Welcome to 2020!! Another decade down and on to the next one. What can you say about 2019 other than ‘that went better than expected.’ It almost doesn’t matter where you invested last year, you saw decent returns. About the only exception in the U.S. were oil and gas stocks. Just look at the oil services ETF (orange line below). It managed to lose -5.6% despite a +34.5% rise in crude prices. That takes some doing.
You also saw credit spreads on energy bonds blow out last year as well. This means the bonds lost money as investors priced in a higher chance of default (chart below).
But outside this sector, the markets rewarded investors in 2019. But we probably should look at 2018 and 2019 together. The chart below shows the S&P from the high back in September 2018 through the end of 2019. While 2019 felt like a big bull market, a big part of the rally last year was just recouping what was lost in the 4th quarter of 2018.
The major leg higher didn’t start until October – this coincided with the Fed ramping up their bond purchases to calm the repo market. And boy are they buying a lot of bonds. The chart below shows the monthly change in the Fed’s balance sheet going back to the financial crisis.
The liquidity injection in the fourth quarter of last year rivals what we saw during the depths of the financial crisis. That’s really saying something given that we aren’t in recession, unemployment is at 50-year lows, and the markets are bouncing around new highs.
Iran and the Energy Markets
Of course, the major news for the week was the escalation of hostilities in Iran. There was a time a few years ago this would have hit the markets hard and oil prices would be through the roof, at least temporarily. Granted, right after the news broke the futures were off roughly -2% and oil prices were up modestly. But the selling didn’t last, and the markets closed higher the next day. Can you believe oil prices were down over -6% this week??!! I can’t either. I had to check the number a couple times this afternoon.
What gives? Geopolitically we have no great insights, but we would point out that the link between oil prices and the U.S. economy has really broken down. In the past the main conduit through which Middle-East tensions hit the U.S. economy was through oil. Think of the first Iraq war. Oil prices surged and investors started to worry this would translate into recession. Or the oil embargo back in the 70’s. However, over the last few years this linkage has broken down. The chart below shows net imported energy as a percent of total U.S. energy consumption.
In 2019 we became a net energy exporter. You could even make the case that higher energy prices actually helps the U.S. economy because all those oil services stocks we mentioned at the beginning of this piece see their cash flows boosted.
But oil was down this week amazingly. Oil services were down -3.4%. Brutal
This really is an amazing change. Makes you wonder what the next decade has in store.
Disappointing Jobs Report
The other major economic item this week was Friday’s payrolls report. Nonfarm payrolls rose a disappointing 145k in December, 15k below consensus. Job growth in prior months was also revised down modestly. The unemployment rate held steady at a 50-year low, as you can see below.
Probably the most interesting number was average hourly earnings – it rose by less than expected in December, with the year-on-year rate dipping to 2.9% (chart below).
So why did the market rally right after the number came out? One reason could be that the jobs report puts the Fed on the sidelines for longer. The odds of a rate cut in 2020 actually increased after this report. The chart below shows how the market is pricing in various Fed Funds scenarios for all of 2020. The odds of no change stand at 38% after Friday’s payrolls report. The odds of one cut stand at 37.8%.
The cumulative odds of a rate cut in 2020 increased from 50.3% on Thursday to 58.4% on Friday.
The Downside of Cargo Shorts
Never let it be said that economics is boring. How about an economic analysis of on-line dating? Tyro Partners LLC put out a piece that is well worth a read if you want a chuckle.
The best bit is as follows:
“Below are some entertaining charts from OKCupid on how men rate women versus how women rate men. Men broadly rate women on a nearly perfect normal distribution.
Women rate men on a curve that we assume approximates male ownership rates of crocs/cargo shorts. 0% of men rated most attractive makes sense. Women know all men secretly own at least one pair of cargo shorts.”
Have a good weekend.
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