Oil Prices Seem Headed South

Several data points combine to convince me that oil prices are probably headed lower – perhaps by a lot – but certainly not up.  They include 1) the Saudi’s increasing daily production to 10 million bpd (the highest level in nearly 30 years!) 2) the IEA releasing 30 million barrels from its strategic reserves and 3) the U.S. releasing 30 million barrels from the Strategic Petroleum Reserve (only the 4th time in its history that reserves have been released – they are at capacity with 727 million barrels in storage).  These actions amply overcome the loss of 1.5 million bpd of production from Libya. Some of the implications from these points (in addition to the rally in the US$) are for lower crude oil prices =>lower gasoline prices => lower consumer inflation.  Sharp increases in oil prices have led to drops in equity prices and, importantly, vice versa.  The following chart from Yardeni.com depicting the Saudi daily oil production highlights the historical significance of the announced increase.  Jeb Terry, Sr. June 23, 2011

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Concerns over economic “soft patch” appear overblown

Data displayed by Prieur du Plessis on his excellent website (here) does a good job tracking the global trend in the purchasing managers’ index for the major countries.  The slowdown in the U.S. PMI number early this month has fueled concerns of economic weakness and contributed to the recent stock market correction.  As can be seen below, Japan dropped into contraction (below 50 on the index level) following the recent earthquake and nuclear accident.  Their slowdown has been largely to blame for a significant slowdown in the U.S. auto industry and hence- the U.S. PMI metrics.  As can usually be said – “this too shall pass”.  The commentary from Prieur is encouraging . . . “Despite the markets showing their dismay when the manufacturing PMIs for May were published, the pace of expansion in the global economy has actually picked up. The JPMorgan Global Composite PMI, which takes the manufacturing and non-manufacturing/services into account, rose to 52.6 from 51.8 in April (a number above 50 indicates expansion) as the turnaround of Japan since the twin disasters seems to be lending solid support”.  The sharp upturn by Japan may cause a reversal in the U.S. PMI when reported in early July.  Jeb Terry, Sr. June 14, 2011

Source: Prieur du Plessis, Investment Postcards from Cape Town

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The Put/Call ratio is indicating the stock market is materially oversold – primed for a bounce.

Merrill Lynch reported yesterday that the ratio of puts to calls on the CBOE is approaching extremes last seen in May 2010 and late 2008.  The hedgies have been busy!  While this ratio can be “noisy” it is a pretty good indicator at extremes – like now.  The Q2 earnings season is fast approaching.  Stronger earnings and a likelihood for a more positive tenor to macro-economic metrics could cause a significant stock market rally and confirm the signal from the option pits.  Jeb Terry, Sr. June 13, 2011

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The press has focused on weak job growth and largely ignored growth in hours worked.

A recent report by David Malpass of Encima Global had a good chart illustrating the trend and relationship of aggregate weekly hours worked (a combination of the # of workers and hours worked) and GDP growth.  The red line in the following chart shows that hours worked is growing at the best rate in 5 years.  It is instructive to note the indicator is much stronger than in 2010 when the market was last fearful of an economic slowdown.  More hours worked logically leads to more workers hired.  Jeb Terry, Sr. June 14, 2011

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If the economy is slowing down it’s not reflected in earnings estimates.

The most recent published earnings estimates by S&P show no meaningful slowdown in 2011 earnings estimates.  The value of the S&P 500 is up only 16% from December 2003.  Earnings for the S&P 500 are up 52% since 2003!  Ten year Treasury rates are down 28% in the same time frame.  Rising earnings and falling interest rates are supposed to lead to rising P/E multiples and rising stock prices.  Instead, forward 12 month P/E ratio today is down 30% from 2003.  The S&P 500 would be 37% higher today if it traded at the P/E of December 2003.  Jeb Terry, Sr. June 13, 2011

Source: Standard and Poors

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Yet another signal the market is oversold to a degree consistent with prior lows.

Bespoke Investment Group has published another compelling chart (here) displaying the relationship of the percentage of stocks trading 1 std. deviation below their 50 day moving average stock price relative to the S&P 500 price index.  It should be no surprise that the present condition where over 50% of S&P 500 stocks are trading substantially below their 50 day moving average is unusual and has been an accurate signal of a short term market bottom over the last 12 months.  Jeb Terry, Sr. June 7, 2011

Source: Bespoke Investment Group

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The amount of money of zero maturity remains at a staggeringly high level – big sign of fear, sign of disengaged investment potential, near historic high percentage of GDP.

Investors remain extremely cautious if MZM is a guide.  There is over $10 trillion of money held in cash and securities of zero maturity.  It’s no wonder economic growth is sluggish.  The good news is this condition is not common at market or economic tops.  A decline in the amount of money sitting idle back toward 50% of GDP would release over $2 trillion of capital into the economy for productive investment.  Jeb Terry, Sr. June 3, 2011

Source: St. Louis Federal Reserve Bank

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Forget the backward looking government jobs data – look at job advertising for a view of what’s ahead.

While the market reacted negatively to the government jobs report today people ignored a positive signal arising from the level of online help wanted ads reported by the Conference Board on June1 and commented on by Mark Perry on his blog here.  The signal is straightforward.  The level of help wanted ads have returned to pre-recession levels.  While the pace of job creation will continue to be hotly debated, the direction in job creation is up – not down.  The implication is that the economy is still primed for growth and hence equity values can also grow.   Jeb Terry, Sr. June 3, 2011 

Source: Mark Perry, Carpe Diem

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The spread between the S&P 500 earnings yield and the 10 year Treasury rate is near a historic high – history implies stocks will rise soon.

The current earnings yield for the S&P 500 is 6.8%.  The recent 10 year Treasury rate is 2.97%.  There have only been 14 quarters since 1970 (20% of the time) when the earnings yield has been 150% or greater than the 10 year Treasury rate.  In 79% of the cases when this condition existed, the S&P 500 gained an average of 8.5% sequentially in the following quarter.  The breadth of the spread can be viewed as a fear monitor.  Clearly fear is keeping investors huddled in cash and Treasuries and avoiding stocks (other than LinkedIn –eh?).  History suggests the spread is excessive and is resolved by rising stock prices.  Jeb Terry, Sr. June 3, 2011

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Recent market correction has stocks testing near record undervaluation

I have updated my data series that calculates a fair value for the S&P 500 relative to the 10 year Treasury rate.  We are at a level in the S&P 500 that implies a 56% UNDER valuation.  This is highly unusual.  An undervaluation in excess of 50% has only occurred in 5 quarters prior to the current measurement going back to 1970.  All of these quarters have occurred since the Lehman panic of 2008.  While the number of occurrences is limited, the market has been up 80% of the time after such deep undervaluation.  The market has gained an average 10.4% sequentially in 4 of the 5 quarters when the market has been undervalued by more than 50%.  This size of sequential gain is over 5X greater than the average quarterly sequential gain since 1990.  Jeb Terry, Sr. June 3, 2011

Source: Standard & Poors.  St. Louis Fed

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