Is the market really falling because of oil?

The consensus view is that the overall stock market is being dragged down by the slide in oil prices. This makes sense – logic dictates that falling oil prices have an immediate negative impact in terms of dragging down the prices of oil-related equities, and a longer term positive impact due to an increase in consumer spending.

The immediate negative component will be larger now than in the 1980’s, because the economy has grown more dependent upon oil companies in the wake of the 2007-09 crisis. Oil companies were partially responsible for the recovery America has shown since – it makes sense that anything that imperils the health of these companies would imperil the recovery as well.

Oil price may have overshot to the downside. This is the consensus view anyway – most market participants expect the oil price to overshoot to the downside, as part of a Saudi Arabian scheme to shake out American shale oil drillers. Market participants also expect that oil will rebound within 18 months to previous levels (circa $100) after many of the weaker, more highly leveraged firms have been pushed into bankruptcy.

If the consensus view is correct, the move is to be short oil companies now, long retail and airlines, hold until a bottom in the oil price, then switch to well-capitalized mid-cap oil companies. These latter companies will be able to survive the downturn, and emerge more profitable than ever when the oil price picks back up. The added bonus of holding these companies is that oil majors, like Exxon, would rather acquire than drill for growth in an environment of oil price instability, so by picking the strongest companies, investors could benefit from an acquisition.

The fact that there is so much consensus on this makes me nervous. However, I have no basis for arguing with it. The real question, then, is whether I should join in. With oil prices in the mid $50’s currently, I can answer with a no. The risk of joining the “short oil, long retail and airlines” play is that a trend so advanced may easily correct, so even if I got the trend right, I could be pushed out with a loss by a sharp correction.

Therefore, I have to wait for the next leg of events to begin to participate. In the meantime, I have to formulate a working hypothesis of what is going on.

One thing is apparent, if the market is really falling because of oil, then the market should stop falling when oil bottoms. However, if oil price were to stabilize at current levels and the market were to continue to decline, it could be a sign of something bigger.

I have been expecting a serious correction in equity prices for some time, but I have been repeatedly punished for my bearish views. This could be simply a case of wishful thinking. However, there was a sharp correction earlier this year, that I never found a satisfactory explanation for, other than simply “valuation”.

The fact that market participants are starting to take valuation into consideration is dangerous for the market. In an environment of historically low interest rates, we would expect historically high valuations. If participants are starting to question this process, it could begin to unravel. What makes such an unravelling especially dangerous is the fact that the Fed probably has the data it needs to begin to raise interest rates. Market participants placing more importance on valuation considerations, combined with an increase in interest rates, could create a rapid and deep correction, and possibly a bear market.

The only argument I have against this scenario is that there are strong disinflationary forces in the market: 1) the falling oil price and 2) the strong dollar. These may function to keep inflation below the Fed’s target, allowing it to delay the interest rate hike further and further into the future. The market consensus has been that the rate increase would happen in the early part of 2015, however, latest events should push this at least into the latter half of 2015, if not later.

If this is the case, then the bull market ought to be able to sustain itself, and the indexes will emerge from this dip stronger than ever. In fact, after so many small corrections, we might expect valuations to completely detach from reality. We might see former high flyers in the tech space regain their peaks.

On the other hand, if the market continues to slide after oil stabilizes, then the market may be in for a longer term beating, in which high-flyers are pulled down by the market correction.

One thing is for sure: oil cannot stay in free fall forever. Eventually, it will hit a bottom, and at a current price of $56, I think this will happen sooner rather than later. Then we will have our answer to the above question, and I will have a basis for beginning some speculations.



After the massive gas deal between Russia and China, Gazprom looks like it might be an interesting play.

  • We know it will be doing $400 billion of business over the next 40 years.
  • The market has discounted the price of Gazprom over concerns that Europe may stop buying its gas. However, this is an unlikely scenario.
  • The company trades at a P/E of 3. Part of this may be because of distrust of accounting at Russian companies. However, the valuation looks extremely low.
  • Russia’s market as a whole has been discounted because of the invasion of Crimea. This discount may subside as the situation de-escalates.
  • The key risk is the cost of building the pipeline. China will front $25 billion for the deal. However, the excess costs will come out Gazprom’s capital expenditures. These costs will come over the next several years, while the revenues from the deal will not come until 2018. Equity markets are notoriously short-sighted, typically with a time horizon of 18 months. So any gains in the stock may not come until 2016-2017, while in the near term the stock may be weighed down by costs.

