FINANCIAL REVIEW

Strange Bedfellows

Sinclair Noe — December 10, 2014

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

DOW – 268 = 17,533
SPX – 33 = 2026
NAS – 82 = 4684
10 YR YLD – .05 = 2.17%
OIL – 2.64 = 61.18
GOLD – 6.30 = 1227.10
SILV – -.05 = 17.16

Well, that was ugly. This is why we enjoy milk and cookies while we can. We’ve seen a lot of record highs in the major indices this year, but they remain rare birds. When we fall from record highs the drop can be fast, as it was today. The worst day since the start of October; wiping out gains from the past month.

The month of December has brought positive returns to the Dow every single year for the last five consecutive years. As you might imagine, there’s a lot of pressure to make it six. And it might still happen, despite the past couple of days. Still it’s a good reminder to stay awake through the holidays, keep your stop loss in place, however you employ your stop loss; and if you don’t have a stop loss it is time to wake up and smell the coffee.

Beyond that, it was just an ugly day, with decliners beating advancing issues 4 to 1. All 10 S&P industry sectors were down, with the energy sector down 3.3% as oil prices continue their slide. Brent crude dropped to $63.56, a 5 year low; and West Texas Intermediate dropping down to a critical area of support just above $60. If prices drop below $60 a barrel, the next level of support is around $50, and then further support at $33 from back in January 2009, at the depths of the financial crisis. Oil is cratering; it hasn’t done the full belly flop to $33 but this has been a wild drop.

The latest drop in oil comes as the US Energy Information Administration issued its weekly status report, showing weekly crude stocks were up 1.45 million barrels, against expectations for stocks to drop by 2.2 million barrels. In short, there was an increase in stockpiled crude inventory last week. This morning, Reuters reported that the falling oil prices have started to affect US domestic production, with the US Energy Information Administration (EIA) cutting its forecasted growth by 100,000 barrels per day, a move linked to generally weaker oil demand.

Also, in a report released today, OPEC also reduced its global demand forecast to 28.9 million barrels per day for 2015, the lowest since 2002, and about 1 million barrels a day less than current production. Increased US production and decreased demand have been cited as the culprits for crude’s rapid decline over the last several months. Now there are a couple of reasons for decreased demand; first, the technology has improved and we now have more fuel efficiency; conservation works (and a side note: Bishops from every continent have called upon the 1.2 billion Catholics worldwide to support renewable energy at a climate change conference in Lima, Peru. “As the church, we see and feel an obligation for us to protect creation and to challenge the misuse of nature.” The other reason demand is down is that the global economy is slowing and there is just less activity.

Again, think back to late 2008 and early 2009 when the global financial system was on the verge of meltdown. Today’s oil prices force us to question whether something is not quite right in the global financial markets. And if we have global economic problems, then that would imply that some things in the financial market have been mispriced. Start with the bond market. The Treasury yield curve has been flattening, meaning short-term rates have been rising, while longer-term rates have been falling. If oil were to hit $40 a barrel – and I’m not saying it will and we still have an important level of support at $60 – but if oil hit $40, that would most likely imply a 10-year Treasury with a yield of around 1%, especially in light of global markets where Greece is crumbling, the Eurozone is stagnating, China is slowing, and Japan is frozen in place. Consider that Germany’s two-year bonds have been negative, meaning that if you buy a German 2 year, you pay Germany to park your money.

Meanwhile, as stocks have tumbled and oil has cratered, volatility has picked up. The VIX is up almost 50% since Friday, rising from around 11 to almost 19 in less than 4 sessions. The VIX was up to around 26 in October, when we nearly had a market correction, but for much of the year, the VIX was almost asleep; back in the summer, a big story was how low the VIX was and how volatility had completely disappeared. And while markets were shook up in the fall, the VIX has still remained historically low.

