How the Petrodollar Could Drive US Stocks

How the Petrodollar Could Drive US Stocks

Could the petrodollar prop up the US stock market for the remainder of the year?

I know what you’re thinking: Bond yields are rising. Trump is a loony. And the European economy is slowing.

There are always factors to explain why stocks can’t rise.

But there’s also the danger of overthinking things.

I was reminded of this after reading about Diana and Lionel Trilling recently.

They were literary critics and writers living in New York during the interwar period. Importantly, they were also neurotic.

Some of this rubbed off on Jim, their child, who began to develop a fear of elevators early in life.

Diana theorised that this was a result of his ‘fear of the male genitalia being lost in the endless chasm of female genitalia’.

‘Actually mum,’ said Jim, ‘I’m just worried the cable might break.’

Like Diana Trilling, too many people are theorising about why stocks can’t go higher.

In overthinking matters, they’re missing the simple reasons why stocks can in fact go much higher.

The bullish tailwinds behind US stocks

Take your mind back to 2015 and early 2016.

The US stock market tanked twice in this period.

The worst fall was in January 2016.

The Dow Jones fell nearly 11% in about three weeks.

It was the worst opening day for a start to the year for US stocks since 1932.

What was the culprit? It wasn’t obvious at the time. It never is.

But it was no coincidence that the price of West Texas Intermediate (WTI) oil made a bottom on 11 February at a few cents over US$26. In 2014 the WTI was over US$100 a barrel.

This massive collapse in the oil price drove the sovereign wealth funds of the oil producing countries in the Middle East to liquidate their holdings of US stocks.

On top of this, they needed money to fund their domestic spending.

Importantly, producers have two figures they track when it comes to oil.

There’s the price they can profitably pull oil out of the ground — this can be under US$20 a barrel.

Then there’s the price needed to cover the cost of social spending and armament purchases, among other things.

This is why experts say Saudi Arabia needs US$80 a barrel oil to break even despite being the lowest-cost producer in the world.

So you can see there are two tailwinds for US stocks when it comes to oil right now.

There are the US energy companies making good money with oil over US$70 a barrel.

And there are the global producers that must spend the dollars they earn from trading oil.

This is where the potential boon lies for US stocks.

Sovereign wealth funds to recycle dollars in the stock market

Of course, sovereign funds don’t have to buy US stocks. But it stands to reason that if a crashing oil price can bring the US market down, a rising oil price can take it up.

Of course, there’s a limit to how high oil can go before it hurts the real economy. US gasoline, for example, is now at the highest price point since 2014.

However, I don’t think it’s gone so high yet to really crush demand. Americans have been cruising the roads extremely cheaply in recent years.

Here’s a chart of foreign inflows into the US stock market dating back to 1994.

Source: Yahoo; Hedgopia.com

You can see that the heaviest period of outflow was during the oil bear market.

I’m not saying the market won’t be volatile, or that other factors won’t come into play.

But this oil angle seems underappreciated at the moment.

Of course, the US stock market can set the tone for risk sentiment and outlook for equities in general.

But there’s no guarantee the ASX will follow if the US market does move up (or hold steady) from a profitable energy sector.

The Aussie stock market has lagged the US for nearly a decade now. We’ve got an idea as to why lately.

According to the latest Janus Henderson Global Dividend index, dividend payments lifted around the world in the first quarter of the year — except in Australia.

Thanks in part to Telstra Corporation Ltd [ASX:TLS] and QBE Insurance Group Ltd [ASX:QBE], the Aussie market actually went backwards. It’s only the miners that have delivered on the dividend front lately.

I’ve never liked the argument for buying a stock because of its dividend yield. Telstra is proof right now of how dangerous this strategy can be. It’s no good receiving a decent yield if your capital is running down.

Regardless, the Global Dividend index is further proof that, if anything, it is resource stocks that have the momentum and strength at present.

Regards,

Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia