of direct foreign investment could be the key to finding the next China-like economy. My bet's on Africa.

The Global Risk Report discussion highlights many risks that may not center on economic issues. I have chosen not to cover some in order to stay specific to what my previous articles have been loosely based upon. If there are any more requests for elaboration on the Global Risk Report (a very rich document indeed), please let me now, and I will write some more. This article written here may not be the last you hear of the World Economic Forum anyway. So please, I encourage reader interaction/discussion/development. I really just want ideas to flow because, in the end, collaboration can make this information 10 times better.

Friday, January 15, 2016

Confirmation Is The Key

Last year's stock market brought up major questions surrounding the sustenance of the broad bull market advance that had begun after the financial crisis. With dropping oil prices threatening the energy market and deflationary pressures leaving the Federal Reserve in tough positions, many investors were stuck between believing in a long-term trend of growth or coming to terms with the inevitability of cyclicality. Don't get me wrong; the last statement should not lead you to believe that I think the market is dropping into a trough because that may or may not be the case. What seems true, though, is that these bulky sell-offs are communicating the popular bearish feeling in most sectors of the market. Perhaps truer than any presumption made by analysts is the 2199.95 point gap between the closing DJIA price today and the high over the past 52 weeks. That's an average of an 11% discount across the major industrial shares that make up the index. Another fun fact, today's closing price is closer to the 52 week than that high. The current trend doesn't appear to be changing anytime soon as well. The largest corporations in the S&P 500 show a similar trend as the index descends past the 1,900 level on a major plunge today.

If we look back to last year, investors created numbers like these in reaction to the Chinese stock crash late in the third quarter of 2015. The same crowd traded shares back up to previous levels making the major sell-off appear unbased and, in some ways, irrational. Looking at the Dow in late August, an abrupt correction sent the DJIA to 15,666 for a brief foray below 16,000. Just seventy-three days later, the same index fell short of 18,000 by only 90 points in early November. Does anyone else think such an ascension was a bit hasty with a bearish trend clearly in effect? Oil prices and that sector, though recovering, were clearly still going to take double-digit losses through to the end of the year. Most Q3 earnings reports showed soft growth if not losses that questioned the fundamentals of a lot of companies. It might be interesting to see what corporate profits in the fourth quarter will look like when considering the rebound of stock prices during that period.


A chart-based analysis of corporate profits compared to the Dow Jones Industrial Average shows an interesting picture of how the stock trend could have developed. In red, the DJIA has been plotted to compare its performance against quarterly corporate profits where the point above 2015-07-01 shows profits recorded for the third quarter. Noticing the significant drop in profits in that quarter, traders sold off into a down trend that appeared to be confirmed by fundamental weakness visible during earnings season. It seems like a logical move with no emotional trickery or voodoo dolls involved. After the correction in August, the latter half of the third quarter and the beginning of the fourth usher in a small period of growth that approached the highs of the first half of the year. Based on this positive trading, a rational estimation of fourth-quarter corporate profits would be somewhere in the range denoted by the green bar, a jump of around $20-30 billion dollars. While we wait for the true numbers to come out later this month, assessment of the viability of this fundamental valuation is possible. Investors are assuming that companies can boost their bottom lines in a deflationary environment where warm weather hurt a winter season that is usually bubbling with retail frenzy. In the Federal Reserve's Beige Book produced today, growth in most districts was described as "modest" at best with little to no growth in consumer spending. Compared to the seasonal trend, retail sales were flat with no signs of a Santa Claus boost. At the same time, the Fed reported, "most manufacturing sectors displayed a weakening in activity." All these symptoms of a slower economy could be attributed to the slowdown in oil and lagging in the consumer price index. After all these facts (most of which were similar to those revealed in August of 2015), the stock market is experiencing a slower but deeper sell-off in equities. Why is that?

In the history of stock market trading, most erratic pricing can be traced to a carnal desire to rid oneself of all pain and fear in order to reach a more pleasurable, peaceful state. While the explanation for a phony price recovery is less zen, the idea contributes to errors the mob may have committed during the early fourth quarter months. Trends are very fickle things; ask any trader who has lost money on the sudden reversal of a stock price. That's why when Charles Dow wrote about the financial markets in the early 20th century. He highlighted the concept of confirmation in order to decrease risks when trading certain stocks and bonds. While most of the stock indices he created were meant to stress diversification in the industry, the ideas around Dow theory sought to support the idea of confirmation through intermarket analysis. An example (which is used on this site often) would be the performance of the Dow Industrials versus the Dow Transport. This relationship can be used as a litmus test for the current trend with behavior that either supports or disagrees with the current trend. This is what made the August correction so tricky. Coming out of the routs in Chinese and U.S. markets, a lot of traders saw weakness compartmentalized to the Chinese economy and the energy sector. Broad-based declines seemed to be a reaction to the fragility in these sectors and were believed to be a temporary kink that was meant to be massaged out. Confirmation of an overall down trend that defined the end of the bull market might have saved investors money on the new long positions they were making at the new lows. We're now seeing those lows as a real possibility on the stock market today. Charles Dows writings also bring up the idea of the various lengths of trends and how they may intermingle to confirm or deny the perceived momentum. He looks at three periods: the tertiary (intra-day trend), secondary (20-90 day trend), and primary trend (1-2 years). While the exact length may vary, each type of trend shows different movement based on how trading occurs in that particular length of time. Intra-day movement tends to be choppier with short-term trading dominating the trends, and primary trends are typically good indicators of business conditions and economic health. 