There has been volatility at the gas pumps as well. The lower prices have been a windfall for drivers, with estimates that it puts billions of dollars back into our wallets. Goldman Sachs had estimated the savings at $75 billion; now they say it will be closer to $125 billion. Goldman analysts wrote a research report stating: “History suggests that higher gasoline consumption should show up quickly, while the boost to other categories of spending may take a bit longer to materialize,” and that should lift real gross domestic growth by up to half of a percentage point in 2015. And think about it, when oil prices go up, we have seen that it can throw the economy into a recession, but when oil prices drop it inevitably leads to economic growth.

So, heading into 2015, we have a boost from lower oil prices, then let’s make a comparison to same time last year. In 2013, we were just coming off a government shutdown that cost somewhere around $50 or $60 billion and by some estimates lopped off almost a full percentage point of GDP growth. And then there was the sequester, which lopped off another half a percentage point of GDP growth, more or less. And then there was the polar vortex, all that lousy weather that hit much of the country to start 2014. By comparison, the economy is looking pretty good right now.

The Treasury Department reported this morning that the budget deficit for November shrank 58% compared with a year ago. The November shortfall was $57 billion, compared with a deficit of $135 billion in November 2013. And the November deficit would have been $92 billion, or 8% less than the November 2013 shortfall, if not for calendar quirks. For instance, $41 billion in payments of veterans’, active military and other benefits that would usually have been made in November were sent in October since Nov. 1 was a Saturday. November is the second month of the 2015 fiscal year. For the fiscal year to date, the deficit is $179 billion, 21% lower than in the first two months of fiscal 2014. The shortfall for fiscal 2014 was $483 billion. Last year’s deficit was 2.8% of gross domestic product—the lowest by that measure since 2007.

And late last night, House and Senate lawmakers reached an agreement on a nearly $1.1 trillion bill to fund most of the government through September and avert a shutdown. It still faces an actual vote, which could be messy, because there are a bunch of things that are included in the bill that aren’t really part of the budget. And one thing not many people have heard about that may be a real problem.

If you have a pension and if House and Senate lawmakers approve the $1.1 trillion bill to fund most of the government through September and avert a shutdown, there is a provision in the spending bill would allow the promised pension benefits of up to 1.5 million workers and retirees to be cut. It would affect the pooled pension plans – called multiemployer plans – of mostly union workers across a bunch of companies, where it looks like the plans won’t be able to cover full benefits in coming decades. This would not affect all private pensions. The 31 million people in so-called single employer plans wouldn’t be affected by the bill. The bigger fear is about the 10 million workers and retirees in pooled plans. Ten to 15% of those workers are in plans that may need to make cuts. And the cuts could be drastic. For example, a retiree with a pension of $24,000 per year and 25 years of service could see his or her annual benefit cut in half; although not all troubled pensions would need to be cut that deeply.

Again, this doesn’t affect everybody with a pension. Nothing in the proposed bill affects pooled plans that are in good financial shape, or any of the plans offered by single employers. Still, I’m thinking this one will tick off a bunch of retirees, especially because this is not something that has been debated openly, but just seems tacked on because it can be tacked on.

But wait there’s more! It’s not just retirees, there is another little provision tacked onto the spending bill that would cut $303 million or 1.3% of the $22.5 billion for the Pell grant program. This is the grant program for low income college students. Not a huge part of the overall budget, but the interesting thing is where the money will go. Part of it will be used to fund student loan debt servicers. So, they cut the grants and spend the money for debt collectors on the loans.

And then there is the partisan bickering over the spending bill. Some Democrats are opposed to a Republican-backed provision in the $1.1 trillion measure to ease regulations imposed on big banks in the wake of the 2008 economic meltdown. They also opposed a separate section that eases limits on campaign contributions to political parties. Some Republicans are upset that the measure left the administration’s controversial new immigration policy unchallenged, at least until the end of February.

It seems there is something for everyone to hate. The AFL-CIO and the Heritage Foundation have both called for the spending bill to be defeated, proving that politics makes strange bedfellows. And maybe, just maybe setting the stage for the 113th Congress to make one more mess of things before they convene.