What A Difference Three Months Can Make

This article was originally published on RealMoney Pro at 12:00pm EDT on May 16th, 2016

What a difference three months can make.

In our post on February 16—three months ago today—optimism was in short supply on both Wall & Main Street. The story on a daily basis was oil, which had fallen below $30 per barrel, putting at risk the finances of just about every single energy producing country and company in the world. Further, cheap oil (priced in USD) was putting enormous upward pressure on the greenback, creating strain for anyone who does their borrowing in dollars (and then the obvious knock-on effect for any companies who rely on consumers doing their borrowing in dollars).

Since not a whole lot has changed in the past three months, aside from the prices of just about everything, I thought it might make sense to revisit the six “most crucial data points” originally discussed in February’s post:

– Economic Data
– US Dollar
– Oil
– China
– Central Bank coordination
– Technical Picture for stocks

1. Economic Data

The argument for lower stock prices generally comes not necessarily from weak economic data—but from weakening economic data. And whether or not  economic data is weakening, or about to weaken, is often a matter of opinion. Nasty selloffs, like the one with which we began the year, have a way of influencing our view of the economy’s strength and prospects. And it’s understandable, but also the reason why there is no place for emotions in successful long term investing.

Gasoline demand was one piece of information we pointed to—this remains strong, aided by lower than normal oil/gas prices. The bottom line is Americans are driving more miles today than ever before; US consumers’ optimism is reflected in their driving habits (notice the dip after 2007).

Earnings are up among US workers, too. While there is certainly some skew in this data, the trend is slowly and steadily—but most certainly—up since 2010.


Low unemployment rates with rising average hourly earnings = a healthy(ier) US consumer. And a healthy US consumer is pretty darn important since Americans’ consumption is responsible for an estimated 70% of our nation’s GDP.

2. US Dollar

Three months ago there was no doubt—according to television prognosticators—that the US Dollar, whose strength last year wreaked havoc on S&P companies’ earnings per share, would continue strengthening. After all, we are supposedly entering a Fed tightening cycle (while other major Central Banks remain in ease mode) and prospects for growth in the rest of the world remain tenuous at best.

We argued that the Dollar had almost certainly peaked, maybe as long as a year ago, and had in fact already begun to weaken against a basket of other currencies. Further, we pointed to the fact that—once USD weakening was confirmed—a very bullish picture could emerge for several different asset classes. With every decade, the global economy becomes more and more interconnected, which means stability and growth in the United States depends more and more on stability and growth elsewhere. If commodity markets are falling apart (Commodities are mainly priced in dollars, so dollar strength puts downward pressure on commodity prices) there is little chance for stability, let alone growth, in commodity-producing nations. And then you have the negative knock-on effects to their currencies—if a commodity-producing country has issued debt in USD terms, that’s a vicious cycle.

If the strong dollar cycle has truly come to an end, as I believe, we could see continuation in some major trend reversals which have begun to unfold already this year.

In my opinion the USD is the single most important data point in today’s market—both for stocks and bonds, in every market across the globe.

3. Oil

Three months ago you couldn’t pick up a paper or login to any news website (financial or not) without seeing a story about oil at multiyear lows and how the Saudis were going to keep it there in an effort to “destroy” US Shale. And Iran. And Russia. Unfortunately for those who believed that story line, not even Saudi Arabia has that kind of power.

In our February article we questioned the argument that the Saudis can afford to keep their government running, and currency pegged to the US Dollar, with oil as low as it was. The fact is they cannot. They are burning through their US Dollar reserves at a record pace—partly to offset the loss in revenue from low oil, and partly to support the Riyal (they must spend dollars to buy Riyals to support its value). Additionally, the Kingdom has recently come out with ambitious, if not laughable, plans to wean the nation off oil by 2030. Bear in mind that the petroleum industry is responsible for generating over 90% of Saudi Arabia’s government budget revenues and 55% of their annual GDP.

It seems the market is starting to call Saudi Arabia’s bluff, or at the very least come to terms with the fact that production is starting to drop off rapidly almost everywhere else—supply and demand are coming into balance, finally, and the market is anticipating that at current prices (and likely until we see $60-70 per barrel) that dynamic will continue to get healthier. At higher prices, we’re likely to see some production come back online which would once again ramp the supply side of the equation; we are nowhere near that.

We hear a lot about how the price of oil is influenced by the strength (or weakness) of the US Dollar. As far as I know, I am the only person advocating that it may well be the exact opposite—that the price of a barrel of oil is actually the key determinant in figuring the value of a dollar. Since nobody else is making the argument, I have literally no data to point to on this topic. But if I’m right and oil continues to stabilize or move even higher still—which I believe is not only possible but the most likely outcome—then we could see further downward pressure on the dollar. This would be good for risk assets (and bad for bonds).

4. China

China has remained relatively quiet for the past few months. I maintain that it’s their currency—the value of their Yuan versus a basket of other major currencies, including the USD—that is the most important thing, and not their stock market (as represented by FXI or ASHR). Both the Yuan (vs the USD) and China’s stock market are, more or less, in the exact same place as they were on February 16. To be fair, though, both their stock market and currency have been trending lower for the past month. This is definitely something that deserves our attention.

Again, we’ll be watching this one closely, but it wouldn’t surprise me if we see the Yuan remain in a quasi-manipulated range for a bit, and their stock market begin to react favorably to its newfound stability and, of course, any continued improvement in commodity land.

5. Central Bank coordination

While you won’t find anything in writing, there are plenty of rumors circulating the finance world about a so-called “Shanghai Accord” that may (or may not) have been reached at the most recent G-20 summit in February. The rumors go like this—the US Dollar got too strong, for everyone, last year and if the world’s other major economic powers will agree to stop devaluing their currencies in coordinated fashion, the dollar ought to naturally weaken against them. Those using their dollars to purchase goods or services denominated in other currencies would be “hurt,” true, but the benefits from more stability in commodity markets, and the economies and currencies of commodity producers, would be more than offsetting. At least, this is the argument being made.

Again, there is nothing you will find when searching the internet for such an agreement—but most market action immediately following the G-20 meeting suggests this may be exactly what’s going on. A more thorough description of the rationale behind the rumor, and the basis for it being just what the markets needed, can be found here.

6. Technical Picture for stocks

The technical picture is a bit mixed, actually. The charts suggest caution is more warranted today than at any time in the past three months (which only makes sense after a nearly 15% advance).

However, we are seeing other signals that reflect the amount of bearishness among market participants which is generally associated with short-term bottoms. The CBOE Options Total Put/Call ratio is a measure of how much options volume is being purchased for insurance (puts) versus that for upside exposure (calls). The ratio as of Friday’s close is indicative of fear in the market—substantially more puts than calls changing hands—and, as you can see below, is actually a pretty decent predictor of good entry points. Of course, the put/call ratio can go higher than it is now. And if the market is to head lower still, it almost certainly will.

* Thanks to @ukarlewitz for the above chart.

Taking all the information above, one could certainly draw several varying conclusions. And every investor’s goals and timeframes are different. But there is no doubt that upside opportunities in US stocks are not what they were three months ago.

Our next post will focus on other opportunities that have presented themselves as a result of under-the-surface shifts we’ve seen over the past year.

Don’t hesitate to reach out if you would like to engage us in a dialogue about your investments, whether or not they are held with our firm.

Have a great week.

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main

Adam Scott’s profile on RealMoney can be found here.