Energy and the Global Economy
For months now, many Wall Street market mavens have
explained that rising oil prices wouldn”t have any significant
impact on domestic or world economic growth. I have recently
disagreed with this view. And if you caught any of the action in
Europe this week, or comments from around the globe, you
probably understand where I am coming from.
For starters, the IMF said that $30 oil (it finished the week
closer to $36), would cut growth rates by 0.5%. That doesn”t
spell recession, necessarily, but it can do a number on corporate
profits.
Meanwhile, Asian economies have become increasingly
dependent on oil over the years. The Asia-Pacific Economic
Corp. noted “the risks posed by oil price volatility to the world
economic recovery and for developing economies that are
heavily dependent on oil market conditions…The level of
increase in oil prices is seen as a major risk to the robust growth
which is the outlook for the vast majority of APEC economies.”
It”s important to remember that since the end of the Gulf War,
cheap crude has been a major factor in fueling the worldwide
expansion. But when the trend reverses in the violent manner
in which it has, beware.
Despite the high value of the U.S. dollar against European
currencies, this was not a week to be traipsing about the English
countryside or checking out the sites in Belgium, Germany and
Spain, to name a few. Government leaders were faced with
their biggest crisis in years as it seemed that anyone whose
livelihood was dependent to any extent on the price of oil took
to the streets, blocking roads and refinery entrances and, in
some cases, bringing whole cities to their knees.
Two weeks ago, the French government had given in to many
of the demands of the fishermen and truckers. The other
European governments were determined not to do so.
As I have written of extensively these past few weeks,
appreciate the fact that when the average European fills up their
gas tank, 75% of the cost is taxes. Yet Europe”s leaders
refused to lessen the burden, mainly because they wouldn”t
know how to begin to replace this revenue source they all have
become so dependent on.
British Prime Minister Tony Blair issued a statement typical of
the times.
“The sensible way, the only right way to deal with this problem
is to put pressure on OPEC.”
So what is OPEC doing? Last weekend they hiked production
for the 3rd time this year by promising to pump an additional
800,000 barrels per day. But the reason why oil continued to
surge was because most experts feel that 600,000 of that figure
was already in the pipeline, i.e., OPEC was really only
increasing 200,000 barrels and, from a supply / demand
standpoint, that doesn”t cut it.
As you”ve read in this space, ad nauseum, the problem is one of
capacity. The world is paying the piper for failing to invest in
new sources of energy as well as a failure to maintain existing
refineries. In fact, U.S. oil production peaked way back in
1970! [I have further thoughts on this topic in my 9/14 “Hott
Spotts” piece.]
So, suddenly, it”s hitting home that this could be a rough winter
if North America and Europe have normal weather. And, with
heating oil inventories already low and energy companies
straining to meet the increasing demands for natural gas, prices
should stay high, or rise further.
It”s not as much that oil, in and of itself, is inflationary as it is
that rising crude can hurt global growth. And as shaky as world
markets have suddenly become, there are some potential
wildcards.
What if, suddenly, there was a real supply disruption in the
energy patch? We saw a small hint of this earlier in the week
when Royal Dutch announced it was reducing its Nigerian
output by 130,000 barrels. But, more importantly, what if our
old nemesis Saddam Hussein decided to do one of two things?
First, Saddam can simply shut off Iraq”s flows which measure,
by most estimates, up to 3 million barrels per day. That”s equal
to the entire stated OPEC production increase this year. The
markets would be roiled further, big time.
Or, Saddam could lob a scud into Kuwait or Saudi Arabia and
take the chance that the Western response would be muted. [If
he did anything to Israel, you can be assured the response
wouldn”t be so.]
It was confirmed this week that an Iraqi fighter jet flew into
Saudi airspace on the eve of the U.N. summit, in clear defiance
of the no-fly zone. It was the first such breach of Saudi
territory by an Iraqi jet in 10 years. British and American planes
didn”t scramble in time to challenge the plane before it left.
And this week, Iraq threatened Kuwait in the exact same manner
it had in August 1990, saying that Kuwait was stealing oil from
Iraqi reserves.
It”s election time in America. Saddam could help determine the
winner.
One last note on Iraq. Russia announced that it would shortly
resume flights between the two countries, a breach of U.N.
sanctions. And it shouldn”t come as a surprise to anyone that
Russia did not ask the U.N. for approval beforehand.
What Now?
