Oil Plunges, Europe Steps On The Gas As Earnings Downshift

fall down oil barrel

Oil prices have now fallen as much in % as did stocks back in the 2008 mortgage meltdown (57%). There is a terror war idling some Iraqi Oil production, Libya is in civil war with Oil refineries burning and US Oil rigs are seeing their biggest reduction since 2008 when Oil crashed from $145 to $33 a barrel. Yet the Oil  glut continues and even lower energy prices remain the consensus. 

oil chart

The combination of marginal shale producers going bankrupt before spring, strong seasonal demand beginning in February or March and the prospect of Europe’s new monetary stimulus (QE) creating greater energy demand later this year should all be factors in creating a bottoming process for Oil by March. Hopefully Hedge Fund extremes will pinpoint the bottom as well as they did the top for our forecasts.

It was no surprise that Mario Draghi’s European Central Bank (ECB) announced today that the printing of Euro currency – Quantitative Easing (QE)  – would finally begin. The mild surprise was the Bernanke sized plan to buy $60 Billion Euro worth of sovereign bonds monthly forever – until inflation rises above 2%. Currently there is no inflation! The ECB’s plan to buy massive amounts of debt, sequestering it from the free market, and to flood the the banks with new Euros has sent the Euro currency plunging again. Once 118 – 119 support was broken last week the new long term target for the Euro became 100. This means the US Dollar should also rise to 100 or higher as the Euro devalues.

Stock Market Risk Is Rising

Now for the bad news: A surging US Dollar will hurt exports. Further drops in Oil will increase default risk. Both of these trends hurt US earnings forecasts and create greater stock market risk in the first half of 2015.

junk bonds 1-15

As Oil falls junk bond prices fall. We have shown the leading indicator of Junk Bonds peaking prior to stocks in recent months that correctly forecasted the September and December 2014 tops.  As long as Oil is hitting new lows every couple of weeks stocks are at risk of deeper declines. Should CCC Junk yields rise into the 13 to 16% yield zone then stock prices would be at risk of a significant double digit % decline.

junk bond etf

These next two charts show how the strong dollar and falling Oil prices have significantly downshifted the forward earnings outlook of US stocks. While a large rally in Oil could quickly reverse this warning, as long as the Dollar is rising and Oil is falling the risk of negative earnings revisions and much lower stock prices remain a concern.

earnings forecast chart

EPS rate of change

These medium term warnings don’t change the positive longer term perspective we have maintained for 6 years. It just means that the Global recession bottoming process is likely to culminate in 2015 and the euphoric stock markets may have to live with increased volatility until the rising earnings growth forecasts can be restored. Markets rise on positive “expectations”, not just actual earnings growth. In the long run low inflation and interest rates combined with the monetary stimulus of the UK, US, Japan and now Europe will provide the equivalent of a  massive Put Option on the market that will guarantee unlimited stimulus from all industrial countries until self sustaining economic growth arrives.

 

 

 

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