As oil prices plunged in recent months, debate heated up regarding whether the drop was due to falling global demand, rising supply, or a combination of both. For substantial periods during the declines, equity markets traded in sync with the price of oil, indicating a widespread belief that falling global demand was the culprit. Lower overall demand implied global economic weakness, and a reason to sell stocks.
Equity markets have since disconnected from this thesis and for good reason. According to recent estimates from research firm Energy Aspects, Global demand for crude hit a record high in December of 2014, growing by 2.2 million barrels per day, the fastest annual pace in a year and a half.
Without question some of this increased demand is a direct result of lower oil prices. We've seen a recent pickup in gasoline demand and sales of light trucks and SUVs are outpacing their more fuel efficient counterparts. But regardless of the increased push from lower prices, the key takeaway is that demand for oil is trending higher over the long-run.
This of course has both positive and negative implications. On the positive side, growing demand, even in the face of a worldwide push towards energy efficiency and green energy, signals that worries about major global economic weakness may be overblown. The negative implications are primarily environmental and sustainability related, as we continue to use up this precious resource at an alarming rate and incur the environmental repercussions of doing so.
Another research firm, the International Energy Agency (IEA), corroborates Energy Aspects' estimates that global demand is at an all-time high. Their data is presented below, showing oil demand in the fourth quarter approaching 94 million barrels per day. This chart also highlights the notable, but not world-ending reduction in demand that was seen in the first and second quarters of 2014. Even at those subdued levels, demand was still higher than in the first and second quarters of 2013. Perhaps the markets were confusing volatility in demand for a change in trend.
If flatlining oil demand is not the culprit for the halving of oil prices, that leaves two other options: supply growth outpacing demand, and possible price manipulation from traders. The chart below, also from the IEA, demonstrates the dramatic increase in supply. It's a bit hard to tell, but the supply levels seen below for each quarter of 2014 are higher than the demand figures for those respective quarters in the chart above. That implies that during each quarter of 2014, stockpiles grew. This fits with data elsewhere showing that oil stockpiles are at record levels.
We know that oil, just like many other markets, is the subject of speculation, and that momentum tends to carry trends pass their point of equilibrium. Unfortunately, it's difficult to tease out the effects of this non-fundamentally driven behavior, and so in many ways we must simply disregard it, knowing that once the pendulum swings too far, it will eventually move back towards the natural supply-demand price equilibrium.
That being the case, we are left looking primarily at the supply and demand data, which shows that the main cause of oil's precipitous fall is not collapsing global demand, but rising supplies that are outpacing demand. Until supply and demand become more balanced, we are likely to see continued pressure on oil prices. That suggests oil prices will not move substantially higher in the near future, and will continue to be a boon for consumers and spending.
From a technical perspective we can see that oil has attempted a minor bounce from late January lows, but that rally is encountering resistance at the 50-day moving average. Short term momentum, evidenced by the lower MACD indicator, is moving back to the downside.
Changing topics completely, last week The Conference Board released their latest monthly data for the leading, coincident and lagging indexes. The leading economic index rose by 0.2% in January, indicating the US economy remains on an upward trajectory, but the pace of growth has slowed marginally from a 0.4% increase in December. The coincident economic index also rose by 0.2% in January, mirroring a 0.2% increase in December.
The Conference Board cites "lack of strong momentum in residential construction" and a "weak outlook for new orders in manufacturing" as possible downside risks for the economy.
The leading and coincident indexes are shown in the chart below. As you can see, and as we have discussed many times, the leading index reliably turns down well in advance of recessions. The coincident index also has a habit of turning down very close to the onset of a recession. With both these indicators still moving higher, it suggests the possibility of a recession in the near future is very slim. Since most bear markets are accompanied by a recession, it also suggests a bear market in the near future is unlikely.
The following was an excerpt of Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
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