Sources: Rates Data and Economic Calendar—Bloomberg Markets as of 11/10/14; Equity Market Returns and Fixed Income and Alternatives Data—Wells Fargo Advisers as of 11/7/14.
The Complex Dynamics of Cheaper Oil
The steep and rapid decline in the price of oil has caught many investors and energy experts alike by surprise. OPEC’s Secretary General El-Badri was quoted by Bloomberg at an October 29th London conference saying, “We see that demand is still growing, that supply is also growing, but the magnitude in the increase in supply does not really reflect this 25 percent change in the market… Unfortunately, everybody is panicking” (full article here). Similarly, The Wall Street Journal wrote on October 28th that even the EIA was caught by surprise: “By July, the EIA was saying that Brent would average $110 a barrel in October. In its latest forecast, released Oct. 7, the EIA settled on a $97 a barrel average for this month” (click here for the article). Oil during the month of October, however, averaged $84.40 a barrel, 13% lower than the EIA’s Oct. 7 forecast. The drop was unexpectedly further fueled on Oct 13th when Saudi Arabia (OPEC’s largest producer) began to tell investors they were comfortable with prices in the $80-$90 range for up to two years.
Since WTI Crude reached its 2014 high of $107.95 a barrel on June 20, it has fallen 28% and is currently trading at $77.41 a barrel. Economic intuition suggests that cheaper oil means it costs consumers less to fill up their gas tank (after the oil is refined into gas of course) allowing them to spend more on discretionary goods. This basic relationship, however, could be changing as the U.S. is moving from being the largest consumer of oil to being the largest producer of oil. Barron’s discusses that point in their October 15 article Watch out for Falling Oil and in doing so references the following excerpt from a Goldman Sachs’ research piece: “Lower oil prices, to be sure, are good for consumer spending, but they are bad for investment and employment,” Goldman writes in a research note. “The U.S. oil and gas industry has added 400,000 jobs since 2003, and a February 2014 report by Mark Mills of the Manhattan Institute claims that an additional 2 million jobs have been added in transportation, construction and manufacturing due to the U.S. oil boom.”(Barron’s Article)
While there is some debate as to the lag between the drop in Oil prices and subsequent increase in consumer spending, cheap gas in time for the holiday shopping season could potentially increase consumer sentiment and allow shoppers to loosen their purse strings to purchase more holiday gifts. For a variety of reasons we have contended that U.S. equity markets will likely outpace their developed international counterparts for the balance of this year. So far, this has proven to be the case.
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