The Three Biggest Surprises of 2014 Were the Collapse in Oil Prices, the Rally in the Treasury Market and the Outcome of the 2014 Election.

Today’s comments are perhaps my least favorite ones to write for they are my outlook for the following year.  Many times I have opined it is not what one does but rather why one does it.  What do we think may happen and how we think the market may respond to such events.  All must remember markets are people and people move markets where psychology is an integral component.

One of my continuing themes is to expect the unexpected, where velocity of change is frightening.

Perhaps the three biggest surprises of 2014 were the collapse in oil prices, the rally in the Treasury market and the outcome of the 2014 election.  I did not foresee the oil implosion.  I thought Treasuries were going to fall in price.  But did suggest the environment was conducive for a tectonic change in Washington.

I was also correct the popular indices would register a “high single digit return,” and both GDP and employment surprising on the upside.

I will now argue the odds are greater than 65% there will be a major geostrategic alignment in 2015, the result of plunging crude.  The longer prices remain at current levels, the greater the possibility and change.

I have always argued a major reason for Saudi Arabia’s position is the result of America abdicating its 70 year unspoken role of global policeman, commenting several times the President’s statements are/were equivalent to Dean Acheson stating South Korea is not in the US protective sphere.  In the absence of good, evil prevails.

I believe Saudi Arabia has embarked upon economic warfare against Iran, Russia and Syria.  Collateral damage is any other high cost oil producer.   Estimated cost of production vary, but it is generally accepted that Russia, Libya, Syria, Nigeria, Iran, Iraq and Venezuela’s costs are somewhere over $75 barrel.

The countries listed above are already teetering on anarchy and supply disruptions are possible as is regime change.   I think it is noteworthy the difference between the world being oversupplied and undersupplied with oil is between 1.2 to 1.8 million barrels.  If Nigeria implodes, 2 million barrels would be lost.

I will argue the drop in crude is a massive transfer payment of over $2 trillion from oil producers to oil consumers with the US being the largest beneficiary.  I believe not only will the American consumer be rewarded with lower energy prices; I will also argue so will American oil producers. The cost of US oil production is continuing to drop because of technology.  I can cite many reputable sources stating that costs are between $25 and $40 barrel.

I can envision a scenario of 3.5% to 4% growth as the low margin consumer returns to the economy, the result of the stimulus from dropping crude.  This should permit a further drop in the unemployment rate leading to a change in monetary policy sometime in early to late spring.

I think oil will rebound to the mid to high “seventy levels” as the US continues to lead the world in global growth, something akin to the “technology miracle” of the late 1990s.  The weaker oil states may be mired by civil conflict.

And then there is Washington.  If Washington produces anything of substance, the odds of which is around 45%, growth may accelerate to almost 4.5% to 5.0%.  Wow!  This is almost equivalent to writing last December oil will drop 45% in five months.

Many times I have opined Washington is the greatest impediment to economic growth, evidence based upon massive cash balances and almost every sentiment survey in the known universe.  The electorate spoke clearly and the preponderance of polls are now clearing stating the voters want compromise versus obstinateness, the inverse of the last five years.

If the economy is growing at this rate, the odds of a high “three handle” on the 10 year are great.  I would then argue this year’s decimation in the oil market will be nothing compared to the implosion of higher rated debt.

Many, including me, are surprised by the complete collapse of energy sector bonds, partially the result of capital changes mandated by Dodd Frank.  I will also write a hallmark of the past several years is the utter and rapid abandonment of a sector, sometime regardless of merit.

Concluding, I think by December 23, 2015 the odds favor the dissolution of several nations’ states whose economies are based on oil with the non-state oil firms benefitting from such demise.  I also think this transfer of wealth and the continued stimulus from dropping energy prices which is equivalent to main lining sugar will permit a GDP with a “a four handle.”  If Washington actually does something, growth may be close to 5%.  If the above occurs the 10-year may be close to 4%.

Equities will be volatile, trading between 12% and 15% lower in the days leading up to and just after the first interest rate increase but end 2015 higher by 7% to 10%.

How much of the above will materialize?  I will tell you in 365 days.

Commenting briefly upon yesterday’s markets, led by the technologies equities ended higher on Fed optimism.  The 10-year was essentially unchanged.

Last night the foreign markets were up.  London was up 0.42%, Paris up 0.70% and Frankfurt up 0.22%.  Japan was up 0.08% down 0.32%. and Hang Sang

The Dow should open quietly higher ahead of a data deluge, a deluge that can potentially help validate or nullify the optimistic outlook for the early part of the New Year.  The 10-year is off 1/32 to yield 2.17%.

MERRY CHRISTMAS AND HAPPY HOLIDAYS

kent
The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. The material provided in Daily Market Commentaries or on this website should be used for informational purposes only and in no way should be relied upon for financial advice. Please be sure to consult your own financial advisor when making decisions regarding your financial management. Members of FINRA and SIPC, Capitol Securities Management is a privately owned full-service retail brokerage and investment advisory firm headquartered in Richmond, Virginia. For nearly 30 years, we have been serving the needs of our investors. Today, more than 200 Capitol Securities Management investment professionals and support staff serve approximately 18,000 customer accounts from Southern Florida to the New England coast.