Plunging Oil Prices Spark Fears of Global Recession by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
December 16, 2014
IN THIS ISSUE:
1. Could Plunging Oil Prices Portend Something Worse?
When Baupost, the $30 billion Boston-based hedge fund now managed by Seth Klarman, was founded in 1982, it was launched with a core set of aims. Q4 2021 hedge fund letters, conferences and more Established by Harvard professor William Poorvu and a group of four other founding families, including Klarman, the group aimed to compound Read More
2. Worst Week For Dow Jones Stocks Since 2011
3. Americans Finally Turning Bullish on the Economy
4. National Debt Topped $18 Trillion in Late November
Today, we touch on several bases. No doubt everyone reading this noticed that stocks tanked last week, and now seem to be moving in lockstep with oil prices. While consumers welcome cheaper gas and heating oil prices, there is a growing fear that the collapse in oil prices may be a harbinger of a global recession.
Despite worries that the oil price plunge is pulling down stock prices, the latest Reuters/University of Michigan Consumer Sentiment Index soared to a near eight-year high this month. Expectations for a better job market helped power the Index from 88.8 in November to 93.8 this month, well above expectations.
Finally, I am sad to report that our national debt topped $18 trillion on November 28 according to the Treasury Department. It was not widely reported by the mainstream media, of course. While our annual budget deficits have come down significantly from the first four years of the Obama administration, we are still on-track to hit a whopping $20+ trillion national debt by 2019.
Could Plunging Oil Prices Portend Something Worse?
Cratering crude oil prices may be a blessing to cash-strapped American consumers, but it’s a double-edged sword when it comes to the overall economy. The problem for the overall economy is not so much the drop in oil prices as it is the velocity at which oil prices have fallen.
The plunge from a peak of just over $107 (West Texas Intermediate) per barrel in the early summer to today’s sub- $56 is a massive drop of apprx. 45% in just a few short months, most of which has come in the last few weeks. This has analysts worrying that something worse may well be going on.
The rapid fall in crude prices is a telling sign to some Wall Street analysts and economists that there may be a global recession taking hold and the slowing growth is pushing oil lower. Remember, at the height of the financial crisis, crude got down into the high $30s a barrel at the end of 2008 as the US and Europe went into a recession.
Some forecasters believe that energy pricing forces have gone well beyond the supply/demand models and are now considering other geopolitical developments. As I wrote last week, I know of no forecasters that predicted oil prices would fall this far this fast.
There are plenty of commodity fund operators and hedge fund managers holding high-yield energy bonds that are taking it on the chin. Plus, several of the largest banks came out last week saying that while business in general was good, trading revenue will be down from last quarter – presumably due to losses in energy positions.
The banks did not attribute it to oil’s slide but, given the collapse in crude prices, it should be safe to assume that their profits from rising bond prices of late were dampened by plummeting oil prices in their commodity holdings and cratering high-yield energy plays, which may default at some point.
The swift collapse in energy prices has certainly taken a toll on our fastest-growing US industry and our country’s #1 job producer since the recession – domestic drilling for oil and natural gas. As the price of WTI crude is now below $55 a barrel, domestic drillers in Pennsylvania and the upper Midwest may be hard-pressed to keep production going full throttle.
At stake are nearly two million well-paying jobs. According to the most recent Bureau of Labor Statistics figures, the average worker in the oil and natural gas industry was making $107,198. That’s almost $58,000 higher than the average annual pay across all industries.
Big Oil is definitely feeling the pinch. ConocoPhillips just slashed its 2015 capital-expenditures budget by a whopping 20% to $13.5 billion earlier this month. The more than $3 billion budget cut was significantly larger than analysts were expecting.
In the past, lower oil prices were beneficial to the US economy, and they will be this time as well. Yet there are growing fears that the current collapse in energy prices may be a harbinger of a global recession. This explains why the plunge in oil prices spilled over into the equity markets last week and so far this week.
Worst Week For Dow Jones Stocks Since 2011
US stocks were pummeled last week as investors, rattled by collapsing oil prices and concerned about the health of the global economy, fueled triple-digit losses in blue-chip stocks. The S&P 500 ended the week with the biggest loss in two-and-a-half years, down over 3.5%, while the Dow Jones Industrial Average recorded its largest weekly decline since September 2011. Both markets were down again yesterday.
Last week’s jarring selloff came on the heels of seven straight weeks of gains and was closely linked to the precipitous fall in oil prices, sending a measure of volatility, the VIX, to its highest level since October 17.
Crude oil futures dropped more than 12% over the past week as global supply continued to outstrip demand, while the International Energy Agency cut its forecast for global demand yet again. Despite that, OPEC voted earlier this month not to cut daily oil production despite its own forecast that global demand for its oil is now the lowest since 2003.
You would think that those facts alone would sufficiently explain the sudden plunge in oil prices. Yet investors are growing increasingly concerned that the global economy might be succumbing to deflation, a consistent decline in prices that usually leads to recessions and depressions.
Stocks plunged from mid-September through mid-October before staging a sharp rebound that culminated with the Dow hitting a new all-time high earlier this month on the back of a strong US jobs report. Heading into last week, many investors were predicting that the Dow would soon top 18,000 for the first time.
But the sharp sell-off in oil has changed all that. Crude prices are now below $55 a barrel, their lowest level in more than five years. Energy stocks have been hit hard as a result. However, oil stocks were not the only big losers last week – and that could be another sign that investors are growing more nervous about the overall market and a weakening global economy.
It will be interesting to see how much longer this trend can last. If oil prices continue to drop and the economies of Europe, Asia and Latin America weaken further, that eventually has to hurt the US economy at some point.
