Defense

Defense.  Markets were roiled on Friday in response to an American drone strike which killed Iran’s top military commander.  Bad economic data was largely overlooked in the market mayhem.  

 

N O T E W O R T H Y

 

• Dark slimy substance.  Is the price of crude oil even relevant anymore?  With more and more use of electric vehicles, an expanding awareness of the negative effects of carbon-based fuel, and a changing demographic emerging in which car ownership is decreasing one would expect demand for crude oil to shrink.  On the supply side, technological innovation such as shale fracking has allowed the US to become a net exporter of crude.  The increase in supply and power shift away from the Middle East-dominated OPEC cartel has made price support more difficult.  Given this high level analysis of the commodity, one would expect that the price of crude oil is no longer as important as it was historically.  Unfortunately, the analysis is much more complicated, and while the longer term trend for crude oil may not be as positive as it once was, it is still very relevant today.  Let’s unpack Friday’s events to get an understanding.  The  US drone strike which killed Iran’s top military commander will almost certainly draw a response in the already unstable region.  Iran sits on the northern border of the Persian Gulf which narrows in the Strait of Hormuz before widening into the Arabian Sea and ultimately into the Indian Ocean.  The width of the strait narrows to around 40 km making shipping vulnerable to hostilities.  Roughly 18 million barrels of crude pass through the strait daily which amounts to around 25% of the world’s oil supply.  Iran has demonstrated in the past that it would exploit the flash point… remember last year’s rocket strikes and vessel commandeering?  This would make the Strait of Hormuz one of the likely soft targets in any Iranian response.  This is precisely why the price of crude oil rose by 3.55% on Friday.  Now onto the reverberations beyond just the price of crude oil.  Airlines were down by -1.93% as fuel costs are a big factor in the industry’s profitability (American Airlines was down by -4.95%).  What about the energy industry as a whole? Down by -0.34%.  The reason for this is that distillers which turn crude oil into useful things like natural gas and gasoline will have increased costs thus affecting their profitability.  Philips 66 (PSX), a downstream oil refiner, is an example.  PSX was down by -3.31% on Friday.  Should the trend continue, we can expect gasoline prices to rise, which would not only affect average consumers at the pump, but also potentially the mainstays in the newly minted gig-economy.  Think Uber and Lyft whose drivers must supply fuel.  What about shipping costs?  Think about UPS and Fedex, who need jet fuel and gasoline to deliver that package with a big smile on its side (you know the one).  We can keep going down this line of analysis, but it is also important to remember that crude oil is also used for heating (much of the World’s population is in Winter).  Crude oil is also utilized in the production of plastics, food, soap, and fertilizer, to name but a few others.  These are just some of the reasons why I often say that crude oil is actually the oil of industry.  So, is the price of crude oil relevant?
• Can we build it?  On Friday, most traders were focused on the fallout from the US drone attack, which largely overshadowed a notable economic number miss in the morning.  The Institute for Supply Management (ISM) released its Manufacturing PMI which showed a drop from 48.1 to 47.2, missing expectations.  The release was the fifth straight month below 50, which represents a decline, or contraction, in activity.  The level is the lowest reading since June 2009, which was when the US economy was emerging from the last recession.  This, despite the fact that trade tensions are somewhat warming.  A little perspective is necessary.  While manufacturing is important, it roughly represents just 12% of GDP.  Further the PMI likely reflects the slowdown in production at Boeing and the GM strike.  Still, this number, like all of the ones I highlight, plays an integral part in the overall health of the US economy and should be carefully monitored.

 

THE MARKETS

 

Stocks traded down on Friday in response to the US drone attack in Iraq, which killed a top Iranian military commander.  The S&P500 dropped by -0.71%, the Dow Jones Industrial Average traded down by -0.81%, the Russell 2000 sold off by -0.35%, and the NASDAQ Composite Index slid by -0.79%.  Bonds rose as a safe haven asset and 10-year treasury yields climbed by -9 basis points to 1.78%.  Gold rose by +11.51% in a safety trade.

 

NXT UP

 

– Markit Serviced PMI is expected to be 52.2, same as the prior reading.

– Later in the week we will get Factory Orders, Durable Goods Orders, ADP Employment Change, ISM’s Non-Manufacturing PMI, and the monthly employment situation. Please refer to the attached calendars of economic and earnings releases for details.  

 

Flying South

 

I will be in South Florida this coming Thursday and Friday meeting with clients in our Boca Raton and Miami offices.  I would love to spend some time with you so please reach out.

 

 

daily chartbook 2020-01-06

econ numbers 1_6

earnings releases 1_6