The month isn’t over yet, but it looks like the S&P 500 is off to the worst monthly start as far back as I’ve seen data (1950). While I have no idea if this is the market bottom, I do think the selling is irrational and driven by misplaced fears. Here are the 10 reasons I’m buying stocks for both myself and my clients.
1. Low oil prices are a transfer of wealth
It’s important to remember that the crash in oil prices is not so much destruction of wealth as it is the transfer of wealth. What used to be a dollar in the pocket of oil producers and oil exporting countries is now a dollar in the pocket of an oil user and oil importing countries. Wealth is not being destroyed, it is simply transferred.
Will there be energy companies that go bankrupt? Absolutely. Will there be some banks that run into trouble with bad loans? Of course. Will there be layoffs in the industry? Yes. But all that pain will be balanced by gains elsewhere in the economy
For instance Delta Air Lines DAL +0.00% (NYSE:DAL) just announced quarterly income of almost $1 billion. What used to be Exxon Mobil’s (NYSE:XOM) profit is now Delta’s profit. While companies like Delta benefit from low oil prices immediately, there will be a bumpy transition period as wealth is transferred to other sectors and in particular consumers. This brings me to my next point.
2. U.S. consumers will benefit
The U.S. economy is roughly 70% consumption based (compared to about 1% oil and gas production) and U.S. consumers are getting huge savings. I remember back in 2010 and 2011 as oil prices rose towards $120/bbl listening to the conference calls of consumer companies and hearing the executives lament the effects higher gas prices were having on consumer budgets. At current oil prices, the average American household is saving over $1,000 per year in gas costs, and even more when the effects of other savings such as lower heating oil is factored in.
According to the Atlanta Fed, it takes consumers about a year to begin spending their savings in earnest. We are just now passing the one year anniversary of the first leg down in oil prices. While energy companies have responded by reducing investment spending immediately, it will take a while for consumer spending to ramp up and replace that lost growth. Patience is certainly not one of Wall Street’s virtues and the lack of broad, immediately higher consumer spending has the Street worried.
3. The crash in oil is due to speculation and deregulation
The sharp selloff in oil is certainly due to some real economic issues. Demand for raw materials in China is decreasing and there is a legitimate supply glut as OPEC and U.S. shale oil producers continue to pump oil. Let’s not forget Iran’s production coming to market soon as well.
However, an enormous contributing factor to the sudden crash in oil prices is due to the deregulation of commodities markets in 2000 and the influx of over $350 billion (likely even more) in speculative money. Commodities funds have been pushed on institutional and retail investors alike by the financial industry. The result is a dysfunctional market. For instance, prior to 2000 the oil market was made up of roughly 30% speculators and 70% bona fide hedgers (producers and oil consumer with legitimate financial interests in oil). Fast forward to a few years ago and the market structure had changed to 70% speculators and just 30% legitimate hedgers.
Oil and other commodities prices no longer act as reliable indicators of underlying demand, but instead reflect the whims of the speculators. Should oil prices fall due to weaker demand and higher supply? Absolutely! But the fall has turned into a complete crash due to deregulation and the influx of speculative money (If you are interested you can read more about the commodities market here).
4. The end of austerity in the U.S.
Over the past four years, sequestration and budget cuts have meant the government sector has been a drag on the economy. Budget cuts and tax increases cost the economy almost one million government jobs lost and subtracted around 3.5% (perhaps even more) of cumulative GDP growth from the economy. The new budget deal reached this past December, however, is set to change all that as the graphic below shows.
We are set to get around $300 billion in new spending and tax breaks in 2016, which should add measurably to U.S. growth.
5. The budget deficit is set to grow
For the first time since the financial crisis, the U.S. budget deficit is set to increase. The CBO is projecting the budget deficit for 2016 will be 2.9%. This is 2.9% of net financial assets the government sector will be adding to the private sector economy. Just as the massive stimulus spending and budget deficits supported growth and the recovery after the financial crisis, we should see the same fiscal benefit albeit on a much smaller scale. While conventional wisdom is that deficits are bad, I encourage you to read a previous article I wrote, which goes into more detail about how government deficits and debt actually work. And speaking of deficits and debt…
6. U.S. household debt service is at historic low
The U.S. consumer is in about as good a financial situation as they have been in during the last few decades. There is plenty of runway available for a consumer credit led expansion before debt service ratios reach worrisome levels. Additionally, low debt service levels cast some doubt on the common mantra that consumers will be spending their gas savings primarily on paying down debt. Furthermore, a consumer credit expansion isn’t the only thing that could drive an economic expansion.
7. Housing starts still below average
Despite recovering from the recession, new housing starts are still running below average and not keeping pace with household formation.
There is plenty of headroom for residential construction to increase before reaching the level of a housing bubble.
8. Stocks are cheap – S&P 500 forward P/E is below average
With today’s market rout, the S&P 500 forward earnings multiple is 14.9, solidly below its 25 year average of 16.5. We have strong job growth, low inflation, the prospect of years of housing led growth, consumer debt service ratios at modern era lows, increased government spending and tax cuts, and still low interest rates. I’d say you’d be crazy not to invest in American businesses at these prices. A good economic outlook and below average prices on stocks should make for good returns in the coming years.
9. China isn’t as important as people think
What about China? While China is certainly a large economy and what happens in China can affect economies around the world, let’s keep a few things in perspective. First, China grew at an annualized pace of 6.8% last quarter and 6.9% for the year. Is growth slowing in China? Yes. But, it has been slowing for many years now and 6.9% growth is hardly anywhere near a recession or even a hard landing.
The U.S. is probably one of the most insulated economies from China. China is not a very large export market for the U.S. and only about 5% to 7% of the revenue of S&P 500 companies comes from China. That’s it. As long as China doesn’t explode into a ball of fire tomorrow and can maintain some semblance of growth, we are talking about 5% to 7% of the stock market revenue that is at stake. Hardly the reason to justify a panicked selloff of U.S. corporations.
10. Even if I’m wrong, I’m probably right
Even if I’m wrong about the nine reasons I listed, I’ll still probably end up being right. Let me explain. The natural state of the market and the economy is growth. Take a look at a graph of stock market returns or GDP growth over any reasonably long period of time, and the line goes up. Every day, humans all over the globe get up and strive to make their lives (and others) better. They try to do more, and make more and live better than they did yesterday. It’s foolish to bet against progress over the long term. Sure, there will be bumps in the road, but the economy and the stock market grows over time. Three out of four years the market is up. Even better, 101 times out 105the rolling 10-year return for the stock market has been positive. Even if my nine reasons are wrong, I’ll take those odds any day.
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