Despite Uncertainty, US Economy Seems To Be Limping Toward Stability

The stock market and the oil market both seem to engender feelings much like summer vacation time when I was a kid.  Kinda boring, not much happening, a time to wander around, allow your attention dwell on whatever news of the day happens to come along and rest your mind before getting back to the “real world” some time around Labor Day.   So we can be distracted by Gov. Sanford’s bazaar behavior, the political drama of health care reform, Berlesconi and his babes, or Wimbledon - all of which are equally unlikely to have any real economic importance.

One comment on a current event related to oil: I feel so sorry for the reform politicians and demonstrators in Iran who are not likely to change anything in the short term and in many cases will pay a very high personal price for trying.  Obviously, many already have; 20 are reported dead so far.  The seeds of Middle Eastern democratic reform sprouting in Iraq, Lebanon, and now Iran are like putting small deposits into a savings account.  If you keep adding to the account over time and it keeps accruing interest, it could amount to something significant some day.  But in the short term there will be no change I think and the oil market seems to agree as it basically ignores the news from Iran.

The irony of Iran’s “revolution” is that the primary short term impact may be to bolster Iran’s effort to get a nuclear bomb.  If the West perceives that a real possibility of regime change exists, as it wants to perceive, there are two implications.  First, that perception will inhibit Obama’s efforts to negotiate with Ahmadinejad because doing so would seem to “legitimize” him and thus put a stick in the eye of the reformers.  Second, it will be hard for the U.S. to support an Israeli military attack on Iran’s nuclear facilities if A. we haven’t had a chance to try negotiations, and B. such an attack would be seen as uniting all Iranians against the West and thus undermining the potential for a popular uprising of “reformers.”   So if both negotiations and a military “solution” are delayed, the main impact of the popular uprising may well be to give Iran a lot more time for building their bomb.

Investing

The U.S. economy, as reflected in statistics and most anecdotes, seems to be limping toward stability with consumers coming back into the market a bit when tempted by something really interesting like a great new I-phone or a super-cheap California house, but most consumers are still saving as much as they can.  Investors, meanwhile, seem to be holding their breath while waiting for the next big injury to the economy to manifest itself.  That will come in the form of commercial loans going bad, particularly real estate loans.  Investors hope to see some signs that an actual recovery has begun.  But so far real estate prices are still falling: end of story.   No bottom in real estate, no recovery.

Despite the bleak statistical picture, I was reminded of how robust the actual existing economy still is, despite the recession, when I went out to CitiField to see the Mets play the Cardinals, my first trip to a baseball park in decades.  My busy lawyer son treated Nina and me but the main treat, of course, was getting a chance to spend the evening with him. We had a nice time at the game; the weather was OK; and baseball parks are always beautiful.  But I must say this new stadium seemed a bit cheesy in terms of its off-field amenities and aesthetics.  I hear the new Yankee stadium has a lot more class.  We’re hoping to make the comparison based on personal experience soon.

Anyway, what all this has to do with the economy is that the cost of the outing, all in, was about $100 per person.  For that we had middling-quality seats and run-of-the-mill, monopoly-priced junk food.  A lousy hot dog was $4.95.  Of course our family is lucky enough that we can throw a few hundred dollar bills out the window without much concern.  But at the game with us were tens of thousands of non-affluent looking fans paying the same sort of cash for their evening’s entertainment.  So what impressed me is how much money the average American still has to throw away for a pretty mediocre evening of distraction.  I guess the U.S. economy can’t be hurting THAT much.  At the game, it certainly did not feel anything like what we’ve all read about the time of the Great Depression.

My sense is that what’s happening in China may have as much macro-economic impact on us as the immediate course of the U.S. economy.  I’m concerned that China’s growth rate may disappoint.  Consider the Chinese-powered commodity boom of the past few months.  It’s now looking like the great boom in China’s commodity purchases in early 2009 was due to  inventory building and will not be sustained unless Chinese growth rates return to the 10% plus area. But the Chinese will not accomplish their growth goals if exports to the West do not revive, which may well not happen. Chinese angst about their growth falling short of their goals seems to be growing and that angst seems to be pushing them toward protectionism.

