Musings: Mixed Economic Data: Is Crude Oil on A Bubble?

Crude oil prices had been bouncing around within the broad range of $45 to $55 a barrel, until the past several days when they jumped to over $58 a barrel. The movement of oil prices has depended on a number of factors including the direction of the stock market, the strength or weakness of the value of the U.S. dollar against foreign currencies, weekly oil inventory data and the positive or negative view of overall global economic data. The most recent upward move in the value of oil appears to be most closely correlated with the soaring optimism about the impending end to the recession and the serious weakness in the value of the U.S. dollar against a basket of other currencies.

The popular economic phrase du jour is "green shoots." These are economic data points that are being seized upon by optimists to be accurate and early reflections of en economic turnaround. They are generating optimism whenever the figures reflect actual increases or show that the rate of decline of economic statistics is slowly turning negative economic news into positive. It makes one think that the investing world is living in an Alice and Wonderland world where things are as we want them to be rather than as they actually are. That is not a complete indictment of the current world view since we must acknowledge that the stock market is an early forecaster of future events, but as such it has been credited with forecasting many more recessions and recoveries, too, than actually occur.

Crude oil prices have jumped in recent days aided largely by positive news about the health of the United States economy and the weakness in the value of the U.S. dollar. One can see that over the past six months, crude oil prices completed their $100 a barrel correction that had begun in July 2008, and then rallied higher as we entered 2009. Since then they had been trading in this wide range, until last week when they jumped again to record highs for the year. But as shown in the subsequent chart, the recent strength in crude oil prices is clearly associated with the weakness in the U.S. dollar as reflected in the course of the U.S. dollar index.

The question on the minds of most managers and investors is: Are we living in a world where the stock market is accurately forecasting the end of the current recession, or is it merely projecting a view of the current world through "rose-colored glasses?" The following set of charts depicts various recent global economic data from multiple sources showing both positive and negative outcomes. Stock market bulls have seized on the positive data as signs that the recession is winding down, but the bears see continued deterioration in economic data as reason for continued concern. The coloring of the outlook must be viewed in the context of a recent 35% rally in





the overall stock market. The market upturn has contributed to a significantly enhanced optimistic view of the world ahead. In fact, a week ago, when the economic data released for the United States was not particularly negative, reporters on Wall Street investing shows were beginning to speculate on when the government would release data showing that the downturn had ended and the official chronicler of recessions would declare this one over.

Since it took the Bureau of Economic data almost nine months to determine that the United States had actually fallen into a recession beginning in the fourth quarter of 2007, we are not surprised there is considerable doubt about whether the current recession has actually ended. The length of the average post-World War II recession has been fairly short - lasting roughly 16 months. At the moment, the current recession is 17 months in duration. As a result, we have only recently passed the average duration of post-World War II recessions. So expecting economic data to begin to show positive traits should not be surprising. Whether the improvement in economic data signals that this bad economic period is behind us is impossible to forecast. Take for example the following data - some of which we would clearly call positive, but other that reflects ongoing negative economic trends.

In Japan, preliminary industrial production data for April showed a 1.5% increase after nine consecutive months of declines. While suggesting a positive view, one must bear in mind that the index is still down by over 35%, suggesting there is a long way for the Japanese economy to go before it reflects significant strength.


The following chart shows the change in export volumes for Switzerland and Thailand through March and the Philippines through February. The chart shows that the annual decline in exports for Switzerland and the Philippines has slowed. This provides some comfort about an improving global trade outlook since these two countries were previously reporting double digit decline rates. But again, these economies have shown huge declines signaling that it might be tough to expect a rapid turnaround.


Recent survey data offers a more encouraging view of the future for the global economy. The German Ifo business confidence index rose to the highest level it has attained in five months. The index's improvement came as a result of inventory liquidations that suggest a recovery in industrial production should be starting. Many other industry sources, however, are suggesting that final demand is not growing so the inventory liquidation is less a sign of an impending manufacturing recovery and more a step adjustment for companies to reduce their working capital stresses.

In the United States, the consumer confidence index surged, which was supported by a 2.2% annualized increase in consumer spending several days later. The problem with this data is that the improvement in confidence is coming from a very low base, so there is skepticism about the significance of any meaningful recovery in consumer spending.


The last data shows the first quarter gross domestic product (GDP) for the United States, the United Kingdom and South Korea. What the data shows is that the decline in economic activity is continuing. Moreover, the rate of decline is about the weakest it has been since the early 1980s recession, or possible worse.


A new measure of economic hope has been the recent data on the U.S. employment market. The most recent data for the change in nonfarm payrolls showed a slowing in the rate of decline, which in today's world is positive data. As shown by history, when the rate of job losses slows, economic recessions soon end. That is not a surprising indicator since an expanding economy will require additional workers to meet demand.


Another indicator of when the recession has ended and a recovery begun is the trend in part-time employment. The latest data shows that there has been a 2-million person jump in temporary employment, consistent with other recessions. However, as shown in the accompanying chart, when the part-time employment number starts to drop, it signals that part-time employees are being hired for full-time positions and manufacturers and service enterprises are restaffing in response to increased demand.


It seems clear that the global economic picture is a mixed bag. At the present time, the optimists looking for an economic recovery are winning the psychological war over the pessimists who see increased economic challenges ahead. How the financial industry will deal with a further deterioration in the commercial real estate market or how the overall economy will deal with prolonged bankruptcies of our automobile companies and some of their suppliers remain serious questions amidst this rosy view of a recovering U.S. economy. Time, and more global economic data, will tell which school of thought is correct.

For the energy business, the economic uncertainty is an impediment to further sustained improvement in company share prices. If crude oil prices are being supported by optimism about the pace of the global economic recovery, than any weakness in that scenario should cause investors to shift their focus from green shoots to the building inventories and flagging demand for crude oil. If oil prices cannot sustain the $50 a barrel level, then we are left most likely with the price falling somewhere into the lower $40 a barrel range. Dashed economic hopes will translate into sharply correcting energy company stock prices.


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