The markets did their best Ebenezer Scrooge impression today, voicing a loud “Bah, humbug” to the holiday time of the year and dropping more than 1.5% mostly because of falling oil prices. I’ve gotten emails from some of you wondering about what’s going on, so I wanted to send you this special update to give you my take and what it means for us.
Declining oil prices are shaping up to be the story of 2014. They fell another 3.8% today to a five-year low of $61.37 a barrel and are now down 40% from the highs of the year at the end of June. The slide has accelerated in recent weeks with prices falling more than 20% in just the last month.
It all comes back to supply and demand, and at the moment, supply is winning. There are multiple reasons for this, starting with increased production in many nations, especially the U.S. New technologies to discover and retrieve oil have led to a production boom in places like North Dakota, Pennsylvania, Texas and elsewhere. Overall, the U.S. now produces nine million barrels a day, about twice as much as a decade ago. Canada and Russia have also boosted output.
At the same, demand is less than robust. Part of that is economic. Places like Europe and Japan are still weak, resulting in less growth and therefore less demand for oil, and China has leveled off as well. Advancements in vehicle technology have also led to more fuel efficient cars averaging five more miles per gallon today than they did six years ago. That also lowers demand.
Oil prices fell sharply today mostly because OPEC (Organization of the Petroleum Exporting Countries) lowered its forecast for oil demand in 2015 to the lowest level in 12 years. As you may remember, OPEC members agreed to not cut production the day after Thanksgiving, hoping that cheaper oil will cause companies in the U.S. to cut back on exploration and production simply because it is less profitable at these prices.
The steep drop in oil amid weaker demand is unsettling investors. On the one hand, cheaper oil, gas, fuel and electricity puts an awful lot of money back in the pockets of consumers and businesses. In that sense, it becomes its own version of an economic stimulus, which may ironically jumpstart the growth that leads to higher oil prices in the coming years. Long-term forecasts are for demand in China, Europe and Japan to increase again, and expectations are that overall demand will grow for the next 25 years as emerging markets continue to develop.
On the other hand, there are negatives. Lower demand can be a sign of a weaker global economy, and economic data from Japan and China over the weekend was in fact weak. Both of their markets fell back in recent days after a considerable rally. There are also fears in the high-yield bond market, 15% to 18% of which is estimated to be energy related, and as I’m sure you know, energy stocks have gotten hit hard. Many companies borrowed heavily to participate in the U.S. oil boom, and lower oil prices means lower profits, making it more difficult to service this debt.
And don’t forget about interest rates. We have the final Federal Reserve meeting of the year next week, and with rates likely headed higher in 2015, there is growing concern that the rising rates will further strengthen in the dollar and pressure emerging markets.
Considering all of that, the market is actually hanging in there pretty well. The S&P 500 is still up almost 10% this year, and slightly more than that since the October lows. The question now is whether the market will start to shift into a quieter holiday mode, which can be a good mode as well, or if money managers chasing year-end performance – by buying up stocks that have performed well – get more cautious. It would be very unusual to start a correction during December, and if there is anything positive about the decline, it is that the Federal Reserve may be extra cautious when discussing the potential to raise rates next year. So I would not be surprised to see the market “saved by the bell,” as the Fed strikes a conciliatory tone to send us into the usually quieter last couple of weeks of the year.
I will continue to watch the market, the headlines and especially our stocks very closely. As always, I will let you know right away if we need to make any moves, but we’ve kept one eye open for the possibility of more volatility for some time now. Nothing so far has changed my thinking, and will continue to look for ways to exploit the higher volatility and price movements with our options trades.
Special Market Update
The markets did their best Ebenezer Scrooge impression today, voicing a loud “Bah, humbug” to the holiday time of the year and dropping more than 1.5% mostly because of falling oil prices. I’ve gotten emails from some of you wondering about what’s going on, so I wanted to send you this special update to give you my take and what it means for us.
Declining oil prices are shaping up to be the story of 2014. They fell another 3.8% today to a five-year low of $61.37 a barrel and are now down 40% from the highs of the year at the end of June. The slide has accelerated in recent weeks with prices falling more than 20% in just the last month.
It all comes back to supply and demand, and at the moment, supply is winning. There are multiple reasons for this, starting with increased production in many nations, especially the U.S. New technologies to discover and retrieve oil have led to a production boom in places like North Dakota, Pennsylvania, Texas and elsewhere. Overall, the U.S. now produces nine million barrels a day, about twice as much as a decade ago. Canada and Russia have also boosted output.
At the same, demand is less than robust. Part of that is economic. Places like Europe and Japan are still weak, resulting in less growth and therefore less demand for oil, and China has leveled off as well. Advancements in vehicle technology have also led to more fuel efficient cars averaging five more miles per gallon today than they did six years ago. That also lowers demand.
Oil prices fell sharply today mostly because OPEC (Organization of the Petroleum Exporting Countries) lowered its forecast for oil demand in 2015 to the lowest level in 12 years. As you may remember, OPEC members agreed to not cut production the day after Thanksgiving, hoping that cheaper oil will cause companies in the U.S. to cut back on exploration and production simply because it is less profitable at these prices.
The steep drop in oil amid weaker demand is unsettling investors. On the one hand, cheaper oil, gas, fuel and electricity puts an awful lot of money back in the pockets of consumers and businesses. In that sense, it becomes its own version of an economic stimulus, which may ironically jumpstart the growth that leads to higher oil prices in the coming years. Long-term forecasts are for demand in China, Europe and Japan to increase again, and expectations are that overall demand will grow for the next 25 years as emerging markets continue to develop.
On the other hand, there are negatives. Lower demand can be a sign of a weaker global economy, and economic data from Japan and China over the weekend was in fact weak. Both of their markets fell back in recent days after a considerable rally. There are also fears in the high-yield bond market, 15% to 18% of which is estimated to be energy related, and as I’m sure you know, energy stocks have gotten hit hard. Many companies borrowed heavily to participate in the U.S. oil boom, and lower oil prices means lower profits, making it more difficult to service this debt.
And don’t forget about interest rates. We have the final Federal Reserve meeting of the year next week, and with rates likely headed higher in 2015, there is growing concern that the rising rates will further strengthen in the dollar and pressure emerging markets.
Considering all of that, the market is actually hanging in there pretty well. The S&P 500 is still up almost 10% this year, and slightly more than that since the October lows. The question now is whether the market will start to shift into a quieter holiday mode, which can be a good mode as well, or if money managers chasing year-end performance – by buying up stocks that have performed well – get more cautious. It would be very unusual to start a correction during December, and if there is anything positive about the decline, it is that the Federal Reserve may be extra cautious when discussing the potential to raise rates next year. So I would not be surprised to see the market “saved by the bell,” as the Fed strikes a conciliatory tone to send us into the usually quieter last couple of weeks of the year.
I will continue to watch the market, the headlines and especially our stocks very closely. As always, I will let you know right away if we need to make any moves, but we’ve kept one eye open for the possibility of more volatility for some time now. Nothing so far has changed my thinking, and will continue to look for ways to exploit the higher volatility and price movements with our options trades.