In the second half of 2014, the price of crude oil had fallen from $108 to the low $70s.
The market was oversupplied. Prices were plunging, and OPEC was expected to deliver an announcement of a production cut, to put a floor under prices.
Instead, they pulled the rug out.
On the evening of Thanksgiving, OPEC surprised the oil market with a well-timed announcement that they would not defend the price of oil with a production cut.
I say “well-timed” as their objective was, contrary to the market’s view, to pulverize the price of oil. And they chose a thinly traded holiday market to do it. With that, oil fell about 14% over the next 24 hours — and was nearly halved just two months later. What was the motivation? They wanted to put the emerging, competitive U.S. shale industry out of business, by forcing prices below the point at which the shale companies could profitably produce.
They nearly succeeded.
Shale companies started dropping like flies, with more than 100 bankruptcies over the next two years.
This came to mind this past Thursday night, when the I saw the announcement of the new variant. Well-timed. By the time many market participants were seeing the news, in thin markets, stocks, yields and commodities were all much lower.
The concern, even Thursday night, had less to do with the virus, and more to do with how governments would respond. Lockdowns? More restrictions?
Thus far, the response seems mild (as do reports on the virus). With that, markets get a good bounce today. But as we know, even before omicron, parts of the world were tightening restrictions. And Austria went back into lockdown.
Bottom line: The probability of economic headwinds, associated with the virus, are higher today than where we left off before the holiday.
With that in mind, we looked at the key reversal signal in the Nasdaq last week (also in the S&P 500) …
Technically, the charts, have already been flashing some warnings signals.
And with the introduction of some new uncertainty for markets and the economy, the Fed will come back into the crosshairs. As we know, they have recently began dialing down QE. And they have given us a target of "full employment" as a trigger to start the lift-off of interest rates. That trigger point is already arguably close, and we get a new data point on jobs this Friday.
So, by the end of the week, with any negative virus news, we could have a deteriorating economic outlook, just as data is hitting (from last month) that shows perhaps a trigger for Fed liftoff (or closer to it).
This scenario would put pressure squarely on the Fed, to walk back on its well-telegraphed exit of emergency level policies. And if the history of the past 12-years is our guide, stocks would punish the Fed (i.e. move lower) until they respond — and they would respond.
Earlier this month, the Fed laid out a timeline and plan for ending emergency level monetary policies. Today we got some insight into the conversations they had to arrive at that plan.
The broad takeaway from the minutes of the Fed's meeting: a Fed that sounds compelled to move even faster than they publicly telegraphed.
That means an end to asset purchases, maybe sooner than June of next year. And a rate liftoff, also maybe sooner than June of next year (maybe as early as March). With that, not surprisingly, there are some Fed members out doing some media interviews in recent days, to start setting expectations for a more aggressive timeline to rate hikes.
A more aggressive path to a tightening cycle: Is this good or bad for markets and the economy?
Consider this chart …
As you can see in the chart above, despite what the Fed and politicians would like us to believe about inflation (i.e. "transitory"), consumers have their own views. And those views tend to be led by the reality of prices that are impacting their daily lives. Prices up. Sentiment down. And ultimately consumer sentiment dictates consumer behavior.
The Fed clearly knows they are dangerously close to the point of losing control of consumer behavior. So, a faster path to normalizing rates (and stabilizing prices and sentiment) should be good for market and economic stability.
As we discussed yesterday, the big tech trade has run into what looks like a catalyst for some unwinding. The catalyst? The re-nomination of the Fed Chair, Jay Powell, which confirms a new tightening cycle for interest rates.
We ended yesterday looking at the key technical reversal signal on the Nasdaq chart. We have the same signal on the S&P 500 chart. Of course, both are heavily weighted and influenced by high growth tech.
Why don't high growth stocks do as well in rising rate environments?
Higher rates tends to bring about lower valuations. When Wall Street analysts start plugging in a higher a discount rate (interest rate) into their cash flow models, they will get a lower price target (in some cases, much lower).
Now, with this said, this should further confirm the shift in market focus to value stocks.
Among the most interesting value stocks, we've talked a lot about the beaten down oil and gas sector.
With that, I want to copy in an excerpt from my note from six months ago (May 20th) on the oil situation …
The globally coordinated "Clean Energy Revolution" promotes higher
oil prices, not lower. That's the structural driver for oil prices. Funding for new exploration has been choked off. So, foreign oil producers (particularly from bad acting countries) will be in the driver’s seat. That movement is underway. And these producers will command/demand higher prices, especially in a less competitive, lower supply world.
As we discussed this dynamic back in February, I said "get ready for $4 plus gas." With the monetary and fiscal backdrop that has evolved, and the inflationary pressures already bubbling up, it will probably be more like $6gas.
It will be self-fulfilling, and yet it will become the justification for the move to "clean energy."
So, this has all come to pass. And today, in an attempt to bring gas prices down, the President announced that he will be releasing oil from the Strategic Petroleum Reserve.
