Happy Cyber Monday! With Black Friday behind us, it’s a pretty good time to do a check of market currents and what they mean. And despite my generally optimistic view of the US near-term economic landscape, a lot of what I am seeing now points to continued disinflationary pressure and global consumption weaknesses. A few comments below
First, on the retail front, it is still to early to gauge how successful this holiday season is going to be. Nonetheless, I want to point out two different data points that give diverging information. First, there is the undeniably good online sales for Black Friday. They were up 22% year-on-year. Bloomberg makes the surge seem like it is a bullish economic sign on 29 November:
Sales online the day after Thanksgiving surged 22 percent from a year earlier as U.S. consumers, buoyed by higher employment and lower gasoline prices, flocked to computers and smartphones to hunt bargains.
The gain outpaced online shopping on Thanksgiving as heavy Black Friday promotions attracted consumers, researcher ChannelAdvisor Corp. said today in an online statement. Sales at EBay Inc. rose 27 percent on Black Friday over last year, and Amazon.com Inc. saw a 24 percent increase.
The online gains give a strong start to a holiday shopping season that the National Retail Federation predicts will be the best in three years.
[…]
IBM Benchmark said Black Friday online sales rose 9.5 percent, and mobile sales jumped 25 percent. For Thanksgiving, mobile sales on smartphones and tablets accounted for 52 percent of online traffic.
The real question here is how much of the surge is about demand pulled forward and a switch to online retail channels and how much of the increase is actual demand increasing. We won’t know until the entire holiday shopping season has played out. Retailers were doing sales well ahead of Black Friday. I believe we are seeing a sizeable gain due to the increase in consumer discretionary income as oil prices fall as well as the lower unemployment rate.
But today’s Bloomberg story has a different tenor as sales fell 11% on Black Friday itself according to one estimate:
Even after doling out discounts on electronics and clothes, retailers struggled to entice shoppers to Black Friday sales events, putting pressure on the industry as it heads into the final weeks of the holiday season.
Spending tumbled an estimated 11 percent over the weekend, the Washington-based National Retail Federation said yesterday. And more than 6 million shoppers who had been expected to hit stores never showed up.
Consumers were unmoved by retailers’ aggressive discounts and longer Thanksgiving hours, raising concern that signs of recovery in recent months won’t endure. The NRF had predicted a 4.1 percent sales gain for November and December — the best performance since 2011. Still, the trade group cast the latest numbers in a positive light, saying it showed shoppers were confident enough to skip the initial rush for discounts.
“The holiday season and the weekend are a marathon, not a sprint,” NRF Chief Executive Officer Matthew Shay said on a conference call. “This is going to continue to be a very competitive season.”
Consumer spending fell to $50.9 billion over the past four days, down from $57.4 billion in 2013, according to the NRF. It was the second year in a row that sales declined during the post-Thanksgiving Black Friday weekend, which had long been famous for long lines and frenzied crowds.
So, the same source is giving us two very different data points that make it unclear how Q4 GDP is going to pan out. I still believe we will see a 3%ish consumption growth number with oil-related problems and capex reductions pulling US GDP growth down.
On that note, it was interesting to see an uptick in the seasonally-adjusted jobless claims number last week. It came in at 313,000, which is about 20,000 higher than where claims have been trending. Continuing claims at 2.32 million were the lowest since December 2000 though. So in general I see the job outlook in the US as supportive of growth. If the uptick in jobless claims remains sustained though, we should be concerned.
That brings me to the so-called oil glut that is causing prices to fall. The Saudis, as the eternal swing producer with excess capacity, have decided to let prices fall by not cutting output. Clearly, they are concerned about market share. But another meme is developing that the Saudis have geopolitical aims and predatory aims to punish shale producers in the US. I think this is all speculative and would prefer to concentrate on what we know. And what we know is the following:
- The conventional production of crude oil has plateaued or peaked. This oil was the cheapest to produce and easiest to find
- Until recent years, the plateau in conventional production was creating a supply constraint that kept prices elevated as emerging market demand surged.
- But, since 2008 unconventional sources of oil production in North America in particular have surged while demand growth in emerging markets has waned. I believe this combination is the genesis of the decline in oil prices, with the Chinese rebalancing and shale oil taking on the greatest importance.
- Shale oil production is expensive and economic only at high oil price levels, making shale producers vulnerable to declining prices, like deepwater drillers and Canadian oil sands producers. The evidence I have seen points to $75-80 a barrel as a tipping point.
So with oil prices $10 below the tipping point, we have to ask what will happen oif these prices are sustained for any length of time. First, lets remember that the Saudis and other conventional producers have costs well below these levels and can sustain production profitability indefinitely. The vulnerability for OPEC producers is fiscal and external account-related, and as such, is not necessarily a hard constraint for OPEC. Second, I am hearing that many shale producers have hedges in that would allow them to continue production even as prices fall below production cost. So, here again, it is not clear to me that we have hit hard constraints. Third, the lead times for production projects is long enough that a lot of production is already in the pipeline and cannot be ’turned off’ like a light switch from one day to the next. We are likely to see shale production remain at these levels for some time, with OPEC really being the swing production lever.
To me, all of this points to lower oil prices. Moreover, markets don’t just mean-revert they overshoot in both directions due to price momentum, herding and other factors. I would expect the boom bust cycle to take us lower and through the lower clearing prices to deeply oversold levels that create the need for severe capital expenditure reductions. And that means the potential for a sudden stop of expenditure and investment to the leveraged and overextended players is likely. We are likely looking at the beginning of a major bust in the oil patch.
Rosneft CEO Igor Sechin compared the shale boom to the dotcom boom. And I think that is apropos because the shale boom is real just as the initial Internet boom was. But it has become a bubble and well over-extended. The weakest players are going to be wrung out, just as the weakest ones were when the dotcom bust occured just over a decade ago. The major difference to note is the debt. There are lots of debts associated with this shale boom and the restructuring is going to have major implications on credit markets.
The oil price decline is one disinflationary sign that I find troubling. We know that there is weakness in China and Europe. And to the degree that these economies were beyond stall speed, the decline in oil prices would be stabilizing. But Europe is not beyond stall speed and perhaps China is not either. But oil is a global disinflationary symbol. The US equivalent, falling long-term yields, has come roaring back, with the 10-year now at levels below 2.20%. I pegged 2.25% as an outlier move because of economic weakness in my ten surprises in February. And we are now below that level. I would love to hear alternate views on what the yield decline is signal – move into safe assets due to high yield volatility, lower inflation expectations that mean lower future Fed Funds expectations, etc. To me, the signal is of disinflation that spells weakness.
At the same time, gold is getting killed here. I had said in February that gold had a 1 in 3 chance of breaking out to $1600 an ounce. But we are going entirely the other way, with gold down below $1150 at one point. This could be a sign of dollar strength, yes. But generally, we have to look at it in conjunction with the oil price decline and the yield decline as a disinflationary signal and one of economic weakness.
Overall, then, despite my upbeat views on the US, I think we are in a dangerous point in this business cycle, with most of the market signals pointing to weakness. What most concerns me is that oil at $66 is not just a disinflationary signal but one that can create distress via the over-leveraged fracking and shale sector that has become so important to the U.S. and to high yield markets. While oil price declines act as a tax cut for consumers and are stimulative, the longer we stay at these levels, the greater the likelihood of an ugly shale bust with severe implications for the U.S. economy.