Oil prices in search of a bottom

March 1st was a “Super Tuesday” in more ways than one. While voters were making their selections in political primaries, investors signaled clearly they have had enough of indecision.

Rather than worry about China’s economy, the price of oil, or even our November elections, investors bought stocks.  

In fact they were in such a rush to buy, that the S&P 500 rose 2.39% for the day. This was the largest one-day gain since last August, and the best March 1st in S&P 500 history. Truly a super day.


Mood Swing

Why would investors go from the extreme fear of February 11th to euphoric buying March 1st?  The answer may lie in one simple observation: the price of oil.  

After a failed rally in January, by mid-February, oil was again at $26 per-barrel.  

Television pundits were assuring us this was not the low and surely oil would see at least $20 per barrel. Some prognosticators were even calling for a low of $10.  

According to these “experts,” this was a sure sign of an impending worldwide depression. And, thus, the stock and bond markets would certainly fall an additional 10% to 20% before hitting their lows.

Oil Bottom

While “Super Tuesday” may not have signaled the start of a new bull move up, in my opinion, it showed that February 11th was the end of the bear slide.  

As confirmation, we look at the percentage of common stocks more than 20% off their highs. In December, that number was 40%. By mid-February it had reached 70%.

This is an extreme reading and one associated with the intense pessimism prevalent at market lows.  

Since that time, both stocks and oil have rallied sharply and the percent of stocks 20% off their highs is below 50%.

Oil Rally?

While we are relieved to see higher stock prices at this time, we think the rally in oil is more important.  As we have alluded to in past letters, petrodollars in circulation are a main source of credit for the world economy.  

Low oil prices have reduced those dollars in circulation to a point where the world’s central banks could no longer supply enough credit to prop up their domestic economies.  

In addition, sovereign wealth funds were forced to sell investments in order to subsidize oil export budgets.  In our opinion, an improvement in the outlook for oil prices should relieve those pressures.  

Virtuous Cycle

In our opinion, there will be less stress on the banking system and the bond markets. And sovereign wealth funds may reduce or eliminate their need to sell stocks.

As a result, investors can put those worries on the back burner and concentrate more fully on the one issue that we believe really matters, the outlook for corporate earnings.  

Currently, we are beginning to see more evidence of a stronger US economy. Inventories are declining. Job creation and average hours worked are increasing.  

Optimistic Take

Consumer confidence is growing and, while subdued, consumer spending may start increasing.  

This would be a hopeful sign for the future of corporate profits as consumption represents 70% of our economy.  

So, while we will continue to watch foreign economies and domestic politics as indicators for the future of the stock market, our main focus now will be on the health and spending patterns of the American consumer.

Photo Credit: Troy Williams via Flickr Creative Commons