Barring a “wildcard” disruption, believe it or not, the world
could once again be awash in oil come next spring. New
production is furiously being brought on line and, with the
current price structure, the large oil companies have an
incentive to invest once again.
The whole point is, what happens until then? With the chaos in
Europe this week, a new wildcard hit my list…political turmoil.
For example, a BBC poll showed that 4 in 5 Britons backed the
protesters and 90% want a reduction in fuel taxes. Similar
sentiments are being echoed across the continent. And all of
this is causing tremendous instability in the currency markets.
I wrote the following back on 8/25 regarding Europe and the
U.S.
“Currency gyrations and inflation rates have been non-factors in
our own markets for quite a long spell. That may be about to
change.”
It is. The European currency, the euro, is a basket case, or, as
The Economist screamed on its cover this week,
“Euroshambles.” There is a crisis of confidence within the EU
and it will only gather steam. And with the euro at record lows,
the weakness is beginning to hit large U.S. multinationals, who
do business in Europe, where it really hurts…earnings.
[Colgate-Palmolive and McDonald”s issued statements this
week to this effect.]
Wall Street
The U.S. equity markets have been priced for perfection. It”s
becoming increasingly difficult to attain it. The most telling
example of this during the past week was the case of Oracle.
Having reported spectacular earnings per share numbers for
their fiscal first quarter after the close on Thursday, Oracle
shares promptly collapsed $7 between the news and Friday”s
close. Along with Cisco and Sun Micro, Oracle has been one of
the true leaders of the Nasdaq. But what disappointed Wall
Street was Oracle”s announcement that revenue growth may
not be as robust in the future. And therein lies the problem.
Our economy is slowing and any attempt to rebound strongly
(as I, myself, once thought was possible) could now be killed
by soaring energy prices. Corporate profit growth has been up,
up, up. Now the rate of growth is decelerating and it would
appear that my favorite word, valuation, is once again gaining
popularity.
Maybe you could build a case for buying an established
company with a 100 P/E when earnings are growing 30-50%.
But when once high flyers start growing at 15% and the P/E is
100, you have a dilemma. Cisco, Oracle and Sun are now all
trading at multiples in the 80s…based on the next 12-months
profit picture. That is still lofty under any scenario.
Action was decidedly sloppy on Wall Street as intraday
volatility continued to pick up. The Dow Jones lost 2.6% to
close back below 11000 (10927), while the Nasdaq had its 2nd
straight awful week, losing another 3.6% to the 3835 level.
Just two weeks ago, the Nasdaq was 400 points higher.
On the economic front, the news was great if you feel that
Captain Greenspan has negotiated a picture perfect soft landing.
August producer prices were down and consumer prices fell for
the first time in 14 years! [The core rate, ex- stuff we use, rose
0.2%] And figures on retail sales and industrial production also
showed that the economy is cooling, reinforcing the belief that
the Federal Reserve”s job is complete…no more interest rate
increases for the foreseeable future.
It”s funny how the Street got what it has long hoped for,
evidence of a true slowdown, and yet it reacted so poorly.
Something about earnings, I guess, and oil.
The bond market went for its wildest ride in months. Long
Treasuries have outperformed shorter maturities for a number
of reasons, chief among which were the low inflation figures
and the continuing reduction in supply due to the federal
government”s paydown of its debt. But now oil is fueling
inflation fears again (remember, this week”s economic figures
were for August; September”s releases could be ugly) and
politics is finding its way into the bond pits.
For years, one of the truly positive developments was the fact
that the federal deficit was shrinking. Coupled with low
inflation, you couldn”t ask for much more as a bond investor.
But today, look what both parties are doing as they finish up the
fiscal 2001 budget process. Discretionary spending in the new
year will explode. It”s expected to hit $614 billion, almost 5%
higher than last year”s $586 billion figure. So much for the
surplus, especially if the economic slowdown becomes more
than that. And what this means for investors in 10- and 30-year
U.S. Treasury securities is that the government may not end up
buying back as many bonds as once thought, renewing the
supply / demand issue. Also, Treasuries have to compete with a
large amount of corporate supply for investors attention.
Bottom line, the shorter end of the yield curve did far better
than the long end, and for the first time in ages, the yield on
the 30-year exceeded that of the 10-year, a more normal
scenario. But don”t read too much into this last bit, yet.
U.S. Treasury Yields
1-yr. 6.08% 2-yr. 6.05% 10-yr. 5.83% 30-yr. 5.89%
Street Bytes
–Chase Manhattan acquired J.P. Morgan for about $36 billion.
