Friday, January 1, 2016

Bulls or Bears for 2016?

The DJIA ends the year flat.  What is going on?

For investors, it has been a rocky year.  The DJIA stayed flat for the first part of the year, tanked a bit in September, and seems poised to recover in 2016.   Will next year be recession or recovery?   I think it all gets down to two things:  Interest rates and cheap oil.

Predicting the future, of course, is never a precise science.   When I was a young lad at General Motors Institute, my professors told me that by the year 2010, the world would be out of oil.  They also said that our generation would never travel as fast as the previous one - that the 55-mph speed limit was here to stay and that 200 horsepower cars would never be coming back.

Well, today we are awash in a sea of cheap oil and it turns out there was a lot more of it that we thought.   Problem is, of course, burning oil causes all sorts of other problems, and people would like to switch to alternative energies.   Alternative energies in turn decrease the demand for oil, which in turn drives the price down, making gas-guzzling cars more attractive.

I call it the Prius Conundrum - every time someone buys a Prius, it drives down the cost of gas, making buying a Prius a less-attractive financial proposition.

My professors at GMI were wrong about a lot of things.   Oil (and gas) is very cheap again.  And the 700 horsepower cars sitting on showroom floors today are more powerful (and better made) than anything sold in the past.

But of course, this could all change in a heartbeat, as it did in 1973 during the Arab oil embargo.   One sunken tanker in the Persian Gulf is all it would take to drive oil prices through the roof.   And I think old Vladimir Putin (whose economy is suffering due to low oil prices) is setting out to do just this - provoke some long-term war in the region.

But assuming low oil prices are here for a while, we might see the economy boom in the coming months, as it did under the Clinton administration - the last time oil was super-cheap.   Since the price of oil is a huge factor in the price of everything, low oil prices mean low consumer prices.   One of my professors (again, at GMI - they were not very optimistic bunch, considering who they worked for!) often quoted the statistic that "a glass of milk requires a half-a-glass of oil to make."   Between the oil used to generate electricity to light and heat barns, the oil used to make fertilizers to grow corn for cows to eat, the oil used to drive tractors (and build them) and to  refrigerate and transport the milk to market, not to mention the packaging, marketing, etc., it does not seem like such a far-fetched statistic, particularly at the time when many utility plants were oil-fired (today, running on natural gas).

Speaking of natural gas, it has hit all-time low prices as well - here in the US -  and many utilities are converting coal-firing power plants to natural gas.  As a result, we have some fairly low energy costs in the US and as a result, foreigners are investing in production in the US, as we have lower energy costs than their home countries - and unlike China, we have a better transportation infrastructure, as well as huge domestic market.

Now of course, these low prices spell bad news for some industries.   Oil exploration companies - particularly the leveraged kind - are going to go bust.  A lot of wells will be capped off until prices rise again.  Layoffs will be common.   But this is only one sector of the overall labor market.

With gas so cheap, people have more money to spend, and they will spend it, on things like gas-guzzling new cars - and boats (which are literally made of oil) and RVs.   We saw this in the 1990's when 87-cents-a-gallon gas made 10-mpg motorhomes make "sense" - at least for a while.

So, provided oil prices stay low, the economy could boom.   And so long as we have these huge shale reserves in North Dakota (and oil sands in Alberta) even if oil prices rise, we can weather the shock.

As for interest rates, many are crying gloom and doom that the Fed has raised rates from zero to 0.25%.   I don't think the world is going to end quite yet, as these are still record low rates.   It will drive up interest rates on loans and credit cards a bit, and maybe ratchet up inflation a bit (which low oil prices will ratchet right back down again).   But overall, I doubt this is going to kill the economy in the short or long run.

In fact, I think it is a good thing, as these weird financial policies of the last few years (giving away money to banks, basically) were not good for the economy in the long term.

And speaking of which, what about the national debt?   A lot of people are shouting gloom-and-doom over the national debt.   But some of the arguments they raise are so idiotic, it is hard to take them seriously.

One comment I hear (from rednecks) is that "China is holding all our debt, and one day they'll call it and then where will we be?"

And comments like those illustrate why rednecks should not be placed in charge of anything.   No, you cannot "call" a Treasury bond or note, and I say this with authority as I own a few.   The Treasury Department can call them (pay me back) any time they want to.   I, on the other hand, cannot march down to Pennsylvania Avenue, knock on the door of the Treasury building, and demand payment.   I have to wait for the maturity date - and in the meantime, get my tiny amount of interest on the money.

And since a lot of this debt is at such low interest rates, the burden of the debt is not as high as it was, say, in the late 1970's, when interest rates were in double-digits (as opposed to fractions).  This is not to say we should trivialize the national debt, but only to say that we should not succumb to fear tactics.

