Oil is the red herring of this market

Discussion in 'Trading' started by detective, Jul 3, 2008.

  1. The problems for this stock market are much deeper and more worrisome than a big rise in crude oil prices.

    When investors make investment decisions, the amount of money they pay for gas or food doesn't matter. It matters to poor people, where the cost of gas is a higher proportion of their income. Most investment money comes from the rich and upper middle class, people with substantial discretionary income, enough to excercise vagaries like buying stocks and Bentleys. Oil could be at $300 a barrel and that would still not even put a slight crimp on this lifestyle.

    Sure there is a trickle down effect of less discretionary spending due to higher sums spent on gas but the effects are vastly exaggerated for investment purposes.

    What matters are assets like real estate, stocks, and bonds. Everyone knows housing is horrible. Bonds excluding Treasuries are horrible. Stocks are horrible. And the economy is not even in a recession officially. That is a huge warning sign.

    The problems haven't changed. Crude oil doesn't matter. It's still about housing and credit markets. You've just added a Fed that is now stuck in a box because its running out of fresh bullets. There is no more TAF or TSLF or emergency rate cuts to come to the rescue to squeeze the shorts. The market is pricing that in. That wasn't the case in January or March.

    Any dip in crude oil that causes the stock market to rally should be used as selling opportunities.
     
  2. Even treasuries are horrible, have you checked the yields? Into a secular inflation environment, you don't want treasuries at 4.5% yield. TIPS are the only acceptable bond to own.

    I agree oil is not the main issue. The main issue is as always in a bear market - the prior bubble sectors. Real estate is widespread and uses massive leverage, that's why it's such a problem for the mainstream economy when it goes pop. Whereas tech stocks don't use much leverage, so they had far less effect on Main Street when they cratered. Real estate crash = banking crash = credit contraction = serious recession for all industries and sectors reliant on bank financing.

    IMO the theme for this year has been and continues to be - leveraged financial & real estate assets get creamed; hard assets and anything related do very well.

    The S&P may have to be taken down to a modest multiple of recession earnings. Recession earnings would be about $75-80 for the S&P. Place a modest multiple of 12-13 and you get a price of about 1000. Financials and real estate probably have to go to secular bust valuations. Selling for fractions of book value, revenues etc (the E won't exist reliably, if at all, so P/Es won't be useful). Think valuations of Brazilian stocks in late 2002, or dot.coms in 2001-02 where many sold below cash. Think Asian or Russian stocks in autumn 1998, where established blue chips sold for 10% of revenues at the lows.
     
  3. This is a worse stock market environment than the market in 2001-2002. Back then, their was still a buoyant real estate market helping investors withstand the storm of a bear market in stocks. Now its a double whammy from both real estate and stocks.

    The one positive factor that this market has is that the dollar is so weak, which is helping the multinationals/exporters. Also when you price a financial asset in cheaper and cheaper units (dollars), there is a natural rising in the nominal value of the asset even while the real value is falling, a.l.a. Zimbabwe stock market, which is the best performing stock market in the world by a moonshot.

    The combination of fiscal/monetary easiness will lead to huge repercussions down the road with high inflation but will prevent housing and the stock market from totally falling apart like they should to wipe the slate clean.
     
  4. Markets remain excellent, particularly liquid futures markets for daytrading. Its volatility (aka movement) that matters. Trade those moves. CL offers huge points all day every session. And successful daytrading makes big bucks.

    If you want to be a trader, trade. Trade where you can keep on making money. Thats movement. So trade movement.

    Doom and gloom is not a helpful emotion. And what is it you are going to put right in the world today from your basement sitting in your underpants watching the trading screen? Thats right. Absolutely nothing. The answer: do your homework (damn near 24/7 if necessary), focus, concentrate, get savvy and make shitloads of money instead - daily.
     
  5. Good thought detective. I agree.

    "You've just added a Fed that is now stuck in a box because its running out of fresh bullets"

    Basically the fed blew their wad on post 911 recovery with cheap money. Problem going forward is who and where is the money going to come from to push this market back up in the near term. None where I can see.

    I do agree though that the oil issue is the red herring.
     
  6. d,

    I agree oil may not be the only problem, but given how much consumer prices on everything from tires, to linoleum, to chemical (including household chemicals, heating oil, paint, cosmetics, distillates, asphalt, carpeting, medications, plastic, clothing, transportation of goods (groceries), etc. etc. etc. is tied directly to the price of oil, oil is a trigger for widespread inflation.

