Forget about oil and water not mixing, these days for investors oil and stocks don’t mix. The near direct correlation between equity markets and the price of oil has far too many confused, perplexed or just pulling an ostrich and sticking their heads in the dirt. Let’s help explain and simplify this new phenomenon.Lower energy prices are a boom for consumers plain and simple.

For most businesses these same lower energy costs are a savings dropping right down to the bottom line as well. Hugely positive.Now the elephant in the ointment. All oil and gas producing companies and countries are getting absolutely pole axed by the collapse in energy. Exploration and production companies can cut capital expenditures and head count to help ease the pain.

Many of these companies during the explosion of US production due to hydraulic fracking and improved technology took on massive debt loads to purchase attractive drilling properties. With oil at $100 a barrel, no problem.At $30 a barrel, ouch. We’re not done. 

Major energy exporting countries  such as Saudi Arabia, Russia etc., already owned the land so that’s not the issue. Oil revenues were the primary sources of these countries funding for their annual outlays and budgets. They are running into similar problems. Many of these exporting nations budgets were set based upon oil pricing $100 a barrel, no problem as long as oil is around that $100 level.With oil at $30, ouch. These same exporting countries ran sizable surpluses over the years and utilized these $100’s of billions of profits to invest in foreign assets through their sovereign wealth funds.

Again, now with oil around $30 those surpluses become deficits.In order to plug government deficits those natural buyers of assets have become net sellers. We’re talking about again 100’s of billions of dollars of assets (stocks, bonds, real estate, hedge fund shares, private equity funds) up for sale putting continuous pressure on near all asset classes. This is a major issue that will continue until oil finds a bottom and or there is a response from Federal Reserve Chairwoman Yellen. If recent history serves us we certainly should not expect our elected officials to think of the country first and build consensus for a policy response instead of worrying more about caucuses and elections. No, speeches about  building walls to keep people out or stealing the money of successful savers and/or business-persons through higher taxes is much more effective economic policy response or at least what we can anticipate.

Where we’re at:

Gross Domestic Product-GDP.4^th quarter GDP came in at an anemic +.7% as of the first reading which is subject to two more revisions over the coming weeks. A very large drag on the top line figure was inventory draw downs. Conversely the second and third quarter figures sported reasonable +3.9% and 2% rates of expansion driven by consumption helped by lower energy prices and employment gains. While the fourth quarter figure is weak by any measure, the inventory draw down leaves open the prospects for better news in the coming quarters as firms look to restock inventories. There are two items that bear watching closely. First the newly agreed to budget was a sequester buster. So, government spending should no longer be a drag on growth and actually may add +.5%-+.75% to growth this year. Second, any stumble in converting the energy savings into stronger and continued consumer consumption could be the canary in the coal mine and bring to fruition the talks of a looming recession.We’re not even close to there yet. But, we’re on watch.

Institute for Supply Management Manufacturing Index-ISMMI. ISMMI registered in at 48.2% that was +.2% from December. While still reflecting a contracting manufacturing sector there were bright spots. New Orders and Production both gained +2.7% and +.3% respectively. No shocker, due to the free falling commodities prices the Employment component dropped -2.1% and the Prices Index  stayed flat at 33.5%. Surprisingly survey respondents remained fairly upbeat. We’ll see if that optimism plays out and translates into a resumption to manufacturing expansion. 

Institute For Supply Management Non-Manufacturing-ISMNM. ISMNM came in at +53.5% comfortably above the 50 level of expansion. New Orders and Employment were softer at +56.5 and +52.1% again a nice cushion above 50. Here again respondents remained relatively positive about current and future business activity. One soft spot was in pricing due to low energy pricing and stronger dollar squeezing margins.

Housing. Housing continues to benefit from ultra-low borrowing costs and higher employment levels. Existing home sales surged +14.7% to an annualized 5.46 million rate in 2015 the highest since 2006. Consumers willing to make such large scale purchases flies in the face of so called recession fears. 

Autos. Another strong sector for the US.January domestic auto sales reached an annualized run rate of 17.58 million from Decembers reading of 17.34 million.Very positive for both of these important economic pillars and drivers of good paying jobs. The question remains are these levels sustainable and is the consumer’s confidence in making these big ticket purchases-warranted or are they too myopic to realize the light at the end of the tunnel is the recession train steaming down the tracks head on. We see no reason why these levels cannot be sustained as the average age of auto’s on the road is still at an historically high eleven years old.

Inflation. The Federal Reserve’s boogey man is largely absent or in hibernation. While the Fed continues on their perennial game of where’s Waldo consumers continue to benefit from these low to slow growth price gauges. The one area being impacted from stronger demand lies in shelter or rents which posted a strong +3.2% which helped support the CPI rising +2.1%.Ex-housing the figure drops to +1.3%.

Leading Economic Indicators-LEI ticked down -.2% in December following the prior two readings of +.5%.Year over year the index registered +2.7% which would continue to suggest a moderate rate of expansion.

Going Forward:

This current market volatility is in our opinion not, contrary to a few popular perma-bears, due to an oncoming recession but very simply (though no less painful) due to the flows of capital. Look no further than the Middle East countries and OPEC members. The overly generous subsidies these governments provided its citizenry (In Valenzuela gasoline costs $0.04 per gallon) in order to keep them happy and politicians/monarchiesin power, at $30 a barrel are no longer feasible. During the prior prosperous decades the enormous sovereign wealth funds, instead of using these surplusesto invest domestically and diversify their economies, purchased foreign assets that now must be liquidated in order to maintain these programs as long as possible. The US’s day of reckoning  will be upon us soon enough if we do not tackle Social Security benefits and Healthcare spending we simply cannot afford as the plans currently operate and are funded today. But the US can borrow our way right up to the gates of Armageddon. At least that’s what our elected brain trust is betting voters will believe. Until oil producing nations have adjusted budgets to the new reality of oil prices being lower for longer the selling pressures will remain a headwind and overhang. Investing in  companies with strong balance sheets, experienced management, excellent products and solid dividends remains a prudent approach. This sell off is and will provide opportunitiesto invest in companies at attractive valuations. In this market patience is an investors best friend and virtue. Trying to call a bottom in this environment would be more tricky than catching a greased pig at a country fair. Oil rules for now. But Chairwoman Yellen is up next and she might just save the day starting tomorrow on Capital Hill.  We’ll be tuned in for her speech. 

For now we remained committed to the market holding our cash, biding our time to deploy.The surprise may be that time may come sooner rather than later. 

Thank you again for your patience in these very challenging markets.