Koenig Investment Advisory Market Update – January 2015
We would look for the U.S. economy to trend towards a steady, but moderate, growth status in 2015. Industrial production in 2014 was 5.2% greater than in 2013.1 This is the greatest increase seen in several years. These gains are broad based rather than heavily weighted towards any one sector. One economic indicator we regularly monitor is capacity utilization. This data point is helpful in determining how much unused capacity companies currently have. The most recent data figures released are from November 2014. November’s capacity utilization figure is 80.1%, about average for the U.S. economy over the past 40 years.1 In comparison, 2009 saw capacity utilization figures in the 50% range, indicating a large amount of slack in the system.
Housing sector – Other economic indicators appear positive as well. For example, the housing market has stabilized. The National Association of Home Builders Wells Fargo Housing Market Index (HMI) is a gauge created by surveying home builders and is widely viewed as a reliable indicator of housing activity. This index ended December at 57.1 Readings above 50 have historically meant positive builder confidence. November showed housing starts at an annual rate of just over 1 million units. While that is still below the 10-year average, it is the highest level since April 2008. The housing sector hasn’t turned around enough to be driving the current economy, but it is no longer the drag it was during the recession.
Stock Market Valuation – The S&P 500 Index finished 2014 at 2,058, and with a price earnings (PE) ratio of about 15.7.1 As a reminder, the PE ratio measures the multiple of earnings versus price. For example, stock with expected earnings of $100/share and having a PE ratio of 15.7 would be worth $1,570. The current PE is at the low end of average over decades of market history. While the market has some room for growth, an increase in S&P 500 stock value above 2,150 would need to see a concurrent rise in earnings projections as the market is not likely to rise above an average PE ratio given current investor sentiment.
Oil – The energy markets have seen some rapid and notable changes in the last quarter. Oil dropped to $35/barrel by the end of the year, quite a change from the $135/barrel high of 2008. Neither this high, nor this low, have been near long-term price averages. The U.S. rig count has recently seen a pullback in reaction to oil price changes, and we are likely to see more pullbacks over the next few months. The excess capacity in oil production was estimated to be in the 1.5% – 2% range a few months ago.2 This is a historic low that is likely to rise as oil producers close the most expensive wells and idle those in the margin. Just as oil dropped from its high to stabilize at lower prices, I expect to see oil prices rise and stabilize at levels closer to historic norms. The general consensus amongst economists seems to be stabilization around $70 – $80/barrel later this year. While that will be an increase from the current price of just under $50/barrel, it will be lower than the near $100/barrel price seen over most of the past few years.
The sharp decline in oil prices has been felt by all American consumers, but most sharply by working class families and retires on fixed incomes who by and large have not seen increases in wages or social security payments for some time. A lowering of a monthly expense by 1/3 or more is greatly felt within these households. The Federal Energy Information Administration recently estimated that the typical American household would save $750 this year directly from lower oil prices.3 This figure is $200 greater than the early December forecast and does not include indirect savings. Heating oil and propane are regularly used commodities for millions of Americans living in the Northeast and Midwest. These residents are expected to save about $750 per household this winter on top of their savings from falling gasoline prices. These savings may not have a big effect on the budgets of the top 10% of households, but are substantial for families earning $50,000 or less annually.
The boost from lower oil prices will benefit the national economy, more than offsetting regional declines in North Dakota or Texas. Household consumer spending contributes roughly 65% of gross domestic product (GDP), compared to about 4% of GDP coming from the oil and gas industry. The January monthly consumer sentiment survey released by the University of Michigan reported its best monthly figure in 11 years. The decline in oil prices is likely a main contributor to this rise. As consumers feel more secure and have more discretion within their budgets, the more likely they are to spend and drive the economy forward.
The U.S. economy has come a long way from recession lows a few years ago. While the effects of the recession still linger in some areas, the economy as a whole has moved on. We have seen positive GDP figures for most quarters since late 2009.5 While this growth has not been felt by all citizens equally, we have moved past the declines of the recession as a whole. Certain sectors may see surprise events, such as energy did in 2014, but the general economy is poised to continue its steady growth. It will be interesting to see what changes 2015 may bring. Will the Fed increase interest rates as is widely expected? What will the inflation rate be, and how will the changes in energy prices affect this? Will we see any game changing technological breakthroughs in any sectors? I look forward to seeing what 2015 will bring and hope you do as well.
- Bob Brinker’s Markettimer, 1/5/2015, page 1
- Mornigstar.com, The Upside and Downside to Low Oil Prices, Jeremy Glaser & Robert Johnson, 1/14/2015