Only a few more to go, like Lehman, Bear Stearns and even,
potentially, Goldman Sachs and Merrill Lynch. But I love the
talk that the bigger you are, the less prone to “shocks” you may
be. Wrong. It”s called “moral hazard.” Someday, somewhere,
the government will have to bail out one of these new
behemoths because they will be too big to fail. Despite all of
the talk about risk management, remember, it only takes one
rogue trader to really screw things up.
–Abby Cohen says the U.S. economy will moderate to a 3.5-
4.0% pace…which is still darn good, if she”s right…and that
earnings (as measured by the S&P 500) will grow at a 10% clip
over the coming 12 months…solid, historically, but decelerating
nonetheless.
–Chelsea Emery of Bloomberg put together some telling stats.
It”s been a few months since I detailed the hypocrisy of Wall
Street where a “sell” recommendation is rare. How rare? Try
0.3%.
The 10 biggest U.S. brokerages published 9,402 ratings on
individual issues and only 29 are pure “sells.” Of course, the
reasons for this dearth of anything negative have to do with
conflicts of interest and investment banking relationships. And
heaven help the analyst who issues a “sell” when his firm”s
institutional clients are loaded to the gills with that stock. By
the way, a large portion of the current 29 sell recommendations
are on gold stocks. Contrarians, take note.
–Private and corporate debt continues to explode. Not a
problem in an expanding economy with fabulous stock market
returns. But…
International Affairs
China: Last weekend President Clinton held totally fruitless
talks with Chinese President Jiang Zemin. Clinton had hoped
that the anticipated approval of PNTR (permanent normalized
trade relations) with China would be rewarded but Zemin held
firm on the two main issues; Taiwan and the sale of missiles to
nations like Pakistan.
Regarding PNTR, the Senate defeated a measure sponsored by
Senators Torricelli and Thompson, which would have required
an annual review of whether China is helping to proliferate
chemical & nuclear weapons. Big business stepped in and
basically said, you defeat this amendment or you don”t receive
dollars for your campaign.
Democratic Senator Robert Byrd, in supporting missile review,
said, “Senator Thompson is asking us to put national security
ahead of greed. What”s wrong with that?” Senator Byrd
should know that”s not the American way.
For his part, Thompson got into an argument with fellow
Republican Phil Gramm.
“(Gramm”s) response is trade with (China), and one day we will
magically wake up and they will be dismantling their
armaments. When that happens I will present the tooth fairy on
the floor of this body.”
[Fred Thompson has now, in my mind, staked his claim to the
2004 Republican presidential nomination…should Bush lose.
Thompson has been the man out in front on the whole issue of
national security and China”s pilfering of our nuclear secrets.
And I can guarantee that in 2004 we won”t be ignoring foreign
policy like we are today.]
Separately, China executed a prominent legislator for taking
millions in bribes. When you see something like this, it tells you
one thing. We are a long way from the day when there will be
democracy in China. The Communist leadership has proved
their point. Toe the line or else.
Russia: Details have emerged on the massive defense cuts that
President Putin has proposed. The Russian army will reduce its
forces from 1.2 million to 850,000 over 3 years and, more
importantly, look to shrink their nuclear arsenal to 1,500
warheads, less than half that permitted by the START II treaty.
[Our next president should match this reduction.]
The issue is money. When the commander of the Kursk is
being paid $150 a month and reports of troops begging for food
are the norm, you have a problem. Putin is smart enough to
recognize sweeping changes must be made. But as Russia is
transformed more into a regional, not global, power, it is
interesting to note that NATO now has 4 million troops in
uniform, China – 2.8 million and, in 3 years, Russia – 850,000.
And with regards to China, Putin and China”s #2, Li Peng, met
at the Kremlin to advance a new “friendship treaty” which will
be signed next year. Doesn”t it give you a warm, fuzzy feeling
that Russia and China are becoming such good friends?
One final note, Michael Dobbs addressed an important issue in
the Washington Post. The U.S. is currently paying Russia to
destroy its biological and chemical weapons. Nothing wrong
with that. But where we are blowing it is in the fact that we are
doing nothing to retrain these workers for peaceful purposes as
we promised to do. This is fueling skepticism both in Russia
and abroad about the benefits of cooperation with the U.S. on
eliminating weapons of mass destruction. And guess where
Russia”s best scientists may turn up? Iran and Iraq.
