Up, Down & All Around
Hello, Volatility. After having very little of it for nearly two years, stocks and bonds rode a roller coaster this week on trading volumes that exploded to the upside. Investors were forced to come to grips with how much could have really changed in such a short period of time. In our view, not nearly as much as the markets would imply. But whatever your persuasion on the topic, what we witnessed this week is exceptional. Blue chip stock gains for the year evaporated Wednesday on nearly 12 billion shares traded and benchmark 10-year Treasuries surged on decade high volumes, all in a remarkable flight to quality bid driven by concerns about a weaker Europe teetering on the edge of recession, plummeting oil prices, and concerns about Ebola. That markets promptly reversed themselves mid-week and stocks moved back into positive territory for the year is a testament to what we believe are still solid fundamentals for the U.S. economy. Healthy levels of job growth, slowing inflation aided by lower energy prices, and newly diminished interest rates that should help extend gains in housing activity all argue for domestic economic growth of 3 percent or better in the second half of this year.
Unusual markets sometimes elicit misleading interpretations, and no shortages of would-be pundits have attempted to explain a 25 percent free-fall in oil prices since the summer solstice. The Wall Street Journal, as much as we read and respect this quality newspaper, did readers a disservice by proclaiming on Wednesday’s front page banner: Global Oil Glut Sends Prices Plunging. What we observe is that developed market inventories of the black stuff now stand below five-year average levels and, despite the International Energy Agency’s recent minor 200,000 barrel/day reduction in expected global demand for this year, the world is still using more oil than it ever has.
Yes, Chinese demand growth has slowed, the U.S. energy boom has added new production to a global oil market, and OPEC member Libya’s exports have risen by about 500,000 barrels/day recently, but all the hub-bub about swing producers Saudi Arabia, Iran, and Iraq (combined export volumes = 15.5 million barrels/day) cutting official selling prices is nothing more than these countries acceding to recently lower prices on stable sales volume. Although oil demand is unquestionably tied to economic growth, which recent developments have called into question, we still see growing demand for oil tied to what we believe will be record levels of economic output globally. The lack of any smoking gun supply surge and evidence that hedge funds have been exceptionally active in trading oil contracts leads us to conclude that the downside in oil has been more about speculation than physical supply and demand. As seasonal refinery maintenance concludes and crude demand rises into winter, we expect oil prices to climb out of their hole in the low $80’s.
And They’re Off. . .!
Third quarter earnings season has begun and results from the 50 or so companies that have reported to date have been relatively encouraging. Banks like JP Morgan and Citigroup are beginning to benefit from rising loan volumes and higher trading volumes in fixed income, currencies, and commodities, while benchmark industrials like GE and Honeywell are demonstrating the ability to navigate a stronger dollar environment without reporting excessive hits to the bottom line. In part because of the industrials’ foreign currency exposure, investor expectations for earnings in this group were muted into earnings season, so decent results are being met with enthusiasm. Next week the floodgates will open wide, as hundreds of additional companies across industries come to the earnings confessional.
Our Takeaways from the Week
- Modest losses in the stock market belie what was one of the most volatile and actively traded weeks in recent times
- Third quarter earnings season is underway, and results so far are encouraging