Jeffrey Saut: Random Thoughts on a Cruise to Nowhere

Random Thoughts on a Cruise to Nowhere

by Jeffrey Saut, Chief Investment Strategist, Raymond James

We have lost our way as a people and a country when we ignore and/or fail to see the significance of history. King Abdullah and his father King Abdul Aziz al Saud were titans of the modern day middle east that so affected us all. I read about his death in the B section of the local paper after a story about our local nursing home under new management. God, Allah, Adonai ... please help us all.

I received the aforementioned quote early Friday morning as I was contemplating the death of Saudi King Abdullah and the potential collateral damage it could cause from a change in Saudi leadership. Our emailer was exactly right, “King Abdullah and his father King Abdul Aziz al Saud were titans of the modern day middle east that so affected us all.” They were “moderates” in an area of the world that is awash with anything but “moderates.” Speaking to Saudi Arabia, and its ability to influence the price of oil, in past missives I have written about the real reason the Saudis have “leaned” on the price of crude oil. It began last summer when Saudi Prince Bandar bin Sultan, Director General of the Saudi Intelligence Agency, went to Russia and asked Vladimir Putin to stop funding Iran and Syria’s Bashar Hafez al-Assad, and he was snubbed. In retaliation, the Saudis decided to use the only real weapon they have – crude oil – to punish Russia, ISIS, Iran, and Venezula by crushing the price of oil. The second derivative benefit would be to damage the U.S. fracking industry. With the King’s death, one wonders what the new leadership will do with the price of oil as Yeman decends into chaos?

Speaking to crude oil, and the price decline’s impact on energy companies’ earnings, over the past few weeks Standard & Poor’s has lopped roughly $11 worth of earnings from this year’s S&P 500 (SPX/2051.82) earnings estimate. Verily, two weeks ago the bottom up, operating earnings estimate was ~$134. As of last week it was $122.74. When quiered about that, someone at S&P had this to say (as paraphrased):

The S&P 500’s 2015 operating estimates have declined 11.27% from the end of June, and are off 5.36% excluding Energy. Energy estimates have declined 53.04% for 2015 from June 2014. Energy was expected to contribute 12.40% of the S&P 500 earnings in 2015 (back in June 2014), and is now estimated to contribute 6.56%. Energy earnings are now expected to post a 39.07% decline in 2015 over 2014, with 2014 already being reduced for Q4:14. In June 2014 the estimate was for a 21.29% gain over 2014. Note that energy estimates need to incorporate oil’s price movement over 2015, so analysts are making estimates on the volatile price of oil. It appears, from the conversations and observations (not quantifiable data) with in house economists and strategists, those analysts may be using the various economists’/strategists’ projections to make their estimates (which seems logical). But note, the oil estimates do not seem to be uniform (shocker). So my question is, if the U.S. economy is still on solid ground (with rising GDP), are the non-energy estimates overblown and reactionary, without adding in any of the potential benefits from consumer spending or industrial savings brought about by lower gasoline prices?

Such thoughts prompted a string of email exchanges among some of Wall Street’s best and brightest like this:

We don't have a good figure for break-even fracking prices. I've talked to oil folks in the Bakken who say there are wells that are in the $30 range. Given the range of breakevens, we're not talking about a total stop to fracking; rather, a decline in the second derivative – the rate of increase. Wells in production will remain so, requiring ongoing employment in oil field services and associated jobs. The drop in oil prices should boost spending in other sectors of the economy, leading to increased hiring in those sectors. Autos, for example, if cheaper gasoline encourages more car sales, or more driving that leads to service station hiring. The stronger dollar that is helping pressure oil prices will cost export jobs, but likely lead to jobs in import industries. Declining jet fuel prices may lead to lower airfares, ultimately increasing tourism employment. The total number of jobs created by fracking and associated hiring is small in the context of overall employment, so the possibility for offsets is high. All of this, and more, would need to be plugged into a model to get a good picture of the impact of prices. I haven't seen such a model yet.

Of course that quip brought this response from another one of Wall Street’s brightest:

That’s great, but if I can get back to the original point, the question is whether the oil decline, like the housing bust, arrests the broader economic recovery. There was a chart at the time, call it 2006, put together by Goldman Sachs that showed U.S. economic growth if one removed the broader effects of mortgage equity withdrawal. The chart showed that the U.S. was (more or less) in recession during the entire 2000-2005 period. I imagine when one says “all of the job growth since X period is because of oil,” they want to make a similar point; the underlying economy is in recession except that recession is masked by gains in one particular sector. That’s the reason the Manhattan study cited by Peter is so prominent; it reinforces this narrative. I’m just one guy, but my analysis doesn’t bear this out. I think a much more convincing argument is that the recovery is predicated on low interest rates and if/when they get around to moving higher, the economy simply won’t be able to withstand rates above say 3%. This is the whole idea behind the lower terminal funds rate debate and, to some degree, secular stagnation as well.

Clearly an interesting discussion, but it is not just what is happening in this country that has been interesting over the past few weeks. First, it was the Swiss National Bank (SNB) abandoning the cap on its currency. At the time I wrote that move was a sign the Swiss were anticipating that Mario Draghi was going to announce quantitative easing (QE). Bingo, roughly a week later Draghi did just that. Second, while those were the two headliners, almost unreported were interest rate reductions by the Reserve Bank of India, the Danish Central Bank, and the Bank of Canada. Third, while they didn’t cut rates the Bank of Japan, the Bank of England, and the People’s Bank of China have all also done some interesting things over the last two weeks. Of course such central bank shenanigans caused the world’s currencies to fluctuate wildly with concurrent swings in various world equity markets. Last Thursday our markets danced higher on Draghi’s QE revelation, leaving the D-J Industrial (INDU/17672.60) better by 259 points, while the SPX spurted 31 points. On Friday, however, investors worried about such shenanigans, leaving the SPX lower by 11 points. Obviously these types of gyrations make it difficult to navigate our markets. For example, I have rarely seen the indicators I use so aligned for a move to the downside as they were going into last Thursday’s trading day. And then BANG, the Draghi QE liquidity announcement caused stocks to soar. Over the weekend I spent hours poring over my indicators and came away with the same results I saw late last week, they are confused. I guess the SPX is confused as well since it has basically been locked between its support level of 1990 – 2000 and its overhead resistance zone of 2060 – 2080 since late October 2014. I have learned the hard way when confused it is best not to do much in the stock market.

The call for this week: Well, I am pulling back into the dock as I listen to the news that Greece leans to the left with the potential for an exit from the EU. That should have the preopening futures lower in the morning. I would note there is a full charge of internal energy built up in the equity markets, but they remain in limbo. A breakdown below 1990 would be pretty bearish, while an upside breakout above the 2060 – 2080 level would be bullish. Until one of the levels is breached ... to everything churn, churn, churn. There is a reason churn, churn, churn. A time to win, a time to lose, a time to stand around and be confused.