Oil, oil, retail, and oil

December 14, 2014

The market seemed to wake up Monday morning on the wrong side of the bed.  The Federal Reserve updated their Labor Market Conditions Index, scoring the month of November with a tepid 2.9, a sobering counter punch to the previous Friday’s report of 321,000 job gains in November.  Too many part time workers, too many long term unemployed, a rate of unemployment that was too high among minorities, those in their twenties and those without a college education.

ISM’s monthly reports showed continued strength in both manufacturing and the services sector. The composite CWPI eased just a bit from the historic highs of the past two months.

The key components of the manufacturing index, new orders and employment, remained strong or robust.  The prices component showed a steep dive from expansion to contraction, 53.5 to 44.5.  George wondered if the falling price of oil had anything to do with this change.  New orders in the services sector grew even stronger while employment eased just a bit and was also continuing a strong expansion.

On his way to Home Depot on Tuesday morning, George filled up his SUV for just under $50.  When had that happened last he wondered.  2009, maybe?  George remembered the lead up to the 2012 elections. “Gas was $1.50 when Obama came into office,” he would hear on a conservative talk show, “and now it’s more than double that. Obama is hurting working families.”  As though Obama, or any President for that matter, had much to do with the price of gas.  Most talk show hosts counted on the fact that their audience was, well not stupid, as Jonathan Gruber had quipped when talking about Obamacare at a conference, but poorly informed.

The market had opened up that morning in a particularly foul mood after China tightened lending criteria so that Chinese investors could no longer use low-grade corporate debt as collateral for loans.  Overnight the Shanghai market lost more than 5% (WSJ ).

The EIA projected that U.S. oil production would rise in 2015 even as oil prices went lower.  Lower prices might curb new drilling but once the wells were drilled, the cost of production was fairly low.  The drop in gas prices put some extra money in most people’s pockets.  The EIA estimated that a gallon of gas would average about $2.60 in 2015, almost a $1 lower than the $3.51 average in 2013.

The continuing fall in oil prices contributed to another drop in the market on Wednesday, erasing the gains of the past month.  To sell or not to sell, that is the question, George thought as the volatility in the market continued to climb, rising more than 50% in the past week.  But he hemmed and hawed, then decided to replace the fence post in the back yard as the antidote to his indecision.

In an economy dominated by consumer spending, the monthly retail sales report and the employment report are probably the two most influential gauges of the strength of the economy.  Thursday’s report on retail sales was a huge positive, showing a rise of .7%.  On an annualized basis, that was an increase of more than 8%.  People were evidently spending the money they were saving at the pump.  The market opened higher and climbed up above Wednesday’s opening price.  Great stuff, George thought, then watched as the positive mood vanished and the market started sinking.  He must have made some sound because Mabel called out asking him if he was OK.  George realized that the early morning run up in prices was traders covering their short bets.  The underlying sentiment was still negative.  A strong employment report last Friday and now a strong retail sales report was having little effect on the mood of the market.  George decided to get out of the way of the darkening mood and sold the equity index he’d bought in mid-October.

The market continued to follow oil prices down on Friday.  George was pleased to find that the long term Treasuries that he had bought last week were up a few percent.  Glancing back at the beginning of the year, he saw that long term Treasuries (TLT) were up an unbelievable 20% so far this year.  Back in January many had projected higher interest rates toward the end of 2014, making long term Treasuries less attractive.  The equity market was up 10% for the year despite the recent change in mood.  Two types of investment that often moved opposite each other had moved in the same direction.  George smiled as he remembered something his  childhood baseball coach would say, “If it ain’t one thing, it’s the other, and sometimes it’s both.”  Which was just another way of saying not to put all your eggs in one basket.

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