Last Friday was January 9, 2015. Brent Crude — the price of North Sea oil and the most widely used benchmark1 for pricing oil around the world — closed below $50.2
Last June, it was worth $112. I think this qualifies as a collapse in oil prices.
We discussed this in a letter recently so we won’t repeat the details, but the bottom line is simply this:
1. Supply is expanding rapidly, due largely to the fracking revolution in the U.S.
2. Demand is lower, as the international economy softens. China, the world’s largest energy consumer, is definitely slowing down.
How far down can oil — and gas prices — go? That is anybody’s guess. But it appears that these lower gas prices have provided quite a shot in the arm to consumer spending, which has perked up. We also had a strong, third-quarter GDP growth number, the best in years.
What happened in the markets last year?
Well, U.S. markets for stocks and bonds did well, as the S&P 500 index continued to lead world equity indices and interest rates fell yet again, driving pretty good returns on bonds, one more time.
International equity and bond indices were negative, especially as the U.S. dollar rose against other major currencies.3
Profits have been strong, and though valuations have risen in equities, they are still within the range of reason, in terms of historical averages. One analyst pointed out that the NASDAQ is now close to breaking the 5000 mark that it last saw in the spring of 2000 at the top of the tech boom. The difference: Back then, the price-to-earnings ratio hit a sky-high 100! This time, it would be about 22. Heck of a difference. Different companies this time, many of them, and they have real earnings.
We point this out, because it is far too easy to be fooled by pictures and stories. A chart of NASDAQ prices could appear to indicate that we have returned to sky-high levels and another crash is sure to follow. I have heard people say that in response to price charts like this. A story: Look how long this rally has lasted! Six years! It has to end soon, of course…doesn’t it? Well, no, it doesn’t.
Logically, stocks are priced based on the expectations of the broad market for future earnings and an assessment of risk. The estimate of future earnings can change, risk tolerance can rise or fall, and perceived risk can get better or worse. Those things will affect stock prices. How long the rally lasts, what the price is versus some chart of yesteryear…those things mean very little.
So how is that recovery going?
Well, we have good news and bad news — same as the old news, unfortunately.
Labor force participation languishes at 1977 levels at 62.7%, and the average wage fell recently. People are still dropping out of the workforce, causing the reported unemployment rate to drop to 5.6%. We are creating jobs at a somewhat faster pace; it’s just nowhere near enough jobs. Plus, there is zero upward pressure on wages.
People have not spent money for a long time. Consumer spending has been depressed, until the recent big drop in gas prices put money in consumers’ pockets. This is appearing to do what many other attempts at economic stimulus have failed to do — generate some spending and boost GDP, at least for now, at a 5% annual rate in the third quarter.
We can only hope that continues.
And the international situation…getting any better?
Hard to say. Good news and bad news.
Good news includes greatly reduced oil prices putting severe pressure on several countries that are threatening their neighbors or the whole world, from Iran to Russia. Even ISIS depends on revenue from oil and from oil-producing sponsors of terror.
Cutting their budgets can’t be bad.
The Kurds in Kobani have survived so far. Still under siege.
Southeast Asia was a good story in 2014. India rose 23.9%. Undoubtedly, one of the primary drivers of the Indian equity market was the election of pro-business reformist Prime Minister Narendra Modi. His promises of turning India’s bullish demographics and tech-savvy workforce into an economic success story made this market a big star of 2014.
Other big winners for the year include the Philippines (+26.4%), Turkey (+19.1%), Thailand (+16.8%) and Indonesia (+27.2%).4
Bad news — where to begin?
From Peshawar to Paris, Islamist terrorists continue to be a global threat, killing innocent people in two separate attacks. Meanwhile, as Kurdistan hangs on by its fingernails, ISIS tightens its grip on much of erstwhile Iraq and Syria. U.S. troops are now there, especially in the Kurdish north, but elsewhere as well. Apparently, U.S. troops recently engaged ISIS, helping to repel an attack on an Iraqi air base in Western Iraq (Ein al-Asad). Inch by inch, we return.
Libya, now a failed state, is in chaos. Iran has been successful at delaying any action, pushing out deadlines and continuing its nuclear program. Russia continues supporting and participating in the underreported “insurgency” in Eastern Ukraine, after annexing Crimea. We can only await developments as oil prices fall, and Russia faces a big drop in GDP and a plummeting currency. Less dangerous now — or more?
Less dramatically, economies from Germany to China falter, even face recession, as Greece once again ponders bailing from the Euro.
At this point, you’re probably wondering: What does this mean for my portfolio? Well, with all this bad news, we might see increased volatility in the markets (as we have seen of late). So why does it still make sense for you to invest in international stocks?
It is nearly impossible to predict when there will be an inflection point and when the international markets will take off. Indeed, history shows that there are time periods when the U.S. market has done well and international markets have waned.
But there have also been periods where the opposite is true:
We may feel strongly that the U.S. is positioned to do well and the rest of the world is going downhill, especially given some of the recent economic data. But the economy and the market do not go hand in hand — history shows us that — and the market has already discounted much, if not all, of what we are worrying about today.
While it is uncomfortable to stay in your seat in the face of volatility, the benefit of having a diversified portfolio is that you participate wherever and whenever the returns do show up. This approach may not pay off every quarter or even every year (it certainly didn’t this past year), but over the long run, academic research and evidence show it’s the best approach for a successful investment experience.