This only further solidifies the trajectory of oil prices (up).
Not only have we, and much of the world, committed to defunding new oil exploration, and regulating down domestic supplies, we are now (adding insult to injury) drawing down our reserves.
OPEC+ countries will be even happier now to sell us all the oil we will need (until we are all driving Teslas) just at higher and higher prices. And so will the domestic producers that have survived, thus far, this planned supply destruction of the fossil fuels industry.
On the latter, these remaining domestic producers have become cash machines, producing at wider and wider margins, and distributing the cash to shareholders.
How are we positioned in our Billionaire's Portfolio for this oil market dynamic? Join us here to find out.
As we discussed on Friday, few things will create more uncertainty in markets than uncertainty surrounding the path of monetary policy — especially, when its related to "who will lead Fed policymaking."
With that, there was strange price action across markets last week, as there was a growing view that we might be in for a change in Fed leadership. Markets started pricing in the prospects of a Fed that would be "easier for longer" (maybe forever), with the idea that a Brainard-led Fed would make the White House agenda an input in Fed policymaking.
With the goal of stability in mind, there was good news this morning.
Before the market opened, the financial media was tipped off that Biden would re-nominate Jerome Powell.
What does it mean for markets?
It means the Fed policy that has been telegraphed (tapering asset purchases with prospects for a June liftoff in rates) remains on path.
That should remove the lid on the interest rate market, which has been suppressed, given the economic and rate picture. The 10-year yield traded up to 1.63% today. And now we may see rates march higher, to test of the highs of the year (perhaps before year end).
What suffers when we get a confirming event (the Fed renomination) of a new tightening cycle for interest rates?
Growth stocks — particularly, the much-loved big tech stocks.
No coincidence, the Nasdaq was among the worst performers on the day. Moreover, the decline on the day produced a big technical reversal signal (an outside day).
This will be the spot to watch this week. Will the air come out of the Nasdaq into the end of the year? Conversely, what benefits from rising rates, into a recovering economy? Small caps and value stocks.
We end the week without an announcement on the Fed Chair. The White House says it will come next week.
We also end the week, with the crescendo of government spending plans passing through the House.
We will soon see if the two Democrat Senators that have resisted the package, will put an end to the madness, or fold to the pressure.
Let's take a look at some key charts as we enter the final active trading weeks of the year.
Tech stocks continue to march to new record highs, trading into the top of this one year channel …
Meanwhile rates have, once again, failed to hold above 1.6%, despite the underpinnings of hot inflation …
This rate picture, perhaps driven by the growing possibility of the installment of a new (more dovish) Fed Chair, has taken some wind out of the sails of small caps (which should be leading the way in a recovering economy/rising alongside interest rates).
Add to some of the pain in small caps (oil and gas stocks) this week, is the pressure that has been applied on oil prices, from some interventionist jawboning from the White House. Oil prices were down 6% on the week.
What's the takeaway? Markets continue to look like there is plenty of uncertainty out there. That said, few things will create more uncertainty in markets than murkiness in the path of monetary policy (in this case, who will lead it).
Yesterday we talked about the prospects of more direct government and Fed intervention.
We've already seen unprecedented intervention through monetary and fiscal policy.
Will the Biden administration take it further, and attempt to manipulate commodities prices (lower)?
He took a step yesterday, alleging price gouging from the domestic oil and gas industry and calling for an investigation into producers.
Is this the China playbook?
The Chinese government intervened in the domestic iron ore market in this past summer. Iron prices had more than doubled from pre-covid levels. The government stepped in, in May — with investigations and inspections into producers and speculators. Prices are down 58% since May.
The Chinese government intervened in the domestic coal market in late October. Coal prices had tripled over the prior twelve-months. Coal prices are now 40% lower, in just one month.
In September, China made a move to stabilize oil prices by releasing oil from its strategic reserves, for the first time ever. Prices went up, not down.
What's the difference? China is the biggest producer of coal in the world. China is one of the biggest producers of iron ore in the world. China has less control over oil supply. And now, given that the U.S. has regulated away and is defunding new domestic oil exploration, the U.S. has less control over supply too.
So, the news today that Biden and Xi (China) discussed releasing strategic oil reserves should do little to change the trajectory of higher oil prices. It doesn't address the structural supply/demand imbalance.
We talked yesterday about Biden's impending decision on who will lead the Fed for the next four years.
As we discussed, the incumbent, Jay Powell, doesn't seem to fit the mold of what the administration wants – though he's the consensus favorite. The highest probable candidate that could replace him, does fit the mold (Brainard).
The "mold," in this case, is (seemingly) someone that will carry the water for the White House's agenda.
With that in mind, markets seem to be pricing in some uncertainty about the situation.
We are living in a world of policymaker intervention. The Fed's involvement in the Treasury, mortgage and corporate bond markets over the past year is intervention. The pandemic response from Congress (stimulus, rent moratoriums, direct checks, etc.) is intervention.