Indonesia: Last week I commented on the inadvisability of
investing in emerging markets. This week, a car bomb was set
off below the Jakarta stock exchange, killing 15. It is suspected
that supporters of former President Suharto, on trial for
corruption charges, were responsible.
Bosnia / Serbia: President Clinton desperately wants to arrest
Bosnian Serb leader Radovan Karadzic before he leaves office.
For some time now we have had a $5 million reward for the
arrest of Karadzic, Bosnian military leader Mladic, and
Slobodan Milosevic. But it”s almost comical. We know where
these dirtballs are…Karadzic was in a Sarajevo bar the other
day, for example…so just arrest them, already. [Granted it”s
more difficult to pull it off in Sarajevo but NATO has had other
chances many times before. In other words, they are afraid to
take even one casualty to arrest them.]
For his part, Milosevic is running for president in Serbia”s
September 24 election. The opposition is ahead but facing
increasing problems from his goons.
Israel / PLO: The PLO moved back its declaration of statehood
until at least November 15. The bigger immediate issue now
becomes the fate of Prime Minister Barak”s government when
parliament returns.
This Week in Politics
Columnist Michael Kelly had the following comment about Al
Gore. “You never saw him before today…There is a
breathtaking quality to the act.”
And if you watched “Oprah” (as I did for the first time ever)
this week, you had a perfect example of what Kelly is referring
to. Let”s face it, Gore”s aides (mainly Bob Shrum and Stan
Greenberg) have done a masterful job in transforming Al Gore
into a suddenly likable figure. His ratings are up across-the-
board. Those of us who follow politics more than just every
four years can complain all we want. It”s all for naught.
As Gore threw out his stock lines to Oprah, “I”m for people,
not the powerful,” I am also continually amazed how “the kiss”
still resonates among women.
Meanwhile, the Bush campaign continues to implode. I can”t
believe I”m yearning for those lazy days of 1996, when Bob Dole
lounged in Florida, lying there in his swim trunks, plain white
t-shirt, and knee socks thinking, this sure beats campaigning.
Bush is on “Oprah” September 19.
Robert Samuelson wrote the following comment about George
W. this week. “Bush doesn”t seem agile enough to pick apart the
other guy”s ideas…He doesn”t seem to have worked hard
enough.” Alas, I can”t disagree.
Bush does have issues he can exploit, if he”s up to the challenge.
On the economic front, the Washington Post said of Gore”s
fiscal program, “(With every new tax break), Mr. Gore makes the
federal code more bewilderingly complex.” And, amazingly, in
this 200-page memorandum, he doesn”t propose one single cut.
Another issue for Bush to delve into is Gore”s coziness with 5
Texas trial lawyers, who have given $4 million to the Democratic
Party since 1996 (zero to Republicans). The administration has
steadfastly fought efforts to attach limits to litigation, especially
as it relates to product liability cases.
[I”ll cover the entertainment industry issue, later.]
The Polls
–New York Times / CBS: 42-39 Gore
–Walll Street Journal / NBC: 45-42 Gore
–Newsweek: 49-41 Gore
According to the Wall Street Journal survey, Bush is garnering
only 9% of the black vote (even Dole received 12%) but is
capturing 31% of the Hispanic electorate (Dole got 21%).
Hillary / Lazio
The two main polls in New York show Hillary winning; 48-46
and 49-44. More importantly, perhaps, is the fact that one poll
has Gore swamping Bush, 60-31, in the state! If that proves to be
the case in November, the Rickster can kiss the Senate goodbye.
Hopefully, many of you saw the debate on Wednesday. It was
highly entertaining (the next one is October 8) and as objectively
as possible, I would rate it a draw. Lazio proved he could hold
his own but I have to admit I squirmed a bit when he approached
Hillary with his soft-money pledge. And I imagine many women
saw that as threatening.
As for Hillary constantly linking Lazio to Newt Gingrich, I have
to comment. History will look kindly on the former speaker.
After all, President Clinton co-opted the “Contract with
America.” That”s in large part why the president has been as
successful as he has been…on the domestic policy front.
Unfortunately, the average voter doesn”t know this. Connecting
Lazio and Gingrich thus becomes too easy.
Buchanan
Finally, there is the Reform Party. The Federal Elections
Commission has granted Pat Buchanan the $12.6 million in aid
the party is entitled to. But Buchanan has been lucky to receive
even 1% in any single poll and, to make matters worse, he was
just released from the hospital after serious surgery.
