The U word and the stock market

This past week, woven in between a bunch of post year-end tax selling to lock up gains, we had a big, short-term drop in the price of crude; the Fed’s latest massage of their message on interest rates and the market’s perception that the European Union (EU) will begin their own version of quantitative easing relatively soon. These headlines helped create a lot of daily volatility, ending Friday with CNBC being sure to remind us that the market was “in the red for 2015”.

While true – the S&P500, after all, is “in the red” by around 0.007%, year-to-date – this combination of volatility and scary news sound bites has made a number of investors pretty nervous.

While I can’t say for absolutely sure the market won’t continue to move lower, I can say that I, personally, am not concerned about any fundamentally created market risks right now. That aside, we’ve had low to no volatility to speak of within the market for some time now so it may simply feel as if it’s “more than usual.” I think that we’ll have a more volatile market, in general, for a while, for the same reason I think we’ve seen things more volatile lately.

It’s based on a “formula” I’ve developed over the years. It’s stated as U = V, where U equals uncertainty and V, of course, equals volatility.

Uncertainty

The market’s current bout with uncertainty is, in my mind, linked to the announcement by the Saudis on Thanksgiving last year that they weren’t interested in supporting the OPEC oil price with their personal production. Not an original thought, granted. I’m stating it to provide you a reference point for the some of the effects of this uncertainty.

The biggest uncertainty in the stock market is that the one known in the oil market, OPEC and its price “adjusting” of the global market for crude since the 1960s, is not a known anymore. As the folks at Goldman Sachs say, “the search for a new equilibrium continues.”

Further, the general message I get from the broad media is that this oil price drop must be a bad thing, though I can’t determine why that’s their message. I must say though that as a consumer, having just paid $1.72 a gallon for gasoline, I’m not too upset about that trend to lower prices. (And, for additional perspective as to what’s lower, economist Dr. Scott Grannis notes that while oil was really expensive six months ago, today, its inflation-adjusted price is simply equal to its average price since 1970!) Further, with the American Automobile Association (AAA) saying the national average for US gasoline last week was about $2.19 a gallon, more than a dollar cheaper than a year ago, other consumers are probably liking it. Here’s a direct example of that.

In a meeting last week to talk about his company’s very strong same-store sales results, the CEO of Sonic Drive-Ins, Clifford Hudson, said that a big contributor to the company’s performance during the last six months has been the price of fuel. His and other restaurant stocks traded at highs last week as other investors can directly relate to the extra cash that lower gasoline prices is providing.

In another broad economy benefit, the Energy Information Agency (EIA) last week said that, due to the abundance of shale-produced natural gas, the price of that gas, adjusted for inflation, is now 81% below its 2005 high price and just about the same as what we paid in the late 1990s. Utilities, government agencies, cities, petrochemical producers all – in addition to benefiting personally at the consumer level – are being provided with lower operating costs.

Volatility

My friend, really, Terry Sandven who is now holding forth as the chief equity strategist for US Bank Wealth Management, put it nicely by saying, “lower gasoline costs are a boost for consumers, bolstering discretionary spending and income levels.”

On the negative side – the one causing the uncertainty – he offers this. “It’s a headwind for companies within and around the energy patch, elevating concerns about lower earnings estimates, which translates into valuation concerns.” I speak some economist so what I think he means is that low oil prices might mean that many energy-related companies might not make as much money as the analysts said/thought they would. Therefore, the price of the shares may not represent what those companies are “really worth now.”

Traders see phrases like that and, being uncertain about improving earnings/prices, sell until they feel more certain about that data. Add to that the short-term orientation traders, together with the type of headlines last week and – tah dah – volatility.

Perspective

Regarding that negativity, Liz Ann Sonders, the should-be world-famous chief market strategist at C. Schwab, offered this explanation that seems to me to do an outstanding job of explaining the wide effect of this oil price change And I quote…with the exception of italics, which I added for emphasis.

Close to 70 percent of the US economy (GDP) is consumer spending, which will gain nicely from cheaper crude. Only about 10 percent is capital spending, of which 10 percent to 15 percent is the energy sector. That comes to roughly 1 percent of US GDP output, which might decline this year, making it a relative drop in the economic bucket.”

She adds, “The well-publicized challenges for energy producers are small compared with the gains by American consumers and businesses that are paying less for gasoline, diesel, jet fuel, petrochemicals and the like.”

Summary

I’m certain that uncertainty will always be part of the market experience. That is, they say, why stocks have provided good returns over the long-term. You have to earn something for the uncertainty of your return. In most cases, the more certain your return, the less likely will be any additional return from growth.

Further, regarding the oil situation. Until the price finds its own level, it’ll be pretty hard to make firm choices as to when to invest in the sector. Dollar-cost averaging is a great way to step in during fluctuating markets.

Beyond that, the certainty of the wide-ranging benefits to many sectors, industries and consumers should continue to be a good thing for the economy and, ultimately, the earnings of most of these beneficiaries.

Cheers!

Mike

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