But the Fed has now telegraphed a path where they could be out of the intervention business by June. And if the infrastructure package is the last bullet fired by Congress, they could be nearing the end of the pandemic-response intervention business too.
But this Fed appointment, and actions Biden took today on the oil and gas market, suggest we may get more intervention, not less.
What are two markets that create problems for the economic recovery? Runaway oil prices, and runaway interest rates.
On the former, we have an administration (and global initiative) that has restricted domestic oil supply, and given the control of prices to foreign producers. And now we have a threat of runaway oil prices.
On the latter, we have the hottest inflation we've seen in thirty years, following continued massive deficit spending. That's a recipe for higher rates, maybe runaway rates.
Will there be intervention?
Today, Biden launched an investigation into domestic oil producers, claiming producers were price gouging. This claim sounds a lot like the claim that resulted in the Nixon-era gas price controls. It led to much higher, not lower, prices.
On rates: Brainard has been an advocate for yield curve control (managing market interest rates to stated target levels). Just as the Fed is exiting the intervention business, they could be right back in it. This would keep market interest rates from running away, and choking off economic activity — but market interest rates are a market mechanism to curtail inflation. Inflation could run wild.
From a headline this afternoon, it sounds like Biden will announce his nominee for Fed Chair on Friday.
This is an important announcement, for markets and the economy.
If we take the actions of the Biden administration as a guide on how they would like to see the Fed behave, we would deduce that they would like to see a Fed that: 1) supports the social and climate agenda, and will maintain monetary policy to support the fiscal spending plans, 2) is willing to clamp down on the banking sector, and 3) is in favor of a central bank-backed digital dollar.
If we evaluate the history of Jay Powell's tenure as Chair, he
doesn't seem to fit the mold. This is a guy that raised rates into a low inflation, slow recovering post-great financial crisis economy – even as stocks were collapsing in 2018. This is a guy that has, no his watch, eased some of the bank regulations that were put in place in response to the financial crisis. And this is a guy that has carefully avoided taking a position on the digital dollar concept.
That said, it does seem like he has made a concerted effort to keep himself in the running for another term, through his maneuvering of the past year. Among those maneuvers, sticking to the "transitory inflation" talking point far longer than he should have.
Now, on the other hand, the top candidate in the running to replace Powell, ticks all of the boxes. Lael Brainard is one of the most dovish Fed Governors. And w
ith Brainard, you get a Fed that would support the move to a central-bank backed digital currency. And she will execute on the Biden social and climate agenda (which includes tougher positions on bank regulation, "looking out for Main Street").
So, how do things look? The betting markets still see a Powell reappointment, though the odds are tightening — a 64% chance for Powell vs. 90% chance back in September.
Not only would a removal of Powell be disruptive for markets from a continuity standpoint, it would imply an even more dangerous inflation outlook from a policy standpoint.
Biden signed into law the infrastructure bill today.
The question is: Will this be the final fiscal bullet fired?
If it is, with monetary policy now pointing in the direction of a tightening cycle (maybe to start by next June), we have to keep an eye on the "bubble" markets – the most vulnerable.
On that note, perhaps the biggest bubble/manifestation of excess money and a mania surrounding the expectations of a global energy transformation is Tesla — a company that has exploded in value, from $78 billion to $1.2 trillion in just twenty-months. Over a trillion dollars of global capital has plowed into this stock.
What happens if the massive "clean energy" bill, that has been in negotiations in Congress and already whittled down significantly in size, does not make it to the finish line?
Does the money move out of Tesla?
We're already seeing some selling from Elon Musk, and some price action that would fit the description of a blow-off top (a steep and rapid increase in a stock's price and volume, followed by a steep and rapid drop in price, on high volume).
Back in early August, we had just come out of the first half of the year, with the economy running at a better than 6% growth rate.
Personal savings were at record levels. Jobs were plentiful, and at record high wages.
But despite these hot numbers, people were living a different story on the ground, emanating from a disruptive policy agenda in Washington.
With that, when the July consumer sentiment data came in (in early August), it was a shocker. Consumer sentiment dropped to a 10-year low. Expectations about the future? 8-year low.
This, as forecasters were, at the time, looking for between 5%-7% annual rate of growth for the third quarter. The economy ended up growing at just 2% in the quarter.
Fast forward three months, and the consumer is even less optimistic.
This morning, the October numbers came in. Let's take a look …
The University of Michigan monthly survey of consumersentiment is at another 10-year low.
Next, here's how consumers surveyed feel about current business conditions. It's not good. The reading is back around pandemic lows. And as you can see in the circled areas of the chart, it doesn't share good historical economic company.
Here's how consumers feel about the future? Eight-year low. Consumers feel worse about the future than they did at the most uncertain depths of the pandemic/lockdown.
This all comes at the Atlanta Fed's GDP model is tracking 8% growth for Q4. The consensus economist community is projecting a little less than 5%. Expect adjustments, downward.