Speaking about fear, it is hard to find any decent and impartial information about the debt and deficit on the Internet.  I was looking for a chart just now, and nearly everything that came up was a gloom-and-doom chart from a goldbug site or a "we hate Obama" site - both of which have a vested interest in getting you to think the world is going to end.  Most use "projections" to show these scenarios (some as far out as to 2050!) to make their point, as they can't make it using existing data.  This article from the Pew research center shows that since our interest  rates are so low, the percentage of our overall Federal outlays, is only about 6% of the budget - far less than in previous years.

Again, perceiving reality as it is, and not some fear scenario.   Anyone who tries to sell you fear, should not be trusted, particularly when they are trying to sell you Gold or Mitt Romney or other bad investments.

Speaking of which, do you notice that no one is talking about the debt these days?   When the GOP runs out of things to say, they usually trot our their "debt clock" as Mitt Romney did, as some sort of boogey-man to scare the shit out of us.

Most of these debt arguments are politically based - designed to get you to fear one candidate over another.   This discussion, from the liberal Washington Post, presents the debt - and deficit - from a number of different views.   Read the whole thing, because the last chart is a real show-stopper.  In terms of who has increased the debt the most during their administration (as an overall percentage) the worst offender was "Voodoo Economics" himself, Ronald Reagan.  Didn't see that coming, did ya?   Oh, unless you lived through those years and remember all the gleeful spending on "Star Wars" and other defense projects that were real budget-busters.

That article also illustrates how our deficit in spending is dropping from year to year, and if the trend continues (and the economy continues to prosper) we could see surpluses and a decrease in the national debt in the near future.  The optimist in me would like to think so, anyway.   Servicing the debt, at the present time, doesn't seem to be too onerous, if the 6% number is to be believed.

But I think cheap oil could prime the pump for expansive growth in the economy in the next few years.  This would mean more tax revenues, decreased deficits (or even surpluses) and decreases in the service cost of the debt (in terms of the overall budget) and the size of the debt (in terms of the GDP).   Let's just hope inflation doesn't wipe out our savings in the interim.

But what about the other side?   Pessimists would point out that since Obama took office, the economy has grown slowly but steadily for eight years, with unemployment going down, stocks going up, and interest and inflation remaining at record lows (those pessimists, pointing out the cloud in a silver lining!).    They might argue that we are due for a correction and that the artificially pumped-up economy (running on cheap dollars, rather than cheap oil) is due for a fall.

Again, this gets back to the debt bogeyman and whether you believe the Chinese are going to "call our notes" which they physically can't do.   Since Treasury notes have very long terms (some as long as 30 years) these low interest rates may be locked in for a good long time, which gives us breathing room to pay down the debt.   Unlike the 1980's, where we borrowed a ton of money at high rates, at least today, we have the advantage of lower rates.

It may turn out that borrowing money right now (for the last eight years) was in fact the best option.  As we are seeing in Europe, using "austerity measures" to cut deficit spending and bring down debt is not the answer to recession, but gasoline on the fire.   A recession is the last time you want to cut spending, but rather increase it.   The depression of 1929 was turned around not by Hoover's spending cuts, but by Roosevelt's increased government spending.

But, what about Europe?  Will the European debt crises bring down the US?   While our economy has largely recovered from 2009, recovery hasn't hit many other countries, and what's worse, the Chinese seem to be entering a recession.   Again, I am not sure whether problems with Greek and Spanish debt will seriously affect our markets.  Yes, I own some mutual funds that invest in foreign government bonds, and yes, they have taken a hit.   But this is not 100% of my portfolio, nor should it be of anyone's.   So I am not sure how the problems in Europe will morph into problems for the US.   For some exporting companies in the US, this may mean more difficulties selling our products overseas (as the dollar gets stronger).   But again, since most of our economy is based on imports, it will be a benefit to most folks.  Cheap Mercedes, anyone?

On the other hand, it seems that most companies out there are cranking out profits and dividends - and hiring people - at a good clip.   While some investments may not be as attractive as they once were, they still are profitable enterprises.   Apple might not have some stellar new product to introduce for 2016, and as the smart phone market has saturated (evidenced by the fact I am shopping for one), it still will likely make money, just not as much as the fan-boys of the stock would like it to.

Of course, I could be wrong.  It could all crash tomorrow - as it did in 2009.   As it did so many times before that - just in my lifetime.

But a funny thing, as bad as the crash of 2009 was, I survived it and prospered.   Most people did.   Sure the leveraged folks who had to "have it all now" got screwed.   I think this time around, fewer people are so leveraged.   It is a lot harder to buy an overpriced mini-mansion on a liar's loan these days.   And if nothing else, more people are skeptical about such financial instruments and deals.  I think fewer people are as obsessed about houses today as they were in the past.  It is like the Dutch and their Tulips.  They still like them, but they aren't going to bid them up to the stratosphere anytime soon.

So, worst case scenario?   Something I survived before, and something I am in a much better position to survive today (having no debt this time around).

I'm optimistic for 2016.   Go ahead and hate me.   But the pessimists never win - at anything.