Over a barrel!

Over a barrel!  Stocks sold off yesterday in response to the drone strike on Saudi Oil fields that took place over the weekend.  Energy stocks traded up while fuel-dependent companies were punished.

MY TWO CENTS

1.  Black gold.  On Saturday, reports began to surface about a drone attack on Saudi oil fields.  By yesterday morning, analysts were able to estimate that almost half of Saudi oil production had been impacted which roughly translates to 5% of global crude oil supply.  Well before the estimates started piling in crude futures jumped in anticipation of the supply shock.  Crude oil, like all commodities, is highly dependent on the relationship between supply and demand.  Cut supply and prices go up.  Increase demand and prices go up further.  OPEC has been cutting supply recently in order to prop up slumping prices.  Their efforts have not been too successful as the Chinese economy struggles, demanding less crude oil.  Additionally, the US, which is now a net exporter of crude, is the largest crude producer in the world.  Despite all of these regular economic dependencies, a 5% supply cut will have an impact on the markets… and not just crude oil markets.  In yesterday’s session, North Sea Brent Crude Oil (the international benchmark) jumped by +14.61%, its largest single day increase in its history.  West Texas Intermediate Crude (the US benchmark) rose by +14.68%, its largest single day jump since 2008.  The increase in crude can be translated into a +15 to +20 cent increase per gallon of gasoline.  The increase in costs at the pump could affect consumption as consumers will have less disposable income.  The price increase will have a much larger impact on companies who are dependent on fuel such as transportation and logistics.  As one might expect, the airline industry is highly sensitive to fuel costs and airlines stocks sold off yesterday with the sector dropping by -2.07%.  Materials transport and logistics costs are also highly correlated to fuel costs.  Supply chain disruptions will certainly have an impact on sectors which have already been under pressure from the ongoing trade war between the US and China.  Finally, there are petroleum derivative products which rely on crude oil who will also suffer materials cost increases.  Those products include plastic, nylon, rubber, asphalt, lubricants, and food preservatives, to name just a few.  There is an old saying that capital is the oil of industry but I like to say that oil is the oil of industry. What happens next?  The Saudis are working hard to repair the damage and bring production back online as quickly as possible.  The President announced that he has authorized the use of the US’ strategic oil reserves which will increase supply.  Additionally, Trump has called for the speeding up of pipeline development projects, which can also increase supply.  Oil producers in other regions, including the US, will increase production to make up the temporary shortfall.  The capacity exists, but timing will be everything.

2.  Threading a needle.  The job of the Federal reserve as the custodian of economic growth, low unemployment, and low inflation, has an increasingly difficult job.  Their very mandate to keep inflation low while maintaining low unemployment is, in and of itself, flawed.  Low unemployment means more folks with more money to spend.  More money spent means increased demand which causes prices to go up… inflation.  Additionally, low unemployment means scarce labor supply.  Decreased labor supply means that wages go up increasing the costs of products… inflation.  You get the picture?  In the years following the financial crisis these basic economics have not seemed to apply.  We are at record low unemployment resulting from one of the longest economic expansions in history.  That would mean inflation should be shooting through the roof right?  Wrong!!  Inflation has not taken off largely because wages have not grown all that much in the past 10 years.  After the last recession employers were reticent to raise wages in order to recover.  At the time, higher unemployment meant a ready supply of workers eager to just have a job.  Finally, the workforce is getting younger as the baby boomer generation enters the retirement years.  Younger workers mean lower wage costs.  In addition to wages, raw material costs have a large impact on inflation.  Technological advances in recent years have enabled raw materials producers to keep commodities prices in check and supply flowing smoothly.  So price increases have been relatively benign in the past decade.  With little or no inflation present, why then did the Fed start to hike rates in 2015?  Because they had to!!  With rates effectively at zero to aid in the recovery, the Fed needed to have dry powder to fight off future recessions.  By late 2018, it became clear that rates were increasing too far and too fast and the market protested causing the Fed to rethink and pivot its policy, ultimately resulting in a rate cut earlier in the summer.  After all, inflation is under control.  Or is it?  One of the effects of tariffs is inflation as producers pass the tax on to consumers.  We have already experienced some signs that inflation is picking up, albeit slightly.  As mentioned above, energy can have a sizable impact on prices and inflation may pick up as a result of the supply shock.  If inflation is about to pick up the Fed may need to rethink its strategy.  The FOMC will announce its policy tomorrow afternoon and a cut appears to be a given.  The dot plot projections and the press conference will be the real draw and inflation will surely be addressed.

THE MARKETS

Stocks slipped yesterday in response to the Saudi oil field strikes over the weekend.  Union workers at GM announced that they would let their contract lapse effectively striking against the automaker further pressuring stocks with the Auto sector falling by -2.47%.  The S&P500 fell by -0.31%, the Dow Jones Industrial Average dropped by -0.52%, the Russell 2000 advanced by +0.41%, and the NASDAQ Composite Index sold off by -0.28%.  Bonds traded up and 10-year treasury yields fell by -5 basis points to 1.84%.

WHAT’S NXT

– Industrial Production is expected to have grown by +0.2% month over month compared to a decline of -0.2% last month.

– The NAHB Housing Market index is expected to remain at 66.

– The UN General Assembly will begin today.

– Fedex, Chewy, and Adobe will announce earnings after the bell.

daily chartbook 2019-09-17