No Inflation Seen in Energy Prices

With the various global tensions impacting the energy market, I thought it was appropriate to write a few articles about crude oil and how viewing different time horizons yield very different opinions. This is part I to be followed by part II next week.

To begin with, energy and more specifically, crude oil, has an enormous impact on the global economy. From common sense items like heating our homes and powering our cars to more derivative things like chemicals and asphalt, crude oil is a vital ingredient in the global economy.

It still seems like yesterday that the pundits confidently proclaimed oil above $40 a barrel would cause a severe recession and $75 would spell depression. That was when Iraq invaded Kuwait in 1990 and of course, they were wrong. From its generational bottom at $10.65 in 1998, oil almost quadrupled by mid 2000 without any economic pause.

From the post 9-11 low at $17, oil once again quadrupled by 2006 to $78.40. And again, there was no economic slowdown let alone recession, save depression! It wasn’t until oil went parabolic in 2008, straight to $147 that, combined with the financial crisis, spelled doom for the economy.

What’s the takeaway from this very basic and brief study of energy prices?

*As we have seen since 1990, higher oil prices do not equal higher inflation.

*Runaway oil prices over a period of time don’t equate to a recession.

*Third and perhaps most important, in my opinion, the American consumer is very able to cope with higher energy prices as long as they occur over time and not in the form of a shock. Obviously, if gas was $10 a gallon, that would severely impact the economy, but $100 oil did not stop the global economy and I would argue that if the financial crisis was not unfolding, the economy may have paused and perhaps even mildly recessed, but it would not have collapsed solely due to oil prices.

Today, I am often asked where I believe crude oil is headed and at what level we should worry that the economy will be adversely impacted. First, it certainly looks like oil is headed higher, right from here at $104. Oil traded to fresh 2014 highs last month and is now resting. Once $108 is exceeded $115 should be next before long. That level is really the “put up or shut up” spot for energy and as a consumer, my “hope” is that the rally ends there. Surpassing $115 opens the door to some much higher scenarios that most of us do not want to see!

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Stocks Growing Tired

With the major indices going vertical since October 9, I am starting to see some signs of tiring. “Tiring” is a lot different than forecasting a full fledged correction or even a deep pullback. It just means that the odds favor either some sideways action to help restart the engine or some sort of mild price decline to shake out the Johnny Come Latelys.

During this rally, we saw the S&P 500, S&P 400 and Russell 2000 hit all time highs with the NASDAQ at its highest levels since 2000. The Dow has been the laggard index, but I do expect that to get in gear after this pullback and also see new highs.

Gold has cooperated nicely from the recent bullish call and I think more upside is ahead for the shiny metal. As I have discussed all year, especially of late, this is the bond market rally I have been waiting for. The train began to leave the station in late August and September and is now in full motion. Treasuries, quality corporates and government bonds all look higher, especially if they see the slightest bit of weakness first. Our clients have owned high yield bonds for some time and that rally has been the strongest so far and may be growing a bit tired itself.

The US dollar has been under pressure for almost four months and it looks like a major bottom is about to be formed this quarter. My long, long-term view remains very, very positive for the greenback. Uncharacteristically, energy has been hit hard even though we have seen dollar weakness. That indicates strong selling beneath the surface with even lower prices to come.

I am about to start working on a Canaries in the Coal Mine update and I hope to post it on Friday.

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