Crude Oil?
by Jeffrey Saut, Chief Investment Strategist, Raymond James
November 17, 2014
“The greatest asset, even in this country, is not oil and gas. It's integrity. Everyone is searching for it, asking, ‘Who can I do business with that I can trust?’”
... George Foreman
“Integrity,” Webster’s dictionary defines it as, “The quality of being honest and having strong moral principles.” Recently the voters of America sent the D.C. crowd a message that they want “integrity” back in government. Consequently, I viewed the midterm election as a “turning point.” And, a turning point approaches on December 21st of this year. That’s when the Winter Solstice arrives. While Americans think of it as the shortest day of the year, I have always liked the French version, “It is the longest night of the year.” Indeed, after December 21st the days will progressively get a little longer and the nights a little shorter. For centuries the Winter Solstice has been worshiped as a “turning point” by various civilizations.
It appears that America has arrived at its own “turning point” with the mid-term elections. As previously written, while the Democrats are trying to downplay the results, noting that two-thirds of the voters didn’t vote, I see things differently. Back in the 2006 midterm elections the Democrats took back control of both the House of Representatives and the Senate after a 12-year hiatus. They also captured a number of governorships. The Democrats trumpeted that as a sweeping victory with a huge mandate and gloated accordingly, but here’s the rub. About the same number of voters voted in the 2006 midterms as voted in the recent midterms. I would warn the Republicans to not make the same “gloating” mistake as the Dems did in 2006.
The win, however, was indeed sweeping as prior to those elections there were 143 more Republican State Senators than Democrats, now there are 257. At the State House level it was even more stunning with the GOP having a 689-seat advantage for an increase of 432 seats. The governorship “win” was equally a mandate. For months I have suggested this was going to happen, often writing, “There is going to be a change in the constituency of Congress with the election of smarter policymakers and subsequently smarter policies.” Now it is up to the Democratic Party to encourage the President to move more toward the center of the political equation. Again, as written, “Either the president can move toward the center, like Bill Clinton and Ronald Reagan did, or he can dig in his heels and become even more intransigent. This is what President Grover Cleveland did and it killed the Democratic Party with no Democrat president for the next 16 years. Despite all of the tough talk, right now all we are seeing is the typical Washington Waltz with both sides posturing themselves. I continue to believe there is compromise in the air, but we will have to see how that plays out between now and year-end. If my view prevails, it would be pretty bullish for the equity markets.
Speaking of “pretty bullish,” my friend Brian Belski has done a study of past secular bull markets and determined that equity markets tend to enter a long period of expansion after emerging from an extended period of negative returns (the lost decade of 1964-1982, or 2000-2012). Typically these expansion periods last for 15 years with annualized returns of ~16% per year. Using March 2009 at a starting point implies we have another 10 years left in this secular bull market with a price objective for the S&P 500 (SPX/2039.82) of 4200+ in 2024.
Recently, however, Wall Street’s attention has turned from ISIS, Ebola, elections, etc. to “rude crude’s” spectacular price decline. Said decline has seen the November crude oil futures contract slide from its intraday high of $107.73 on June 20th of this year into last Friday’s intraday low of $73.25 per barrel. Interestingly, Friday’s trading action has the look of an upside reversal in the charts (see chart on page 3). Ladies and gentlemen, that June through November swoon was a prodigious 32% decline in nearly four months. I actually warned of such a decline last summer, noting it would probably find support around the $75 - $80 per barrel level. Many reasons have been offered for oil’s demise. Some say there is too much supply, while others suggest there is too little demand as the world’s economies slow. As I was told three months ago, the U.S. and Saudi Arabia are going to “lean on the price of oil to hurt Putin, ISIS, Iran, and Venezuela. Some pundits are saying that the bear market in crude oil is an ominous precursor to a bear market in stocks, but this is not backed up by the historical facts. In examining the SPX’s performance during bear markets in oil shows the SPX has an average +3.02% (median +5.51%) gain two-thirds of the time according to the good folks at Bespoke. To further illustrate this lack of correlation, Bespoke constructed the nearby charts and wrote:
Bull markets are shaded in green while bear markets are shaded in red. Here it is hard to make any compelling argument that bear markets in crude oil have been bad for the equity market. In fact, during 84% of all the days that crude oil has been in a bear market, the S&P 500 has been in a bull market. A more persuasive case may be that bear market periods in the S&P 500 were preceded by bull markets in crude oil.
It is also worth noting that the current “bear market” in crude oil, at 416 days, is the second longest bear market in the past 30 years, with the longest being the 541 calendar days affair between 6/24/92 and 12/17/93 (another tip of the hat to Bespoke). Accordingly, I think crude oil is in the process of forming a bottom, but the oil complex stocks will likely have issues in tax loss selling season before they bottom. Still, dividend-paying oil stocks should be accumulated between now and the end of the year because they are trading below “known valuations.”
The call for this week: Most of you know that I am in Phoenix seeing institutional accounts and speaking at events for our financial advisors. While one of my favorite boutique hotels in the world is here, namely the Royal Palm, hands down my favorite Southwestern cuisine restaurant in the area is Richardson’s (http://richardsonsnm.com/) where the general manager, Mary Petty, is plying me with wine as I write this missive. It is the best restaurant in Phoenix. This morning Mary is concerned that Japan is slipping into recession, while the U.K.’s Cameron warns of the weakness in the world’s economy. Meanwhile, Baghdad says ISIS’s Caliphate is expanding, all of which has the preopening SPX futures off 5 points at 5 a.m. If the SPX falls below 2020, 1990 to 2000 comes into view.
