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

Stocks have made a big round trip over the past week, basically running up about 3% prior to the Fed rate hike decision and then running back down afterwards. The Fed did raise rates a quarter of a point last week, but that was widely anticipated. The sell-off seemed to be centered on declining oil prices and concerns over Chinese growth.

 

With respect to oil, recall that whether a price change is bullish (good) or bearish (bad) depends upon what’s driving it. Oil prices are driven by a confluence of factors – supply, demand, and the value of the dollar. Right now, both excess supply and the apparent collapse of OPEC (contributing to that increase in supply as each country increases production) appear to be driving the downward movement of oil prices. Demand growth is slowing, but absolute demand is growing year-over-year. That is, the world is consuming more oil now than it did a year ago.

 

I think the reason that this supply-led price decline isn’t more bullish has to do with the uncertainty created by its large and abrupt nature. Eighty percent of the world’s oil supplies are believed to be held by countries with state-controlled economies. What are the geopolitical dynamics to be expected from them with an oil price collapse? That’s the uncertainty I’m talking about. I do, however, feel that 2016 will start to reflect the more positive impact of lower energy prices for the world as a whole (the world is a net oil importer) rather than just the negative impact of increased uncertainty.

 

As for China, data coming out of that country suggests at best continued slowing, but stabilizing. I heard a fascinating statistic about China last week from former Treasury Secretary Larry Summers: China laid down more cement and concrete between 2011 and 2013 than the US did during the entire 20th century! That is a truly mind boggling statement, and here’s how to think about it:  In market-based economies capital gets allocated according to the dictates of profit and loss. That tends to move capital investment towards its highest valued use. Not 100% of it, because markets are hypothesis testing grounds with a lot of experimentation, but most of it. Conversely, in state-directed economies there is less tendency for capital to be allocated towards its highest valued use, and that leads to capital miss-investment or malinvestment. China obviously has plenty of that, not just in infrastructure but also things like manufacturing facilities. The way this is commonly expressed is, “China has a lot of excess capacity.”

 

So China is slowing, and this has affected other emerging markets, which were formerly the high growth areas of the world (some still are). The debate right now is whether or not this China-led emerging market slow down can pull the world in general, and the US in particular, into recession in 2016. This weekend’s Barron’s interviewee, David Levy of Jerome Levy Forecasting, thinks so. But Levy has been consistently negative since this bull market began in 2009 and has in fact been taken to task for this by Barry Rithholtz at Bloomberg (“My Prediction: Your Forecast is Wrong”- love that title!). I’ve mentioned that historically the US could drag the rest of the world into recession but not the other way around, and Levy in fact concedes that it has never happened in the post WWII period (i.e. a rest-of-the world led recession).

 

Others forecasters, like Jawad Mian, speaking on Wharton Business Radio last Friday, argue that global growth concerns are overblown. There is a return of “old economy” versus “new economy” thinking here, as Mian argues that the negative industrial production numbers are less relevant today than the more positive services numbers.  Mian also points out that credit conditions are improving in Europe, where bank finance is far more important than in the US (which finances through capital markets). And with respect to oil, Mian cites Gavekal’s Anatole Kaletsky that in each occasion on which the oil price was cut in half (1982-1983, 1985-1986, 1992-1993, 1997-1998, 2001-2002), faster global growth followed, while every global recession in the past 50 years has been preceded by a sharp increase in oil prices.  That’s probably putting too much emphasis on oil amidst other factors, but these facts are insightful.

 

All of this highlights an important constant in this business, and that is that you can always find someone who is positive and someone who is negative regarding markets, economies, and just about any asset class. Most analysts, and the data I see right now, point to neither boom nor bust for the global economy.