08 May Ascend “Peak Points”….. 4th Quarter/Year End 2014 review and commentary
The markets exhibited increased volatility in the 4th quarter as investors weighed conflicting data on the outlook for domestic and global economic activity. A strengthening dollar and improving domestic data generally buoyed the US market averages while most foreign markets struggled. However, key US index returns were quite varied. Although the largecap S&P 500™ Index gained a bit over 13.6% for the year, roughly 70% of that return was attributable to only 5 stocks. Small caps struggled throughout the year by comparison, but were able to recover from the market’s sharp October selloff to advance by about 5% by year end. Interest rates continued to fall, defying consensus expectations that rates would trend higher throughout the year due to an improving economy.
Persistent deflationary concerns and a slowing pace of global growth in the Eurozone and China, plus the impact of economic sanctions imposed on Russia and Iran, continued to pressure the commodity complex. The sharp, 50+% drop in oil prices in just a few months caught us and many others by surprise. The magnitude of the drop seems unjustified given that the reported global production oversupply has recently grown to ~ 800,000 barrels/day of crude oil yet represents less than 1% of daily global consumption. Looked at another way, in a month’s time, that translates to about 1/4 day’s worth of global consumption (data from International Energy Agency). Anyone remotely aware of the instabilities in key oil producing regions around the world should recognize how quickly that excess production could quickly disappear. Recent production gains domestically have enabled the US to surpass that of Saudi Arabia, perhaps positioning the US to unexpectedly assume the role of the swing producer affecting global prices.
So why the steep price drop rather than a modest pullback? Several factors played a role. Derivatives trading certainly had an important impact. Fearful of growing US production and weak demand, traders/speculators aggressively liquidated their futures contracts, driving spot prices down. Reports of discounts by the Saudi’s to Asian and east coast US refinery customers to maintain market share was another. Why would anyone think they’d cut production to maintain high prices to the benefit of US producers? Lastly, increasing concerns about domestic storage capacity constraints in conjuntion with rising production have been cited as a factor, although recent US Energy Information Agency data indicates onshore storage capacity hovers at only 60% utilization.
In the near-term, the widely held belief is for lower energy costs to be a net positive for the global economy. Whether these lower prices will provide enough initial stimulus to offset the negative impact of job losses and sharply curtailed investment spending in the energy sector and related industries remain to be seen. Many observers are calling for $20-$30 prices which, while certainly possible, seems unlikely, barring a global recession or other financial crisis. The sharp drop in the active US rig count (left) over the past few months coupled with rapid production decline characteristics of these shale formation wells, should soon result in a slowdown -or decline- in US production growth. As that unfolds, stabilization and higher prices likely will follow.
Should you have any questions or comments, please do not hesitate to call.
John H. Bair, President
Ascend Wealth Advisors, LLC
7750 Town Centre Drive Suite 800
Broadview Heights, OH 44147