Sometimes a dominant story continues from one week to the next. Crashing energy prices and continued selling of any related stock seems to have spilled over into the rest of the market. There will also be a Fed meeting with new projections and a press conference.
Will crashing energy prices change the Fed's course?
Prior Theme Recap
In my last WTWA I predicted plenty of discussion about a Santa Claus rally. It was indeed a popular subject, including some of those new live polls of TV viewers, but the story faded late in the week. It is a good thing I put a question mark in the title!
Here is Doug Short's weekly snapshot (with plenty of additional interesting charts in the post).
Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.
This Week's Theme
The decline in oil prices has been swift and sharp. Last week the selling clearly spilled over into other sectors, grabbing the attention of everyone. This relationship is the subject of considerable debate. It is happening on the verge of the FMOC meeting. Since the Fed remains a focal point for market analysts, I expect these two themes to converge:
Will crashing energy prices change the Fed's course?
The combination of the two requires analysis of each.
What does the oil price decline tell us about the economy (and therefore the stock market)? Here are the contending viewpoints:
Oil prices are a good economic indicator.
- Declining prices imply a serious decline in the global economy (Mainstream media – typical example)
- This decline may drag down the U.S. economy as well (perhaps via junk bonds- extensive analysis from Yves Smith) (earnings analysis from Brian Gilmartin)
- Other stock sectors will trade in sync with energy (investment spending cutbacks could ripple- Oil and Energy Insider)
Oil prices have a complex and varying relationship with other economic indicators
- Declining oil prices have a mostly positive effect on the economy (Dr. Ed on the IMF upgrade of the U.S.)
- Prices often move in a coincident rather than a leading fashion
- In 2008, high prices helped to create the recession, so oil was a contrary indicator
- In 2011, high prices reflected (inaccurate) QE speculation about inflation. The subsequent decline gave a false signal on the economy.
What will the Fed do as a result? Once again, we have dueling arguments:
The Fed is poised to do another round of QE
- A deflationary threat will spark a dovish shift in policy
- The Fed acts to protect stock prices
The Fed will react more to economic data
- This means eliminating the “extended time” before the first rate hike language, perhaps with a weaker substitute
- There may be more hawkish dissents
At the risk of oversimplifying, the “trader” community emphasizes the signal from oil prices. Bespoke has a good analysis with plenty of charts. Here is a key quote and one example:
The drop in oil is finally getting noticed by the market. Shocks to the system like this are not met with enthusiasm by investors, regardless of whether or not falling oil prices may ultimately be good for the economy. For now, it looks like oil is going to need to stabilize for the market to remain in rally mode.
The “economist” community, including economists at major street firms, emphasizes economic data.
Tim Duy is the leading Fed watcher. He believes that economic data support the Fed plan already telegraphed. Read the full article for plenty of supporting argument, data, and charts.
The “investment” community takes a long-term, data-based viewpoint.
Josh Brown is a vocal representative for this group, and argued forcefully both on TV and his blog – They're all making it up. In a refreshing look at actual data, he notes that oil prices frequently show a negative correlation with stocks. His conclusion:
They're watching market prices fluctuate and assigning meaning where none exists. Stories are being told and headlines are being crafted so that there is something for you to click on from your app when you check the news. This is nothing to be mad about, it is what it is. But the sooner you learn this lesson, the savvier a consumer of financial news you will be.
Daily market reports – collections of statistics woven together with quotations from whichever experts answered their phones – are inferior to raw data and charts. They're giving you an ex-post description of the beliefs of your fellow guessers who are no better at explaining day-to-day randomness than you are.
Trust me, I wrote a book about it.
I read that book and you should, too. You will both enjoy and learn.
I have some strong opinions on this question, with implications for investments. More about that in today's conclusion. But first, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.