Future Speculation Ideas

I have had a lot of trouble finding the time to do more formal posts lately. Thus, my blog will transition to more of a quick notes format. More formal articles will now be distributed to my Seeking Alpha page, and linked here.

1. Healthcare bubble. Healthcare stocks have been going up. All the traditional healthcare (Johnson and Johnson (JNJ)) along with newer biotechs (Pacira pharmaceuticals (PCRX)). Likely going up because Obamacare means more people that were uninsured will now be insured. Thus, theoretically, more care overall will be provided. Trend will likely reverse when electronic medical records are instituted. EMRs will enable rationing of care, thus decreasing healthcare consumption. This is a weak theory, needs refinement.

2. Internet of things bubble. I havent seen public excitement about this yet, but the underlying trend is there. My hypothesis is this is in stage 1 of George Soros’s boom bust model.  Fundamentals look promising. The key four companies are Sierra wireless (SWIR), NMRX, ESYS, and Cisco (CSCO).
The PE ratios aren’t that high. 24 for SWIR, 20 for ESYS, 15 for CSCO. PE ratios typically get to 100 in a bubble. If the internet of things does become a bubble, there could be upside here.

3. Marijuana bubble. This looks promising. Many penny stocks. The only real company I’ve seen is GWPH. Pharmaceutical company making marijuana drugs. This company is up 1000% in the last year. It may be at the top of a bubble, or it may continue. It has been experiencing a little weakness in the past few months. Unsure if this is a test phase or a sign of a “double top”. Possibly watch this for signs that the bubble is about to burst, and then short.

4. Russia speculation. Russia’s stock market has been down because of the Ukrainian tensions. There is a fear that Europe will stop buying gas from Russia. However they have no alternatives. There is some LNG from Qatar, but not enough. It would be extremely inefficient to get LNG from Australia. US is not providing LNG until next year. Therefore, Europe will not stop buying Russian gas. Russian market is trading at a P/E ratio of 6. Some of that is because Russian accounting is very bad. But it is probably too low, and will recover in 12-18 months, if Russia does not annex any other countries.

5. China speculation. Chinese market has been depressed because authorities are trying to pop the real estate bubble there. There is a large banking system that is not accounted for on balance sheets (I.e. Companies issuing IOU letters of credit, etc) and there is fear that this informal system will collapse. This may happen. There is real risk. However, eventually markets will recover. China still has a long term expected growth rate of 6-7% or so, more than double the US growth rate. It is currently at a P/E of 10, while the US is at a P/E of 18-19. The perception of China may get better towards the end of the year, because China is predicted to overtake the United States as the largest economy in the world by 2015. The trick with this play is to find the bottom of the downturn, and to pick the stocks that will benefit most from a recovery from the dip.

Your Brain Isn’t Made for Trading

“Our brains are hard-wired to get us into investing trouble; humans are pattern-seeking animals . . . .Our brains are designed to perceive trends even where they might not exist. After an event occurs just two or three times in a row . . . the anterior cingulate and nucleus accumbens automatically anticipate that it will happen again. If it does repeat . . . dopamine is released . . . .Thus, if a stock goes up a few times in a row, you can reflexively expect it to keep going up . . . .Brain chemistry changes as the stock rises, giving . . . a “natural high.” You effectively become addicted to your own predictions.”

Cyprus talks mean the worst may be over for Turkey

Turkey’s stock market has been in a downward spiral as Prime Minister Erdogan looks more and more like a dictator than an elected official. This has alerted me to a possible situation where the worst possible outcome is priced in to the market, and the downside is limited compared to the upside.

A possible catalyst for a rebound in the Turkish market may come on the back of reunification talks with Cyprus. Officials from Cyprus and Turkey would need to cooperate to build a natural gas pipeline to Europe, which would be a huge boon for the region. If reunification does occur, it would provide a boost in the form of increased natural gas exports.