Random Musings
–According to the New York Times Neil Lewis, President
Clinton is very dispirited over the Arkansas disbarment
proceedings. And this is one time he can”t call it a political
vendetta, either. He”s threatening to move his presidential library
out of the state.
–Over 200 have died in Ukraine and Russia this year from poison
mushrooms, specifically, the “death cap,” the deadliest toadstool.
“Look, Sergei. The death cap!”
–Tiger Woods has won 9 of the 17 tournaments he has entered
this year. With all due respect to Byron Nelson and his awesome
season in 1945, Woods”s performance is the greatest in the
history of the sport.
–I didn”t bring up Clinton”s handshake with Fidel last week
because, to me, it was a total nonevent. Clinton didn”t seek
Castro out, what else is he supposed to do? And then there was
the fuss over the Republicans subliminal use of “rats” in an ad.
This warranted being the lead story on the network news?
–But you did have the Emmy Awards. In the “Best Comedy –
Variety Series” category (or whatever it was), the clips for
Letterman and Leno highlighted Hillary and Gore, respectively.
Coincidence? I think not. Separately, Rudy from “Survivor” was
in the audience, thereby extending his fame to 16 minutes.
–The Wen Ho Lee case was a mess. But lost in the aftermath is
the simple fact that China did still receive our weapons secrets.
–North and South Korean athletes marched together in the
opening ceremonies in Sydney. The South Koreans got sick of
their Northern brethren as they kept bugging them for grain.
–I went to a Jets game last Monday night so I can now report
that a bottle of water is $3.00…a gallon of gas, $1.59.
–A Zogby survey shows that 60% blame Firestone for the tire
debacle; only 6% point the finger at Ford.
–House Democrats brought an absurd measure to the floor which
would have pulled the Boy Scouts charter because of the
organization”s “intolerance.” But I”m sure the few idiots who
voted in favor of the bill probably think Eminem”s lyrics are just
fine for their kids to listen to.
–And speaking of Eminem and the entertainment industry, the
FTC released a scathing report addressing an issue any rational
person already knows about; that being the active marketing of R-
rated films, music and video games to children. Democrats from
Clinton on down (especially Gore) used the report for their own
political gains. I loved what one New York voter told a local
NBC affiliate. “It”s kind of hypocritical to have an R-rated
president blast R-rated content.”
It”s also tough to stomach Al Gore scolding Hollywood and the
music industry one minute, and then collecting $6.5 million from
the same folks the next.
–The FAA and the airline industry are warning that the air traffic
mess will continue for at least another 5 years. But it looks like
that Newark to Atlanta flight at 2:00 p.m. on September 16, 2005
is OK. Oops…there”s a thunderstorm in Chicago.
–Long time readers know that I”m not exactly an animal rights
activist. [I save most of those stories for “Bar Chat.”] But I do
agree with the administration when they blast the Japanese for
expanding their whale hunt, which the Japanese label “research.”
Unfortunately, this seemingly small item could escalate. The
Japanese public is solidly behind their president as he refuses to
back down.
Incidentally, it”s been payback time for your editor. I have been
stung by bees twice in the last two weeks, and once was even
overseas! Before this, I can”t remember it ever happening.
Gold closed at $272
Oil, $35.92
Returns for the week, 9/11-9/15
Dow Jones -2.6%
S&P 500 -1.9%
S&P MidCap -0.5%
Russell 2000 -0.9%
Nasdaq -3.6%
Returns for the period, 1/1/00-9/15/00
Dow Jones -5.0%
S&P 500 -0.2%
S&P MidCap +21.7%
Russell 2000 +5.2%
Nasdaq -5.8%
Bulls 50.0%
Bears 31.7% [Source: Investors Intelligence]
SPECIAL NOTE: I am launching a “Pick the Dow” contest
which I hope you will have fun with. Between now and
November 1st, enter your guess for the level of the Dow Jones on
December 31, 2000. [If there is more than one correct answer,
the tie-breaker is the level of the Nasdaq.]
The first, and only, prize is $2,500.
This is my way of soliciting your help in spreading the word on
this site. Your assistance is, as always, greatly appreciated.
So enter where you find the special contest links. *There can be
only one entry per email address. If you enter more than once, all
of the entries for that address will be invalidated.
Unfortunately, my attorneys have advised me that the contest is
prohibited in a few states. We will try and get these approved
before November 1st, but there is no guarantee we can accomplish
that.
Finally, I can personally assure you that the information you are
submitting will not be used for anything other than being able to
locate a winner.
Brian Trumbore
Editor
