March 12, 2010 Edition, Volume IV
Inside Signature Update
- The Market – The Rising Price of Oil May Quickly Becomes Self Correcting
- The Economy – Luxury Retailing Gains Not Surprising
- The Takeaway – Gold Bugs Looking for Profits as Prices Decline
THE MARKET – The Rising Price of Oil May Quickly Become Self Correcting
Three years ago, at roughly this same time of year, we saw oil prices begin to climb to uncomfortable levels. Oil prices rose from the $60-$70 per barrel range in early 2007 to almost $150 in the summer of 2008, before crashing to $33 less than six months later. The rise was due to a combination of increasing demand and outright speculation and market manipulation; the crash came as demand collapsed and the economy presented one of the most difficult recessions in recent memory.
It’s difficult to tell how much oil’s bloated pricing weighed on the economy. Though it isn’t likely that it was a major contributor to the recession, it certainly hastened the event’s economic and market impact. Household budgets were stressed and producers struggled to maintain acceptable operating margins in the face of increased energy costs. That the scenario played itself out along side of a real estate boom and bust and the attending credit crisis is likely coincidental; regardless, it made a bad situation worse.
Today, we’re seeing oil trending higher once again. Global demand is expanding as the recession is subsiding and economies are once again increasing output. Unlike the demand and speculation driven increase in the price of oil during 2006-2008, today’s price levels appear to be supported by international exchange rate changes as the dollar has lost ground. Fully $30 of oil’s rising price tag may be related to the dollar’s value relative to that of other currencies. But that leaves room for another $20 of price increase due to expanded demand.
Though I don’t want to get caught in the trap of suggesting that “things are different this time”, it is important to point out that the fundamental causes for oil’s rise from $100 per barrel to near $150 in 2008 were heavily laden with market speculation and outright manipulation. These detrimental market forces are in no position to make a run at oil following the recent recession; their coffers aren’t filled with profits from real estate and stock market gains, and there simply isn’t the availability of credit capital to employ substantial leverage.
While this doesn’t mean that oil’s value won’t climb further, it does mean that the elements necessary to drive oil’s price beyond that which basic supply and demand influences can moderate are not only not present, but are effectively irrelevant for the foreseeable future; which is good news for the consumer and the economy. Consumers weren’t nearly as sensitive to oil’s price movement three years ago as they are today and it took almost two years of expanding prices before consumer demand began to wane. While still burdened by unemployment, low real estate prices and a shift in savings and consumption patterns, consumers are far more cautious today and will adjust demand more quickly than in 2006-2008.
When consumers finally shifted consumption patterns in 2008, oil’s price collapsed, leaving speculators and market manipulators with dire consequences, but it did so after substantial damage was inflicted on the economy. Not only have consumers begun to shift demand for fuel much earlier than several years ago, but the US dollar has stabilized and appears to be poised to make meaningful gains as interest rates return to more appropriate levels later this year and in 2011. A stronger dollar shifts the price of oil downward, and when combined with demand decreases by consumers, should moderate oil’s rise in price and avoid exaggerating oil’s impact on our recovering economy.
THE ECONOMY - Luxury Retailing Gains Not Surprising… if you know Thorstein Veblen
Higher-than-expected retail sales and unchanged inventory levels were reported early Friday morning; providing a boost to equity markets and showing greater strength than most had expected. February retail sales figures increased by 0.3% in spite of the winter storms expected to have kept many consumers in their homes and away from retail outlets. Analysts had anticipated a 2.1% decline in reaction to the worse-than-expected February weather trends and high unemployment levels, but once again, the US consumer showed their resiliency. At the same time, inventory levels remained virtually unchanged, rather than experiencing an expected increase.
