I update each Saturday with my view of the stock market for the next few weeks (if occupied with family or travel, rarely I am a day or two late, just check back). The monthly “Long Term” update will be on the first Wednesday of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a primary bear market, and buy back in for most of the next bull market.
If you lose your bookmark to the blog, google “Rich Investing Blog” and it should show up on the first page or so.
The monthly Long Term post went up on Wednesday and follows this post on the website.
Economy:
The ISM manufacturing index for May was down to 48.7 from 49.2, while the ISM services index for May was up 4 to 53.8. Factory orders for April were up .7%. The US economy added 227K jobs in May, which is strong and interest rates rose modestly thinking the Fed would defer the first rate cut. The unemployment rate ticked up one tenth to 4.0%.
It still looks like a soft landing. This is exactly what the Fed wants. Powell said over a year ago that we would need a period of below trend growth in economic activity to bring inflation down, and that is what we have had so far this year. That is not what main street wants, but it is what the Fed has delivered. Main Street didn’t want 9% inflation either, and something has to give in order to bring inflation down.
Geo-Political:
Let’s talk about oil. My friends, strap in, because this will be long and not easy. If you think you understand the oil market, you are probably wrong. If you think it responds to the laws of supply and demand, you are partially, but not totally correct. The law of supply and demand works efficiently in a free market. But the OPEC cartel sits in the middle of the global oil market, and they make it a modified free market where some strange things can happen. To illustrate this, I will look at the crazy oil market, primarily in 2015, but things got even worse in 2016.
The first thing to understand is how tight global production MUST equal global consumption in order to keep prices stable. Look how tight the annual production and consumption track in the last 4 years. Producers have learned that they must not produce oil beyond the demand to consume, or prices will fall, to the detriment of all of the producers. The American conservative mantra of “drill baby drill” as a solution to high oil prices is such an over simplification of the issue as to be total BS. It indicates a fundamental misunderstanding of how the international oil market works. Look at the chart below and see how tight is the matching of supply and demand (Global liquid fuels production vs Global liquid fuels consumption). That has produced relatively stable oil prices in the $60 – $80 per barrel range, except for the Russian invasion of Ukraine and the dislocation of Russian oil exports that took a few months to sort out.
Now let’s look at what happened to oil prices in 2015, at the peak of the US oil renaissance brought about by the fracking revolution. The Bakken Shale in N. Dakota was a major new source of US production from 2010 to 2015, and it was shut down by the DROP in oil prices in 2015-2016, along with many smaller US oil companies that eventually went bankrupt, negatively impacting the banks that had loaned money to them.
Although the US was becoming an oil power from 2010 – 2015 because of our success with fracking, oil prices remained high in spite of the oversupply because Saudi Arabia and the rest of OPEC were cutting production to support the price. The Saudi’s could see that the rest of OPEC said they would cut production, but they did not, leaving all the production cutting to Saudi Arabia. Finally, Saudi Arabia said “Enough”! Saudi Arabia began to produce to their capacity and they flooded the market with crude oil. Crude fell from $100 a barrel to $50 in 2015, then to $30 in 2016. Saudi Arabia proved to the world they were the most important producer of oil, because they are the LOW COST PRODUCER and one of the very few who were profitable at $30 a barrel. The lessons to the world were 1) the Saudi’s still control much when it comes to oil, 2) it is better for everyone who can produce to accept a quota that keeps global production closely tied to global demand. If the US were to “drill baby drill” and produce as much as possible, they could produce a mismatch between supply and demand, and Saudi Arabia has the ability to punish such arrogant behavior. Saudi Arabia no longer has the ability to drive prices up for more than a few months until other producers can produce more, but they have the ability to drive prices down to a level where very few can make a profit, and that is a very powerful tool for them.
I’m going to copy in a long post that supports my assertions. It is so long that I won’t use the usual “quote” format, which will give it more room from left margin to right margin.
“May 21, 2015 – The global oil market is in upheaval. Prices plunged more than 50 percent between mid-2014 and mid-2015, leaving them hovering around $60 per barrel. Consumers, producers, and governments, all having grown accustomed to $100 oil, were taken by surprise. After all, just prior to their collapse, oil prices had held remarkably steady for three years, their most stable period since the end of the Bretton Woods era in the early 1970s.
What only a handful of observers saw coming was in effect a perfect storm: a sharp increase in supply driven by the production of unconventional oil from deep rock formations in the United States, coupled with sluggish demand in Asia’s emerging economic power centers, all intensified by financial speculation.
