"Kee" Points with Jim Kee, Ph.D.

Stocks pulled back last week for the third week in a row, resulting in the market being basically flat year-to-date. That’s far more in keeping with the historical data than the 13% annualized rate that the market was registering at the end of February. And while stocks in the US don’t register as particularly cheap, valuation levels don’t cause or predict market declines. Pullbacks (-5%), corrections (-10%), and even bear markets (-20%) are caused by shocks, a point familiar to Kee Points readers and a point well made in this weekend’s Barron’s:


“History suggests that bear markets more often result from factors external to the stock market, such as recessions, wars and credit bubbles. Since the 1920s, there have been ten pullbacks of approximately 20% or greater…Three of these occurred during the depression era and immediately after World War II. Five occurred during the latter half of the twentieth century and were related to global conflicts, bank failures, Fed tightening cycles and oil price shocks. The two bear markets in recent years were the tech bubble and the Great Recession.”


We are in the midst of two rather large shocks right now, namely, the collapse of oil prices and the tremendous spike (increase) in the value of the dollar relative to other currencies. Oil is still down over 50% from its June highs, and the dollar has increased over 17% since the recent spike began in earnest last May. There is a little overlap here, because a stronger dollar usually means lower commodity prices in terms of dollars, like oil. Most of the estimates I see attribute a small amount of the oil price decline to the dollar, more to slowing demand growth, and the most to increasing supply growth. As for the dollar, the mere fact that 10-year US Treasuries are paying above 2% while the rest of the developed world’s debt is paying just above zero, goes pretty far in explaining the dollar’s relative strength (itself a function of the timing of central bank easing with the US moving first and the rest of the world following). Stronger US growth and the global safe-haven role of the US dollar also contribute to dollar strength.


In the US, a problem with low oil prices is that the energy sector has accounted for an outsized share of capital spending and R&D (research and development expenditures) in recent years, and this spending is expected to fall fairly dramatically this year and next. Of course, the positive would be if capital spending in the other nine sectors of the economy could pick up to fill the gap, but a stronger dollar – which hurts US exporters – makes that challenging, particularly for the big global US firms (IBD).


But it is not all negative. The US has far lower energy costs than the rest of the world (partially due to policies like taxes), and the recent decline in oil prices has magnified this advantage. For example, back in June at oil’s peak, US West Texas Intermediate Crude (WTI) traded at $107 per barrel, while Brent Crude prices, set in world markets, traded at $113 dollar per barrel. WTI was about 5% less than Brent. But currently, Brent trades at $60 while WTI trades at $50, so Brent is now 20% higher than WTI. Although a simplification, this translates into lower energy prices for the world in general and the US in particular. That helps both businesses and individuals. And the negative impact of the stronger dollar on US exports can be partially offset by (slightly) stronger global growth, which is the consensus expectation (Wells Capital). Also, a stronger dollar helps firms that source or buy inputs overseas, and it helps consumers in the way of cheaper imports.


Perhaps the most interesting development of all of this will be its impact on the FOMC (Federal Reserve) meeting this week and Janet Yellen’s press conference. That will be on Wednesday.