Markets Recover After Rough Week

Global equities halted a six day rout today as the S&P 500 gained 35 points or 1.95% and the Dow Jones Industrial Average gained 313 points or 2.0%. Retail sales numbers were better than expected this morning and finished up 0.2% in January and December was revised higher as well. These numbers beat almost all analyst expectations and suggest that the U.S. consumer is still very strong.

This is consistent with our narrative that the U.S. economy is still on solid footing and that recessionary fears have been overblown by the media and pundits. The initial jobless claims number was also better than expected on Thursday and suggests that the labor market is also still relatively strong. We are actually starting to see some wage pressure which is a very good sign for the economy.

Oil Prices Rebound:

Oil rebounded from the lowest level in more than 12 years amid speculation that oil producers could cooperate and begin to reduce supply. The United Arab Emirates Oil Minister Suhail Al Mazrouei stated today that, “producers are ready to work together and suppliers won’t make cuts unless there is complete cooperation.” Meanwhile, Venezuela proposed that the OPEC and non-OPEC producers should at least freeze output at the current level.

The demand for oil has been relatively strong over the past few months; the issue is that the supply has consistently outpaced demand over the same period. This has caused oil prices to lose over 75% since mid-2014. We expect to see a continued decline in U.S. oil production over the next few months which should help boost the price of oil. The U.S. rig count has already decreased by over 60% since January 2015, but U.S. production has remained elevated as the rigs that continue to drill have increased capacity. Globally, we are starting to see a similar trend as oil rigs across the globe have been reduced amid this oil price rout.

Equity markets have become highly correlated with oil prices as concerns surrounding the financial interconnectedness of oil throughout the economy have outweighed the positive effects lower oil prices have for consumers and non-oil related companies. These fears were elevated this week as oil prices sank to a 12- year low. Much of the reversal in the equity markets today can be attributed to the 12% reversal in oil prices.

The potential for losses on energy loans has become one of the top concerns for bank investors and the key driver to the over 20% plunge in bank prices this year. However, these fears are completely overblown as the overall exposure is very manageable. Perhaps some investors still have the bad housing loans of last century fresh in their mind and that has caused some of this apprehension. However, this is a completely different situation and there is nowhere near the leverage involved this time.

We expect volatility to continue in the near term and investors will remain fixated on oil price fluctuations. However, the macro economic data still suggests that the U.S. economy is still on solid footing and that recessionary fears are completely overblown.
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