As a result, by the autumn of 2014, markets began to be flooded with oil and prices started to show weakness. At the November 27, 2014, meeting of the Organization of the Petroleum Exporting Countries (OPEC), which drew more attention than any of its gatherings since the global financial crisis of 2008, the cartel was widely expected to cut production in an effort to arrest the price decline.
And yet OPEC did no such thing. Instead, as it left production levels unchanged and prices fell further, observers were quick to declare that the cartel was over a barrel.
In fact, while the fate of individual member states may vary, OPEC as an institution—and Saudi Arabia, its leader—is likely to emerge from this paradigm shift stronger than before in many ways. With its new strategy—one born out of necessity—the kingdom is emphasizing market share, rather than price, while also moving to delegate the burden of balancing the world oil market to the U.S. shale industry. This, over time, will help the kingdom to meet rising domestic demand, and, at the same time, help OPEC lay claim to a bigger share of world oil markets that can be allocated—politics permitting—among resurgent producers such as Iran, Iraq, and Libya in the years ahead. Taken together, the moves mark a significant change in the geoeconomics of oil.
OPEC’s Long-Term View
To be sure, $60 oil hurts OPEC member states. Venezuela would like to see prices shoot beyond the $100 per barrel mark again and lift state budgets out of the red, as would Kuwait and Iran. But looking at the short-term fiscal interests of OPEC members misses the point. OPEC has a long-term view, and it has learned from history—more precisely from the aftermath of the oil price surge of the 1970s.
Embargoes and high prices in the early 1970s brought new producers to the stage, notably Mexico, Norway, the United Kingdom, the U.S. state of Alaska, and the Soviet Union, rapidly expanding global supply by the end of the decade. In response, OPEC started cutting production, which led to a significant loss of market share but did little to stabilize prices, as non-OPEC producers kept on pumping even more. It was Saudi Arabia, the swing producer, that absorbed these losses, while most fellow OPEC countries were free riders.
Saudi Arabia’s oil output contracted to 2.4 million barrels per day (mbd) in August 1985, down from more than 10 mbd in 1980. In 1986, when the kingdom eventually opened the floodgates and ramped up production to 5 mbd, prices immediately collapsed, falling 50 percent from 1985 to 1986.
This undoubtedly hurt OPEC economies. In Saudi Arabia, which had cut production from 1982 onward, the state budget was already in deficit when the price collapsed.
Yet the long-term effect of the low price was a declining market share for non-OPEC producers in the United States and Northern Europe, whose higher production costs were no longer sustainable in the new price environment. OPEC learned an important lesson: accept the immediate pain and come out stronger in the long run.
Today, Saudi Arabia’s economy is far better prepared for a sustained period of low oil prices than ever before. In the mid-1980s, the ratio of Saudi Arabia’s gross domestic savings to gross domestic product (GDP) was about 10 percent; by contrast, 2013 figures from the World Bank suggest a savings rate of 44 percent. The country has one of the lowest debt-to-GDP ratios in the world, even as social spending has accelerated in the wake of King Salman’s ascension to the throne in January 2015, draining foreign reserves by $36 billion, or 5 percent, in only two months.
As Riyadh imposes its will on OPEC, it is prepared to accept short-term budgetary pressures in order to salvage market share in the most important commodities market in the world. That its rivals Russia and Iran are also losing out due to the low price is simply icing on the cake.
High-Cost Competitors Feel the Pain
Low oil prices hurt producers that need prices consistently above $60 a barrel in order to be profitable. That means the biggest loser in the current market is not OPEC, but high-cost producers such as Brazilian offshore ventures, Canadian oil sands, many Russian greenfield projects, which require the construction of new facilities, and, in specific areas, the U.S. shale industry.
Already, prices below the $50 mark have put international oil majors into rationalization mode. BP announced a $1 billion restructuring program in late 2014 that called for thousands of jobs to be eliminated by the end of 2015. ConocoPhilips followed suit, while Schlumberger, the world’s largest oil services company, said in 2015 that it would lay off 15 percent of its workforce. Oil stocks saw a bloodbath, and, in mid-2015, U.S. rig counts were at their lowest levels since mid-2010.
Canadian oil sands in the province of Alberta have high up-front costs but far lower operational costs than conventional oil, meaning that projects that are already on line or under construction will continue apace, but a broad swath of future investments will be scrapped if low prices persist—casting doubt on the prospects of a resource base that was at one point expected to shoulder the lion’s share of future non-OPEC supply growth.
The up-front investment required to extract shale oil is comparatively low, making it easier to halt production when spot and short-term futures prices are low, and to begin drilling again when prices pick up.
In the near term, many of the small and midsize players that dominate North America’s shale sector will not survive. They lack the deep pockets and diversified risk portfolio of the oil majors and their state-owned OPEC counterparts and will increasingly be forced to consolidate and restructure.
