The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Relative to our early conversation on the Half Life of favorite technologies:

Cool graphic (note this is the 1st 10%):

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click for ginormous graphic

Via instamerchant

Some Thoughts About the Oil Price?
March 28, 2011
David Kotok

http://www.cumber.com

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The TV is crammed with industry folks and analysts calling for the oil price to fall $20 or $30 per barrel. They argue there is a geopolitical risk premium that is part of the current price. They may be right, BUT no one knows how to measure a “geopolitical” risk premium. We can only guess at it.

Market forces set prices. We see them in the oil market for various types of oil and for various maturities in the futures markets. Those prices are all well above the $70-$80 range. As Dennis Gartman points out well in his daily letter, the futures market tells you the expected cost of holding an oil inventory in actual storage vs. using a financial instrument in place of the physical storage. If you go by the markets, the outlook for oil is well above $70-$80 and headed higher.

Various estimates of global oil demand center on 88 million barrels a day for 2011. In some excellent research Barclays assembles the outlook for oil from four key sources. Barclays also runs longer-term supply/demand analysis on a global basis and then projects the oil price.

Barclays estimates that the oil price can be about $185 by the end of this decade. It can be $135 within a couple of years. This is without a supply shock that may result from current violence in MENA. In addition, we add, it is without any supply shock originating in Nigeria or other Sub-Saharan African oil sources.

We remain overweight oil and energy in our US exchange-traded fund portfolios. The current weight of the energy sector in the S&P 500 index is about 13.5%. We are about 20%, which is about as high as we would go with a sector this large. We remember that the energy sector reached nearly 25% of the total market weight when the Shah of Iran fell in 1980 and the oil price then spiked to $30 a barrel. We also remember that the sector weight fell to as low as 7% when oil plunged in price to as little as $10 per barrel a few years ago.

The key to oil is to be nimble. You can buy it and hold it forever or you can change your weight, depending on richness or cheapness. When the energy sector is priced as a single-digit percentage of the US market, it is cheap. When it is above 20%, it is richly priced. Currently we are in the middle.

Oil and energy is currently neither cheap nor dear. Therefore, the pricing of the stocks in this sector depends on the outlook. Here the information is available and the outlook for US companies remains positive.

The US is dependent on imports of oil. We get it mostly from ten countries. Dennis Gartman reports the sources in his letter today. They are listed by size of imports: 1. Canada 1.972 million barrels per day, 2. Mexico 1.140 bpd, 3. Saudi Arabia 1.080 bpd, 4. Nigeria .986 bpd, 5. Venezuela .912 bpd, 6. Iraq .414 bpd, 7. Angola .380 bpd, 8. Colombia 338 bpd, 9. Algeria .325 bpd, 10. Brazil .254 bpd

Since global oil is priced in US dollars and is likely to be priced that way for a long time, the issue for a US investor is the dollar price discovery and how that will unfold. MENA violence aside, it is clear that the US dollar price of oil is likely to go up.

Some of that “up” will be due to weakening currency. Some of it will be due to rising global demand. Some of it will be due to the absolute failure of the US ENERGY POLICY WHICH MAKES US DEPENDENT ON FOREIGN-SOURCED OIL. And some of it will be due to the supply shocks from geopolitical risk in MENA and elsewhere.

The total of these things suggests that the upward price bias estimated by Barclays is a correct thematic view for an investor. At Cumberland, we remain overweight the energy sector. As we have written several times: “This is nowhere near over.”

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David R. Kotok, Chairman and Chief Investment Officer

WJB Technical Analyst John Roque channels his inner imp to deliver these delightfully sarcastic bon mots:

“Won’t it be cool if subsequent versions of QE are referenced with Roman numerals like the Super Bowl?”

Oy.

Walter Derzko of Smart Economy gives us the heads up on this interesting map, showing citations in Chemistry papers (below). Thanks to some clever programming, plus Google Maps, we can see the distribution of the cities that produce more excellent papers than expected.  Similar figures are also available for physics and psychology.

Note: Professors Loet Leydesdorff & Olle Persson describe the process of how to use “Google Earth, Google Maps and/or network visualization programs such as Pajek, one can overlay the network of relations among addresses in scientific publications on the geographic map.” (PDF)

Green circles indicates frequent citations, red circles low citations and size of the circle indicates the number of publications:

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Global Chemistry Papers

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Europe Chemistry Papers

Maps via Loet Leydesdorff

Excellent news: Despite the best efforts of misguided government policies (tax credits, mortgage mods, foreclosure abatements) and the Fed (ZIRP), Home prices are falling towards normalized levels. (Yeah!)

That is the result of the latest Case Shiller data for January 2011: “The 10-City Composite was down 2.0% and the 20-City Composite fell 3.1% from their January 2010 levels.”