Throughout the recent recession, economists and others debated whether or not the US consumer would be in a position to help lead the economy back towards recovery. The consensus has been that consumers would be too overcome by high unemployment, a transition to a net savings rate of close to 6%, and depressed housing prices to be in a position to improve the retail markets. All but the most optimistic analysts and economists supposed that consumers would break from a pattern on which we’ve come to depend by their continued avoidance of retailers even after the markets began to show signs of improvement. Each time retail sales reports have exceeded expectations in the last year, pundits have explained the increases as mere anomalies; it’s now become increasingly difficult to do so. In spite of bad weather, labor market difficulties, credit concerns and low inventory levels, consumers continue to make their presence known and the economic benefits are significant.
Manufacturers, both at home and abroad, have increased production to replenish depleted inventories, and the resultant improvement in GDP helped buoy the markets and calm fears. Despite pessimist’s concerns that increased production would equate to increased inventories, we’ve now observed that inventory levels remain low and expect production levels will need to expand yet further.
That’s good news for the economy and even better news for the nation’s unemployed. Though most manufacturing jobs have been exported to other countries, a sufficient number remain to make a meaningful difference. In addition, the domestic labor force required to support distribution represents a substantial number of job opportunities in transportation, administration, retailing, finance and advertizing. While it may not be sufficient to return our economy to full employment, it is certainly enough to improve employment figures by 1-2%.
High-end retailers across the country are seeing improvements in almost every measurable category. Sales volumes, transactions, in-store traffic, and margins have improved across the board, but more so for retailers such as Nordstrom’s and Neiman Marcus than discounters WalMart and Costco. Improved sales of luxury goods appears counter-intuitive when viewed in relation to the nation’s ongoing employment problems, increased savings rate, and limited gains in personal income, but sales at luxury retailers have made meaningful gains, many now with three and four month improvement patterns, while sales at discounters remain flat.
The rise in high-end retailing certainly isn’t due to improved employment or increasing real estate values, but may be indicative of an affect described by the 19th century economist Thorstein Veblen in his 1899 publication, The Theory of the Leisure Class. Veblen proffered that consumers at all levels will choose to purchase goods above that which may be prudent in an effort to increase utility and maximize satisfaction. Some do so to connect themselves to a higher level of society; others simply find greater enjoyment and sense of self-worth through the consumption of luxury goods.
These goods, referred to as “Veblen goods” have been at the heart of virtually every economic recovery of the 20th, and now 21st, centuries; prior to which time wide spread availability of higher end consumer goods was limited. Even though luxury goods are among the first to suffer sales declines when the economy tightens, they’re also among the first to rebound. Consumers simply demand them; regardless of how prudent such purchases may be.
Retail sales increases, particularly in respect to luxury goods has become one of the most certain signs that economic recovery is progressing. It has become an even more accurate barometer than consumer confidence indicators.
Many suggested that this recovery would be different than those of the past, that things were “different this time”, and have offered explanations for why the consumer couldn’t be expected to make any significant contribution to a rebound. We appear to be seeing, once again, that things are rarely different than at times in the past, and that supposing they will be may only lead to greater levels of difficulty for those unprepared to accept the path dependant nature of economic events.
THE TAKEAWAY –Gold Bugs Looking for Profits as Prices Decline
- The potential for meaningful financial and healthcare legislation to make its way through the Congress continues to fade. This may be one of those times when a plan driven by compromise is less attractive that no plan at all.
- After having lost over $100 per ounce in the last two months, the gold markets appear to remain top heavy and are likely to see further weakness. Not coincidentally, advertizing activity from purveyors of the precious metal have increased once again and the public is receiving messages of economic doom and gloom in an effort for these firms to sell as much of the commodity as possible while price levels remain above $1,000 an ounce. Don’t fall prey to inflation fears by Gold Bugs and others looking to off load their holdings while prices are still high.
- Consumers are likely to adjust energy demands more quickly than several years ago in the face of higher oil prices and a still-weak economy. Make sure you’re one of those that pay attention to the potentially damaging affect increased oil prices can have on our economy and take appropriate action. We’ll all be better off for it.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
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