Some would argue that the Chinese, particularly in their Yuan-rate-setting, has been protectionist all along.  Now they are adding new tax incentives for exporters, an illegal subsidy.  They were just hit with a World Trade Organization complaint from the OECD (U.S. and E.U) against their embargoing the export of certain commodities that the OECD claims are vital to OECD production capabilities. (Could the OECD be including Rare Earth Elements among those commodities?) And I’m sure China is continuing to act in a number of other ways to push their own economic interests in conflict with the principles of fair trade including practices like patent infringement and theft of technology.

Two fairly significant and negative implications are: 1. Chinese growth, because of flagging exports, may disappoint both the Chinese and global economists who are counting on China to lead the world out of recession, and 2. A trade war between China and the OECD may develop.  If the OECD is finally forced to defend its economic interests more robustly against Chinese trade infringements, that will not be conducive to global economic growth.

All of the above commentary is consistent with the concerns I expressed in last month’s newsletter.  Namely:  if reflationary forces do not overpower deflationary forces, the U.S. and global economy may continue to sink or to simply wallow at a reduced level for a much longer time than investors have been assuming will be the case.   A corollary to that is that economic disappointment might well  lead to lower stock prices.  And the underlying reasoning for the problem, as was discussed at some length in the last newsletter, is that we are experiencing a deleveraging recession, the first one since the Great Depression.

Oil

As I said last month and in more detail more recently, the dull economic outlook is likely to take the wind from the sails of speculation that have been propelling oil upward.   Even if the economy continues to show signs of bottoming, speculative money that has pushed oil prices higher is not likely to continue coming into oil because prices are now high enough to begin supporting new oil production efforts. I’ve seen evidence in the oil futures options market that speculative interest seems to be coming out of oil.

On the other hand, it must be recognized that there do exist some fundamental oil supply impediments that are being generated by conditions in Mexico, Venezuela, Nigeria, and even Canada, as I’ve discussed.  So I don’t expect a significant collapse in the oil price either.  In fact, it would not be surprising if there were a general drift upward in the oil price.  What I’m suggesting is that the rapid trajectory rise in oil prices since mid-February is not likely to continue in the short term, say the next 3 - 9 months.  I suspect we may see a trading range between $60 and $75.  It would not shock me if oil were above $80 by year end if the economy starts to recover or a bit below $60 if there is no recovery.  Obviously, whatever happens to the U.S. dollar will also have a major impact on the oil price, but the dollar seems to fall with economic optimism and rise with pessimism, which would reinforce the concepts in the sentence prior to this one.

I was interested to read some recent comments from Charlie Maxwell, the dean of oil analysts.  Charlie had been expecting a crunch in the oil supply starting in 2010 which will get worse through 2015, by which time he expects “all liquids” production to peak.  Presumably after that peak, supplies would continue to get even more scarce.   Now Charlie says that the global recession adds another two years to “easy oil.”  But he also says the world is unlikely to take much advantage of that reprieve to augment its future supply capacity or reduce future demand appreciably.  He now expects tightness in the oil market to begin to manifest itself in the 2011 - 2012 area and to build from there and he fully expects a calamity by 2015.  Click on the link above to read his insights.

I continue to expect oil supply tightness to manifest itself in 2011, as indicated in my March analysis.   (It’s always reassuring to be on the same page as Maxwell.)  I think Mexico will be supplying nearly 1 mb/d less by the end of 2011.  Venezuela is likely to be supplying less, particularly to the U.S.  And I think it’s not unlikely that we will hear of problems with Ghawar production by 2011.  Moreover, many OPEC countries will be using a lot more of their own production, thus having less available to export, and oil demand will have continued to grow in developing countries, particularly in Asia.

So all in all my suspicion is that we’re in for rather dull times near term in both stocks and oil with potential for pullbacks in both.  An interesting, positive market may not begin until some time into 2010, after which both a real economic recovery and some early pressures on oil supply may become evident.  Of course markets anticipate, so maybe that “new day” will start to get discounted later in 2009.  But for now and the near term future it looks like the Summer of ‘56 when I was thirteen.  Not much hap’nin’.

Incidentally, all bets are off if we end up in a hot conflict with North Korea.

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