    Oil is in almost everything, or things are dependent on oil to get to the shelf, or both.

    So when oil rises, the prices of hundreds if not thousands of other good rise, directly or indirectly.

    And then you have the direct from the pump to the eyes to the brain effect of gasoline prices, as people fill their gas tanks, and it just saps more willingness to spend on other things out of their souls.

    Did you know there are roads that states and cities are not repaving, under any condition, that are in horrendous shape, because asphalt has risen in price 300% in four years? They can't afford it.

    Oil is a big, big problem.
     
  7. Oil is in almost everything, or things are dependent on oil to get to the shelf, or both.
    -----------------

    Agree. But I think oil will lead the news rather than credit (ie subprime), hence any market up move with a lower "oil" headline will be a false positive.
     
  8. Not to say the S&P won't hit 1000 for emotional reasons, but from a fundamental point of view, most of the time the market will not stamp a typical multiple on a one or two year cyclical result, but will look to a "core" or normalized earnings #.

    For example XOM is only trading at a forward 9 multiple and COP and CVX at even less. Multiples have been contracting here as the market views these as "top of cycle" earnings. The opposite will happen with the S&P's recessionary EPS. A 12 multiple on recessionary numbers would be the equivalent of maybe 9 or 10x the S&P's non crisis/non recessionary earnings power, and would be very cheap.

    Given the wide ranges of multiples the S&P has traded at in the past, this doesn't make the way any clearer, but is more a point about methodology and the danger of stamping a multiple on any one year's cyclical earnings. When dealing with individual stocks, particularly cyclical ones, this kind of analysis is suicide.

    Also worth noting is that the changes in the indexes themselves as they morph along with sector developments. Financials are having less and less of an impact on the S&P and Dow while the impact of energy companies (both in terms of earnings and market cap) is growing everyday. Right now for example Exxon has risen to a 4.23% weighting in the S&P.

    If you look at the top 20 components of the S&P 500 (comprising about 31% of the whole S&P), XOM, CVX, COP, SLB carry a combined 8.47% weighting in the S&P. JPM is the only financial left in the top 20 with only a 1.11% weight.
    Similarly, CVX and XOM now make up about 13.5% of the Dow versus only 7.2% for (C,AIG,BAC,JPM) combined.

    This is the magic dampening effect of diversification in action.
     
  9. High oil is only a problem for the stock market if it causes the Fed to raise rates due to high inflation slowing down the economy. High inflation with low Fed rates is a boon for stocks. Higher inflation with low interest rates lead to higher earnings, all else being equal. Deflation is the killer of stock markets, not inflation. But the Fed in the post-Volcker era doesn't really care about controlling inflation, they are almost exclusively concerned about avoiding recession and financial crises. Only in word do they say they care about price stability, their actions don't show it. Actions speak much louder than words. It is almost the opposite of the Euro central bank, their focus is inflation and have backed up their words with some action.

    Now what is good for the stock market is not necessarily good for the poor. They don't have much money if any in stocks, and spend a larger portion of their money on gas and consumer staples than the rich. So they are the ones getting hammered under the high oil scenario. The spending by the poor was not the driver for the bull market from 2003 to 2007. It was easy credit and a booming real estate market. This led to a spillover effect into stocks. Those are gone, and that's why the markets are going down.


     
  10. Sorry, but I absolutely can't agree with you.

    High inflation absolutely destroys the value of equities. Deflation does, too, but for different reasons. Inflation is far more hazardous.

    High inflation is a shock EVEN when productivity and real wages are rising (productivity has slowed very recently, and real wages have been stagnant for a long, long time).

    Price stability is the key to the health of equity markets.

    Just look at what's happening to all shares outside of the energy sector recently. Most have gotten crushed.

    Only so many companies can pass on the costs of inflationary inputs to end users. Steel makers were able to, but can't anymore (Mittal just had a $250 per ton surcharge shoved back in their face). Airlines, transports, restaurants are all trying to find substitutes, and airlines have cut back on routes and planes flown.

    Retailers have to heavily discount merchandise. Boat, RV and most importantly, auto and truck sales have absolutely cratered.

    Even refiners can't raise their prices of gasoline to match the increase in their crude stock input, because consumer demand destruction has been so high with the increased prices already.

    Inflation is the biggest cancer of the equity markets. I can't think of another metric more damaging to shareholder value than high inflation.
     
    #10     Jul 5, 2008