Americans Finally Turning Bullish on the Economy
While it remains to be seen how the oil price plunge plays out, lower gasoline and heating oil prices are boosting consumer sentiment. Pessimism and doubt have dominated how Americans see the economy for many years. Now, in a hopeful sign for the economic outlook, confidence is suddenly picking up.
Expectations for a better job market helped power the Thomson Reuters/University of Michigan Consumer Sentiment Index to a near eight-year high in December, according to data released on Friday. The Index jumped from 88.8 in November to a higher than expected 93.8 this month.
US consumers also saw sharp drops in gasoline prices as a shot in the arm, and the survey added heft to strong November retail sales data (+0.7%) that has showed Americans getting into the holiday shopping season with gusto. Surging expectations signal very strong consumption over the next few months.
While improvements in sentiment haven’t always translated into similar spending growth, consumers at the very least are feeling the warmth of several months of robust hiring, including 321,000 new jobs created in November.
When asked in the survey about recent economic developments, more consumers volunteered good news versus bad news than in any month since 1984, said the poll’s director, Richard Curtin. Moreover, half of all consumers expected the economy to avoid a recession over the next five years, the most favorable reading in a decade, Curtin said.
The data bolsters the view that the US economy is turning a corner and that worker wages could begin to rise more quickly, laying the groundwork for the Federal Reserve to begin hiking its benchmark interest rate next year.
Many investors polled see the Fed raising rates in mid-2015, and the FOMC will likely debate at its meeting today and tomorrow whether to keep a pledge that borrowing costs will stay at rock bottom for a “considerable time.”
Consumers polled also see higher inflation ahead. Over the next year, they expect a 2.9% increase in prices, up from a 2.8% annual rate in November, according to the sentiment survey. Their expectations run quite counter to recent price data. The Labor Department reported that its producer price index dropped 0.2% last month, brought about by falling gasoline prices. Prices overall were soft last month, even excluding the drag from gasoline.
National Debt Topped $18 Trillion in Late November
On November 28, the Treasury Department reported that the national debt stood at $18,005,549,328,561. It was the first time ever that our debt was above $18 trillion. That exceeds total Gross Domestic Product of $17.555 trillion as of the end of the 3Q. So our national debt was 103% of GDP as of the last Friday in November.
The debt was at $10.6 trillion when President Obama took office in 2009 but has increased by 70% – or $7.3 trillion – during his roughly six years in office. That compares to roughly $4 trillion that was added to the national debt during all eight years of the George W. Bush presidency. Obama is on-track to double the amount Bush added to the debt.
When campaigning for the White House in 2008, then-candidate Obama routinely criticized President Bush for running up the national debt by $4 trillion, calling it “unpatriotic” and “irresponsible.” By his own reasoning then, he has reached a new level of irresponsibility.
Even worse, Obama promised at least four times in 2009 that he would cut the deficit in half by the end of his first term. Despite these promises, he racked-up deficits larger than all previous presidents combined and ran four consecutive $1+ trillion deficits:
|FY2009 $1.413 trillion||FY2011 $1.299 trillion|
|FY2010 $1.294 trillion||FY2012 $1.090 trillion|
The new $18 trillion national debt figure reached on the Friday after Thanksgiving drew little attention in the media largely because the federal deficit – the amount the US government spends annually in excess of revenue – has dropped in recent years from roughly $1.4 trillion in FY2009 to $506 billion in FY2014, according to the Congressional Budget Office.
The CBO expects the budget deficit to fall further to $469 billion in FY2015, but then it projects the annual deficits to begin rising again and approach $1 trillion by 2022 and beyond. Even with these lower annual deficits, the CBO projects that our national debt will top $20 trillion in FY2019.
Interest expense on the national debt is what usually sinks heavily indebted countries. The near-zero interest rate environment we have today masks the problem. When we return to normal interest rates, say 6%, the interest on the national debt will jump to apprx. 25% of tax receipts. We have recently seen what happens to countries with debt problems similar to ours. Spain, Portugal, Greece, and Argentina have all been brought to their knees by excessive debt.
For all these reasons, fiscal conservatives argue that the unprecedented national debt is still a huge problem. Count me among them! Kevin Broughton, spokesman for the Tea Party Patriots, calculates that the debt, when divided equally among the US population, means that “every man, woman and child in the country owes $56,250.”
To see US national debt in live time click here.
Composition of the National Debt
Of the $18.005 trillion in debt at the end of November, $12.923 trillion is “debt held by the public” and $5.082 trillion is “intra-governmental holdings.” Debt held by the public consists of all the outstanding Treasury bills, notes and bonds held by individuals, corporations, foreign governments and others.
Intra-governmental debt of $5.08 trillion includes special securities held by US government trust funds and special funds – or basically IOUs from the federal government for money that it “borrowed” from Social Security, Medicare and other trust funds.
[Note that the chart above from the Heritage Foundation was created last month,
before the national debt topped $18 trillion.]
As noted above, our national debt of $18.005 trillion equals 103% of GDP, if we include both the debt held by the public and the intra-governmental debt. Many analysts, however, only consider the debt held by the public as our national debt. They figure that the intra-governmental debt is money the government owes to itself. That is very misleading!
Intra-governmental debt consists of the debts that the federal government owes to itself through more than 100 government trust funds (Social Security, Medicare, etc.), revolving accounts, and other special accounts.
All of the Treasury securities held by the various government trust funds and other accounts mature at some point and must be repurchased, just like the debt held by the public. Thus, no matter how one treats intra-governmental debt, it must be repaid and should be included in any illustration of our national debt.
So when you read that the Congressional Budget Office estimates our “debt to GDP ratio” is only 74%, you will know that the true ratio is 103% if we add intra-governmental debt – as we certainly should!
Warmest holiday wishes,
Gary D. Halbert