Slipping on an Oil Slick By Lewis J. Walker, CFP(R)

Good has become bad. The worrisome has become cheering. How long can such vexing conundrums continue? No, we are not talking about parental dealings with teenagers. We refer to the odd codependent relationship between energy prices and the direction of the stock market.

For the trading week ending 2/26/16, the S&P 500 Index ETF (SPY) closed at $195.09 per share, down -8.7% from a high of 213.78 on May 25, 2015. This covers a period of increased worry about slowing global growth, China particularly; declines in commodity prices, especially oil; the U.S. Federal Reserve Bank hiking interest rates; pressure on corporate profits. The darkest cloud in the current “worrystorm” seems to be the trajectory of oil prices.

Watch daily trading activity. Oil prices go up, even “a tad” as we say in the south, and the stock market closes up for the day. Oil prices slip, the market is down. It’s a dance between unlikely bed partners.

SPY hit a recent low of $182.86 per share on February 11, 2016. A mini-rally ensued on “hopes” that producers will limit output to prop up prices. For the week ending 2/26 crude oil prices rose by 3.2%. SPY closed at $195.09, up +6.7% from the 2/11 low point. A week or two does not a rally make, and the market either will be up or down by the time you read this. But back away from short term ruminations and ponder overriding realities.

We used an analogy involving parents and teenagers. Parents, you love your children but at times, it’s you who wants to run away from home. Take a boy early in his teenage years. Sometimes you want to slap him silly, and you really don’t like him so much. But do you think that you can put your hand on top of his head and command him to “stop growing”? No, he will keep eating and keep growing. Fits and starts not withstanding, America and the global economy will keep growing.

Current worries are that slowing global growth will slide into recession and take the U.S. with it. We can’t say “never,” but we can opine, “not likely.” Recessions are caused often by high energy prices, high inflation rates, and high interest rates. All three metrics hover near long term lows. According to Bloomberg Businessweek (2/15/16), Goldman Sachs prognosticates the odds of a recession at 18%. A more positive spin is the odds of no recession at 82%.

The cure for low oil prices is low oil prices. World consumption of oil continues to grow. However, thanks to technology, production outpaced demand growth, hence a temporary oversupply. Marginal and high cost producers will be washed out, as real wealth moves from weak hands to strong hands. Debt encumbered assets will move to bargain buyers with cash to invest. It is a cycle as old as the invention of markets and means of exchange.

When the Federal Reserve Bank, midst much concern, raised short-term interest rates on December 16, 2015, the highly influential benchmark 10-year Treasury note rate was 2.30%. On 2/26/16, the 10-year note yielded 1.766%. In the short run, yields declined and bond prices rose. Interest rates remain at historical lows, favoring borrowers over savers. Good for those who want to buy houses and cars, or finance deals!

American writer E. B. White (1899-1985) noted, “Everything in life is somewhere else, and you get there in a car.” People are driving more, albeit with more fuel efficient vehicles. Transportation companies are using low fuel prices to fatten profits.

Investors have worried that the energy slump and a slower growth scenario will impact dividend paying companies. With low to zero yields on most safe bank products, money migrated to dividend paying stocks, and prices have taken a hit of late. Yet, if you extract energy companies, S&P 500 operating earnings have been rising, not falling. This does not presage recession or major cuts in dividends. As of 2/26/16, SPY had a dividend yield of 2.48%. The Dow Jones ETF (DIA) had a dividend yield of 4.42%. If you had a bond paying 4.42%, would you nervously watch daily trading prices? Not likely. You’d probably contentedly clip coupons and live your life.

Consumers power 70% of the American economy. Credit card and mortgage debt is way down from 2007-2008 pre-recessionary peaks. Consumers appear to be banking energy savings. Individually that’s a smart financial planning strategy, but eventually, spending will pick up.

Investors are skittish, with nervousness reflected in stock mutual fund outflows. Pre-recession market peaks usually are framed by rampant optimism and inflows. Our view? A recession is unlikely and dour pessimism unjustified. While nothing is guaranteed, we believe that patience and bargain-hunting will be rewarded! If nothing else, spring is around the corner! That alone is reason for a sunnier disposition!

Lewis Walker is President of Walker Capital Management, LLC. Securities and advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative and investment adviser representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC.