Markets rallied strongly overnight, with the Dow, the S&P 500 and the NASDAQ all up by more than 1%.
The reason? Who knows? ‘A lot of folks are kind of scratching their heads,’ said one strategist about the overnight action.
Perhaps it was another fall in the oil price, which is sometimes good news and sometimes bad news, depending on who you ask. The price of West Texas crude fell below US$43 at one point, before finishing the session at US$43.79. That’s a new low in the oil bear market.
Funnily enough, the falls came after some bullish remarks on oil from Dr Ibrahim Al-Muhanna, advisor to the Minister of Petroleum and Mineral Resources for Saudi Arabia.
Speaking at a conference on the weekend, Al-Muhanna said that the recent volatility in the oil price was due to speculation and expectation, not fundamentals.
He dismissed conspiracy theories being behind the falls, such as Saudi Arabia trying to undercut more expensive US shale oil or a desire to hurt Russia economically.
As much as I love a good conspiracy theory, I agree with the bloke. The oil market is big, complex and ugly. You’ve got all types involved. But for one particular player to engineer a price collapse of more than 50% in six months is a big ask.
And was it the US and Saudi Arabia trying to hurt Russia and Iran, or was it Saudi Arabia trying to hurt US shale oil interests?
The problem with many conspiracy theories is that they are not consistent. Instead, they play on your prejudices and bias’ and prevent you from thinking about things logically and rationally.
Like with most commodities, there are a huge amount of futures contracts backing the physical oil market. This is where the big money players like hedge funds gain exposure to oil.
Their influence is so large that their positioning in the futures markets drives prices. As Bloomberg reports following the overnight falls in oil:
‘Speculators cut bullish oil wagers to the lowest level in more than two years amid warnings the U.S. supply glut may soon strain storage capacity.
‘Hedge funds and other money managers reduced their net-long position in West Texas Intermediate crude by 2.5 percent in the seven days ended March 10, U.S. Commodity Futures Trading Commission data show. Short wagers rose to a record.’
In other words, the money managers and hedge funds are less bullish on oil now than they have been in years.
That doesn’t necessarily mean we’re close to a bottom. These traders are driven by sentiment and momentum. The recent break to new lows for West Texas crude means you could see further falls.
Still, from a long term perspective oil looks like a good bet here. But as I’ve said previously, there is no need to rush in and buy. The trend is firmly down and this could persist for many more months.
In the meantime, a prolonged low oil price environment could do a lot of damage to energy stocks that have made massive investments on the assumption of much higher prices. That includes Aussie produces with big LNG plants about to come online.
It seems bizarre that the markets had such a strong session while oil and commodities in general were under pressure. It’s likely that the upcoming Fed announcement on interest rates (they meet on Thursday) is having a major impact on asset prices this week.
It’s widely expected the Fed will prepare the markets for a rate rise in the coming months. Does the rally suggest the Fed will persist with the ‘go slow’ on interest rate rises, perhaps because of the fear over a stronger dollar?
It’s a good question, because the market sure isn’t acting like interest rate rises are on the way.
One thing is for sure, if the Fed and other global central banks keep this easy money policy going for much longer, we’re heading into one almighty stock market bubble.
Two bubble warnings crossed my path in recent days. The first one is from Doug Nolan’s latest Credit Bubble Bulletin:
‘“Total Securities” as a percentage of GDP is helpful for Bubble Analysis. After beginning the nineties at 173% of GDP, “Total Securities” ended the Bubble year 1999 at an unprecedented 341%. The bursting “tech” Bubble saw this ratio decline to 267% to end 2002. Mortgage finance Bubble reflation then pumped this ratio to a record 360% by the end of 2007. The Bubble burst and “Total Securities” ended 2008 at 297%. Six years of incredible monetary inflation had Total Securities ending 2014 at a record 417% of GDP.’
Doug classifies ‘total securities’ as US debt plus equity market values. That we’re now well beyond late 2007 levels is scary indeed. But what does 417% of GDP mean? Why couldn’t we go to 517% or higher?
That’s the point I guess. There’s no knowing where this madness could go before it all blows up and reduces our financial system to a smouldering ruin.
The other bubble warning popped up in the Chanticleer column of today’s Financial Review. Apparently, a few advisers involved in the purchase of the Indiana Toll Road by Aussie infrastructure fund IFM, reckoned the price paid was an indication of a world gone ‘nuts’.
IFM paid US$5.7 billion for the US-based toll road asset, paying a massive 32 times earnings before interest, tax and depreciation (EBITDA). Ironically enough, the asset was up for sale because its previous owners paid too much and went into bankruptcy.
In 2006, Macquarie Infrastructure Group and Spanish toll road operator Cintra paid US$3.85 billion for the toll road. But the structure was too onerous in terms of debt and the owners couldn’t meet the interest repayments, so it filed for bankruptcy last year.
This is the joy brought about by prolonged low interest rates. No doubt the Fed is wondering just how exactly they can raise rates without causing a collapse of the system.
All major share market corrections over the past few decades were the result of rising interest rates in the US. The Fed raised rates too far, too fast and collapsed equity prices as a result.
Will they do the same thing again? By the end of the week, we’ll at least have a clue to this question.
for The Daily Reckoning Australia