Both countries have an incentive to find a solution. And Western countries have an incentive as well, because European countries need the gas, and United States energy companies are involved in its exploration. Because all parties have a stake in the matter, there is a good chance the deal could go through. If it does, I believe the Turkish stock market could rebound.

Thus I have begun a small speculation in TUR, the Ishares Msci Turkey Investible Market Index. If the deal actually goes through, I may increase the size of this position. However, I want to keep it small in the meantime on the possibility that the situation with Prime Minister Erdogan could further deteriorate.

Thoughts from Victor Sperandeo

After a large bull movement like the one we have just had, the odds for further price appreciation decrease. However, that does not mean that one immediately needs to sell – investors need only become increasingly more critical of positive news, and more watchful for negative news.

In the words of Victor Sperandeo:

“…the median extent for an intermediate swing in the Dow during a bull market is 20 percent. This doesn’t mean that when the market is up 20 percent, it’s going to top; sometimes it will top earlier, sometimes later. However, what it does mean is that when the market is up more than 20 percent, the odds for further appreciation begin to decline significantly. Thus, if the market has been up more than 20 percent and you begin to see other evidence of a possible top, it’s important to pay close attention to that information. ”

– The New Market Wizards, Schwager, 1992

After a 30% up year for the S&P 500, this market move is growing old. Though there are no immediate signs that the move will end, going forward into 2014, investors will need to be cautious and wary of signs of a top.

The Two Sides of the Taper

If the “taper”, i.e., the tapering of the Federal Reserve’s Quantitative Easing program, occurs soon, it has positive implications for the USDJPY. This is because Japan is the probably the only country out there that is using quantitative easing with the express goal of lowering its currency, and it is doing so on a scale that much larger than any other country. Coupled with those two factors, the belief of traders that Japan will be successful in driving down the yen, is further driving down the yen.

If the taper does not occur soon, however, it will mean that Hong Kong will come under greater pressure to release its peg to the U.S. dollar. While inflation is slowly rising here, it is rampant in Hong Kong. Eventually, Hong Kong will need to break this tie. But that time will come sooner rather than later if the US continues to devalue its currency via Quantitative Easing.

More signs of shipping rebound

All signs are pointing towards a shipping rebound. This has become my most attractive investment idea. I will have to find shipping companies that are:

a) trading at significant discounts to book value

b) profitable, or have a high chance of converting from unprofitable to profitable in the near future

c) Geographically distributed. Unless I can get some kind of edge in determining in which areas the rebound in trade will be most pronounced, I may be best suited to distributing my picks to reduce my downside. For example, I could go with an Asia bias in the shipping portfolio. However, this would leave me with too much exposure to a pop in the Chinese and Hong Kong real estate bubble (which would decrease local shipping for Iron Ore). I would likely have to do hours of research to reduce these kinds of risks in my stock selection.

A Victory at Doha?

The Doha round has reached a successful negotiation. Though the agriculture issues have NOT been sorted out, this IS a momentous occasion. 

Until now, there has been no central arbiter of globalization. Globalization was allowed to proceed more or less unchecked during the 2000’s. This culminated in a level of interdependence that allowed a bubble in the American real estate and stock markets to have profound implications worldwide. 

In the years follow 2008, we have seen a total collapse of world trade. In an effort to restart their economies, many (most?) of the world economies are now printing large sums of money. However, this may spark protests of a “trade war”, and indeed, the direction I had expected this to go was a more and more protectionist stance in the major world economies. 

Now that the WTO has some credibility as an international arbiter, there is hope that this will be averted. In addition, there is more reason to believe that global trade will resume the growth trajectory that it has been on for the past 20 years. 

Thus, a speculation on the global shipping industry looks like a solid proposition to capitalize on the resurgence of global trade from the doldrums of the 2008-2012 period. Dryships, (DRYS), a company that has suffered immensely during the downturn, is my initial consideration, though I will have to do much more research over the upcoming days to find ways to best take advantage of this trend. Following a rationale of “invest first, investigate later”, I have already begun to build a position in DRYS, and I am investigating the financials of several shipping and ancillary businesses.