The pervasive narrative on Wall Street is that the collapse in oil prices will, any second now, restore consumers to their profligate spending ways. In fact, financial pundits have been calling for plunging energy prices to imminently rescue the economy for the past 18 months. Most importantly, these same gurus, who love to espouse the benefits of a collapse in oil prices, never connect the dots to what this collapse says about the state of global growth. Instead they argue it is solely a function of a supply glut that is the result of increased production.
West Texas Intermediate Crude (WTI) fell from $105 a barrel in June of 2014, to well below $30 in January of this year. The cratering price of WTI did not occur from a sudden surge in crude supply, but rather due to the market beginning to discount future plummeting demand coming from a synchronized global deflationary recession. According to the U.S. Energy Information Administration, world crude oil production has increased by just 3.3% since June 2014. Therefore, it is sheer quackery to maintain that such a small increase in crude production would result in prices to drop by 75%.
Oil prices are either discounting an unprecedented surge in supply, or a rapid destruction in demand. The Baker Hughes Rig count on an international basis is down by 218 rigs y/y. Therefore, despite any marginal increase in new supply from the lifting of Iranian sanctions, the drop in prices has to be due to the market’s realization that demand for this commodity is headed sharply south.
It’s not just the oil price that has tanked. Stock market cheerleaders have to ignore commodity prices in aggregate and a plethora of economic data to claim the global economy is faring well. Nearly all commodities are trading at levels not seen since the turn of the millennium. It’s not just energy that has crashed but base metals and agricultural commodities as well. In addition, half of US stocks are down more than 25% and the equity market carnage is much greater in most foreign shares. High-yield debt spreads to Treasuries also indicate a recession is nigh.
But to prove the point most effectively, why would the Dow Jones Transportation Average be down nearly 25% y/y in light of the fact that the cost to move goods has dropped so severely? If the economy was doing fine, dramatically lower fuel costs would be a gigantic boon for the trucking, railroad and airline industry. In sharp contrast, these companies have entered a bear market as they anticipate falling demand.
Also, why have home building stocks crashed by nearly 20% in the last 2.5 months if the economy was doing well? Especially in light of the fact that long term rates are falling, making homeownership costs more affordable. And interest rates certainly aren’t falling because governments have balanced their budgets, but because investors are piling into sovereign debt seeking safety from falling equity prices and faltering global GDP growth.
Market apologists are also disregarding the blatant U.S. manufacturing recession confirmed by Core Capital goods orders that are down 7.5% y/y. And the ISM Manufacturing survey, which has posted four contractionary readings in a row. And now the service sector is lurching toward recession as well: the ISM Non-manufacturing Index dropped to 53.5 in January, from 55.8 in the month prior.
It’s not just the U.S. markets that are screaming recession. Indeed, equity market havoc is evident in North America, South America, Europe and Asia. In the vanguard of this mayhem is the Shanghai Composite, which has lost 50% of its value since June 2015; as the debt disabled communist nation tries in vain to migrate from the biggest fixed asset bubble in history to a service based economy.
The chaos in global markets: from high-yield debt, to commodities, to equites is all interrelated. It is no coincidence that the oil price began its epic decline around the same time QE ended in the U.S., and intensified as the Fed began to move away from ZIRP. The termination of Fed balance sheet expansion caused commodities and equities to roll over, just as the USD started to soar; putting extreme distress on the record amount of emerging market dollar denominated debt.
Therefore, it is inane to keep waiting for lower gas prices to save the consumer–that point is especially moot because whatever savings they are enjoying at the pump is being consumed by soaring health insurance premiums. The collapse in the oil price is a symptom of faltering global growth for which there is no salve immediately available. This is because there isn’t anything central banks can do to provide further debt service relief for the public and private sectors because borrowing costs are already hugging the flatline.
And that leads to the truly saddest part of all. If the deflationary recession were allowed to run its course lower asset prices, including energy, would eventually lead to a purging of all such economic excesses and imbalances. However, since deflation is viewed as public enemy number one, no such healthy correction will be allowed to consummate. To the contrary, what governments and central banks will do is step up their attack on the purchasing power of the middle class in an insidious pursuit of inflation through ZIRP, NIRP and QE.
That’s the truth behind the oil debacle. Don’t let anyone convince you differently.