The chart below shows that we have now reverted back to price levels where housing markets launched into their vertical 3 year price rise.

What we have yet to erase is the excess speculation from the 2002 to 07 mania. Until that gets wrung out of the market, I doubt you will see a healthy Real Estate sector. That will only take place through a combination of lower prices, better holders and the elapsing of time.

The good news is that is happening. The bad news is its a slow painful slog . . .

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(As always, click for ginormous chart)

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One of 20 areas (D.C.) rose last month, preventing another shutout (one of 20 rose in each of December (Cleveland) and November (San Diego); all 20 declined in October).

Here’s how far back each of the 20 areas (and the 10 and 20) have fallen:

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And all 20 metro regions on one chart:

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More charts after the jump

Read the rest of this entry »

Joshua Brown, author of “The Reformed Broker,” says he believes there will be no QE3 and that Bernanke deserves some credit for keeping the bottom from falling out. CNBC’s Melissa Lee and the Fast Money traders discuss how to trade the end of QE2 and stimulus.

Airtime: Mon. Mar. 28 2011 | 5:43 PM ET

S&P/CaseShiller said home prices in Jan fell 3.06% y/o/y in the top 20 cities, a touch better than expectations of a fall of 3.2% but it does take the index right back to the lows. At 140.86, it is just 1.1% above the low reached on Apr ’09 and is 31.7% below the record high in July ’06. With the Federal Government the unfortunate growth leader for the economy, Washington DC saw a 3.6% y/o/y price gain. San Diego also saw a gain but the other 18 cities had price declines led by Phoenix and Detroit. Bottom line, prices are retesting the lows again with no reason to think they won’t break below. The question of course is to what degree and whether bank balance sheets are prepared. Most unfortunately do not assume a double dip in pricing.

Reflecting the recent goings on, March Consumer Confidence fell to 63.4 from 72 in Feb and was 1.6 pts below expectations. It does match a 4 month low but the breakdown was mixed as the Present Situation rose 3 pts to the best since Nov ’08 while Expectations were down by 16.5 pts to the lowest since Nov ’10. The answers to the labor market questions weakened somewhat as those that said jobs were Plentiful fell and those that said jobs were Hard to Get rose. Those that plan to buy a home within 6 months fell to a 3 month low and those that plan to buy a car was down by almost 2 pts. Importantly and worrisome for the Fed, one yr inflation expectations jumped to 6.7% from 5.6% to the highest since Oct ’08 and compares unfavorably with the 20 yr average of 4.7%.

• Real Time Economics (WSJ Blog) – Like The Phoenix, U.S. Finance Profits Soar

Not too long ago, during the depths of the global crisis, the finance industry was on the brink of collapse. How times have changed. Friday’s revisions to U.S. gross domestic product contained news on fourth-quarter profits. Top-line, or pretax, operating profits economywide hit a record high at the end of 2010. All of the gain was in the financial sector. During the darkest days of the financial crisis, when Lehman Brothers and Washington Mutual went belly up and the U.S. government had to bail out other institutions, the finance sector reported an annualized loss of $65.2 billion in the fourth quarter of 2008. It was the only quarterly loss recorded in the government data. Since then, the sector has come roaring back. The GDP report shows finance profits jumped to $426.5 billion. While profits haven’t returned to their high levels of 2006, the gain in finance profits last quarter more than offset a drop in profits posted by nonfinancial domestic industries. After rising like the Phoenix, the financial industry now accounts for about 30% of all operating profits. That’s an amazing share given that the sector accounts for less than 10% of the value added in the economy.

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Comment: As the chart below shows, profits at financial companies accounted for 28.72% of all corporate profits at the end of 2010.  The rise in financial profitability relative to all other corporate profits should not shock anyone considering the Federal Reserve’s mission to keep the yield curve artificially steep.  As we said in 2009:

As the yield curve rises, financial sector companies make more money relative to non-financial companies.  As the yield curve falls the financial companies lag behind.  The exception to this rule is the latest period which shows a big divergence between financial sector profitability and the shape of the yield curve.  This can be explained by the huge write-downs by financial companies over the last two years.  But notice the record steep yield curve has caused financial sector profitability to bounce back sharply in the last three quarters.

Before the huge write-downs the financial sector was regularly generating 30%, 35% and even 40% of all corporate profits, an astounding number.  This is especially notable when compared to its longer history as shows in the second chart below.

Prior to the end of Federal Reserve Regulation Q (which set limits on interest rates) and other financial deregulation of the early 1980s, financial sector profits rarely topped 20% of all corporate profits (thick black line, second chart).  Since the 1980s, they have rarely been below 20%.

Sum it up and the most important driver of all American corporate profitability could be the shape of the yield curve.  The biggest driver of the yield curve is government manipulation of the front-end Federal Reserve Policy.

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Click on chart for larger image