The underlying fundamentals of oil and energy remain highly negative. Oil prices have been supported by sentiment for some time now, but that hasn’t changed much from between under $30 to over $40 at the front end. In the latest weekly update from the US EIA, domestic oil production fell rather sharply in the last week of April. It was the largest weekly decline since last August.
Despite the production cutbacks that started around late January, not coincidentally during the worst of the last liquidation wave, domestic inventory of crude oil continues to rise and substantially at that. Inventory in the latest week set yet another new record with non-SPR stocks up 90 million barrels since last September. In other words, purported consumer strength and lower prices have done nothing to visibly stir demand.
This economic warning has moved beyond solely oil in the US, however, as gasoline inventories remain very high for seasonal circumstances. Inventories in the latest week were reported to be 241.8 million barrels equivalent, up 6% from the same week in 2015 and 13.5% from the same week in 2014.
The macro implications of these inventory figures have bled into other areas where oil was believed to be a more positive factor. It was conventional wisdom last year that lower oil prices would be a huge boost to general economic demand for both industry (lower input costs) and consumers (tax cut-like effect). This line was repeated over and over as an assurance that the oil disturbance would be limited to just that. As late as last December, Janet Yellen was still claiming that oil prices were a big benefit:
Job growth has bolstered household income, and lower energy prices have left consumers with more to spend on other goods and services.
These have, of course, simply become mainstream talking points devoid of actual meaning. In February last year, she said the same thing:
Consumer spending has been lifted by the improvement in the labor market as well as by the increase in household purchasing power resulting from the sharp drop in oil prices.
Whether or not she truly believes these words is another matter. What is clear is that she thinks everyone else does, or worse that they will do so because she is the one speaking them. As the economy has clearly slowed and slowed some more, this has been the familiar shriek of economists going down with the ship; “but the unemployment rate and oil tax cut!”
There is evidence that at one point Yellen was taken at her word on these specific matters. In the stock market, despite the oil crash (or because of it if we believe that stock investors once believed) retailer stocks rose sharply all through the first wave in early 2015. They remained high, as viewed by the retailer ETF XRT, until last July. Having declined during the August liquidations, however, the ETF never recovered afterward even though the broader market eventually erased almost all the August drop. Retailers were sunk yet again in January and to a much lower bottom, but the EFT and the retail sector remains still depressed even though oil prices are much lower now than last year (even factoring the rebound since February 11) while the Establishment Survey continues to rack up huge gains. By Yellen’s version, retailers should be swimming in so much good fortune.
The DJ Transportation Index is just as simple in its likewise shifting position. Oil prices are undoubtedly a great help to shippers’ and freight runners’ bottom lines, but lower energy costs won’t make much difference if their top lines are under heavier pressure. In fact, it is undoubtedly a good part of the reason oil inventories have remained so high with freight activity falling off sharply with fewer goods moving around in this “manufacturing recession.” As Warren Buffet admitted during Berkshire Hathaway’s last shareholder meeting, the railroad industry (Berkshire owns Burlington Northern) is suffering and “will almost certainly” continue to be down the rest of this year.
In short, stock prices may reflect continued concern about demand but not just in immediate terms as that has been the case for some time. As I showed yesterday, the decline in US demand has gone hand in hand with the oil crash (really “dollar” run). What seems to be different between the first quote from Janet Yellen in February 2015 and her rerunning the same exact formulation in December is how the world perceives this drop in demand. There seems to be growing apprehension, rightly, that Yellen’s talking points were never correct, which is a much larger re-evaluation than simply rejecting “transitory.”
In my view, the same reluctance is relatedly found in financial stocks. “Something” changed in the middle of last year which has altered investor views about the risks and conditions of 2016 as compared to what was thought for this year early last year. Again, sentiment clearly shifted on February 11 in very broad fashion, but there is a very visible and applicable reluctance to fully embrace it in these key sectors.
It seems as much a nod to reality as anything else, since no matter how many times we hear about job growth and lower energy prices they never produce the awaited economic rebound – “demand” only drops further. As demand sinks, so too do financial prospects relaying further concerns about the economy.
For now, at least, some parts of the stock market may have finally become more interested in, and attuned to, physical conditions and fundamental prospects than FOMC blathering banalities. That is a problem separate from monetary policy, but in terms of policy projections we have to ask whether it might preclude another QE in the US? Have US investors tuned out enough of blind faith in monetary “stimulus” and FOMC assurances like European investors? It is, for now, just an interesting discussion but one certainly to keep in mind as the US and global economy continues to justify these comprehensive doubts.