The impacts are already being felt across the U.S. states of Texas and North Dakota. Many companies that are active in shale oil have been spending more than they are taking in, and they have relied on optimistic price and productivity assumptions to fund their growth. Their debt has overwhelmingly been downgraded to junk status; their revolving credit facilities, linked to the price of oil, are shrinking; and capital is increasingly scarce.”
If anyone thinks that “drill baby drill” will work to lower oil prices in the US for more than a year, read the article above again until you understand why it will not. The new sources of oil in the US require a certain oil price to remain profitable, and Saudi Arabia can drive the price below their cost of production, bankrupting them. Saudi Arabia has and will again accept the short term pain for their long term objective, which is protecting their market share. They have demonstrated what the rules are. They don’t have this power because they produce the most oil, the US has surpassed Saudi Arabia in oil production for several years. Saudi Arabia has the power because they are the low cost producer. They can survive a price war better than anyone else, so they have the power. I think all the other producers see that, and it is no use to poke a tiger. It is not a good idea to raise production above the level of demand; they must stay in close synchronization.
If you look at the report in the link below there is a graph showing that in 2015 there were 38 oil company bankruptcies in the US, followed by 70 in 2016. Again, if you think “drill baby drill” is a viable US energy policy, you did not understand what was going on in 2015-2016. Those conditions have not changed; Saudi Arabia is still one of the lowest cost producers of oil. Those who don’t know history are doomed to repeat it.
Some conservatives have blamed the banks for being woke or pushing an environmental agenda for the harsh seeming conditions they place on oil companies looking for loans in order to drill. That is a lie. Bankers care about making a profit most of all. The bankers have long memories, they look at the 108 oil company bankruptcies in 2015-2016, and they are cautious. The oil companies are sometimes overly optimistic, and if the banker really wants to get his money back, he has to look at the proposed project with a more rational eye. He may require the oil company to put more of its capital into the project and borrow less, and he may charge a higher interest rate because of the risk the bank is taking. Oil prices are volatile. It’s not about being woke, it’s about doing sound business.
I have thought about writing something like this for a while, and I did not because I knew it would be hard to do in the space that I normally take, hard to do period, and it would take quite a bit of research. I finally took the bit (that’s an old expression that refers to horses, for my young readers), and yes, it’s long. I put in a special effort, so I hope you got something out of it, if you made it to this point!
Technical Analysis:
For the week ending 6/7/2024, the S&P 500 was up about 1.5%.
Technically (see chart below) the market looks positive. RSI at the top of the chart is high neutral at 67. Momentum shown by MACD at the bottom of the chart is neutral. The price action is positive, but the last three closes are flat.
There won’t be much big news in the near term since earnings are mostly over, and corporate buybacks will stop in mid-June. Apple has their big developer day on Monday and that could boost AAPL, which would boost the stock indices a little. But the general lack of earnings news and the halt of buybacks until after earnings represent risks, along with elevated PE valuation of the market in general.
Click THIS LINK to open the chart in a separate window.
What am I doing? The market is nearly overbought again and while rising, it does not show much energy. I sold some of the good stocks I bought on the recent downturn. I kept my PLTR and sold covered calls on it, the call premium was nice for a low priced stock. I sold CRWD after it popped up, then it popped up higher since it will be added to the S&P 500 on Monday. Every time you buy and S&P index fund, the fund will have to buy more CRWD as well as all the stocks in the index. The move to passive investing through index ETF’s is concentrating gains in those stocks in the index, whether the company is doing well or not. They get bought by the index funds.
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I would like to call your attention to a page of my blog called “CLASSICS”. It is located at the top of the blog, on the banner just under the title. The banner has links to “Home”, “About”, and now “Classics”. These are articles that I wrote one time for the blog, but they are valuable insights at all times for investors. I will announce in the weekly blog when I add a new classic.
There are currently 3 Classic topics posted: 1) Is it a bull market or a bear market? 2) Why does healthcare cost so much? and 3) Implications of a large national debt. (posted August 2022)
You can use the hyperlink below the chart of the S&P that will open a larger picture of the chart in a separate window. If you bookmark the link to the chart you can look at it each day of the week to see how the market is progressing to certain milestones. The picture in this post is a static .jpg so it does not update.
I am a retired person and preserving capital and seeking income are important objectives for me. I also want a growth component to my portfolio, while minimizing major risk. My style of investing will not suit everyone. I like to sleep well at night. Investing involves risk, including the risk of loss.
Rich Comeau, Rich Investing
Rich Investing 