Looking at a long-term chart like the one above, one can observe a change in momentum that occurs around the beginning of the year. In the chart, the Dow Jones Composite Average, which measures stock prices across industries, shows a general down trend for about a year before the correction in August. Just before the major plunge, we see a major technical signal of the 50-day moving average dropping below the 200-day moving average, a phenonmenon that usually shows a shift in the long-term trend. What I fail to understand is how a continuation like the upward sloping dotted arrow is confirmed by the recent primary and secondary trends?  The new trend line below that seems more realistic especially given the weakness of investment and consumer spending and the failure of industrial production to reach the levels before the correction. The question still does loom at large: have we confirmed a larger bear market? Where will the current secondary and tertiary trends take us in the long term? This time around, most losses infect all sectors and commodity prices are continuing to lose steam that was supposed to be recovered. Recession-like symptoms may be the most likely case as the economy appears to swing down into the trough of the business cycle. Contrarian analysis supports this view when considering the substantial growth of the market in the long-term. Lower oil prices continue to heap pressure on growth and will be an indicator in the future when things are looking up. Investors, it is now more important than ever to look for confirmation in long positions. Some sectors may have a softer fall as well as a higher probability of recovery making them ideal to buy as lows are found. As for broad market trends, do not forget the goals of Dow theory in which intermarket analysis can warn of a gradual (or even sudden) reversal that can be used to improve the integrity of your portfolio. 

Friday, January 8, 2016

Global Weakness Strikes The New Year

The year of 2015 took investors through a wild roller coaster ride of extreme volatility complete with extra screaming from the oil and gas industry. Many analysts labeled the past year as the end of the bull market that had benefitted from the overextension of selling after the crisis. Just about seven years after the start of the Great Recession, mood swings start to become evident once again. The beginning of the new year tells no different story. Despite stabilization today, the Dow Jones Industrial Average has already lost almost -5% for the year. Pent up global pressure once again mires any hope of U.S. equities lifting off ground zero. A combination of political and economic trepidations has compromised any short-term optimism that was present in the market. North Korea's claim of testing a hydrogen bomb contributed to a Chinese stock rout that sent tremors through the rest of the world. For the year, the S&P 500 is down -4.88%, the Euro STOXX 50 is down -5.90%, and the Shanghai Composite has sparked the plunge with losses of -9.97%, a number that has recovered with gains today.

As an impending result of the global weakness, crude oil prices have responded with more price cuts in a nihilistic fashion. China, the world's largest source of demand for fossil fuel, has hinted at further slowdowns with the weakness perceived by the stock market. From the supply side, gushing faucets of cheap crude continue unabetted with incentives to keep pumping looming for Saudi Arabia, Iran, and even some major shale producers. While Chinese weakness hurts U.S. oil and gas companies less, a stronger dollar against the world's currencies makes their gas more expensive for their buyers overseas. This could be why prices hover at all-time lows of $32 a barrel.


The blue lines representing a trendline and high volume levels don't spell out particularly good news for those who are long oil. The masses selling WTI have been noticeably large with volume numbers larger than those of 2015. Interestingly enough, the only periods of volume that are above the blue line represent bullish spikes. Three such spikes can be observed in February, April, and September on this chart. This calls into question the motives and sustainability of demand in the oil market (and for that matter, most commodity markets). A lot of money is rushing out of these core products creating gaps in the pricing mechanism. Gaps that typically lead to a stimulation of consumption spending when prices loom lower up until now. Despite extremely low gas prices, demand for gasoline has remained stable, and natural gas was just hurt by one of the warmest winters on the eastern seaboard. The truth is, this year's decision-making will be riddled with doubt and bearish speculation as a result of a mindset created seven years ago. Home and construction are on the rise, jobs are being created at an astounding rate (given the current rate of unemployment), and even auto sales have hit records, but commodities and prices have failed reflect that seemingly positive business conditions. There's something like a facade built around the economy, perhaps like one built around Greenspan's economy, but this time, investors and consumers can feel it. While much of the disturbances in the economy and the stock market can be attributed to global financial weakness, I think that we shouldn't discount a recession that mirrors the one about seven years after the Great Depression in 1937-1938. The re-recession was a puzzle to many great economists like Galbraith and Schumpeter. Now, it peeks my interest. While a direct parallel may be unrealistic, there are no doubt connections between the mindset of that time as well as the business conditions that surrounded it. Perhaps we can go back to this period to analyze potential connections between now and then.