Long-time clients and members know we began warning of “impending doom” in the price of oil as 2012 dawned. We reiterated same in a special report in winter of 2013. Witnessing what has unfolded since is always humbling – much like missing the tech bubble was in 2000-2003.
Back then I recall many asking “when will it be time to buy tech again?” My answer was always the same, “When it is time, you will want nothing to do with tech stocks.”
When I wrote the first piece on the aspects of an oil collapse, it was laughed away. The US was cresting at a 7.7mbd output. Fracking was termed too short-term and the thesis was it would be a one-shot wonder. That might be the case if we were only finding new oil via fracking. Our output each day in the US now? Over 9mbd. Heck, even the Gulf of Mexico has just hit all-time high outputs.
Even as we see rigs in operation hit multi-year lows, the assumption all along was simple: production will plummet. Not.
Hard To Kill
Even after the torture for the energy sector, the U.S. pumped a near-record 9.18 million barrels per day in January, according to recent stats released by the U.S. Energy Information Administration. That’s down a minuscule 0.6% from the end of 2015 and is actually slower than the pace of U.S. monthly production declines that started last year.
In other words, America’s incredibly resilient oil boom has not tapped on the brakes hard enough yet to fix that epic global supply glut.
U.S. oil production peaked in April 2015 at 9.69 million barrels per day. Yes, it has come down in the months since then, but only modestly.
In late January, after watching values get shattered in the oil sector, we suggested the following in your morning update:
Earnings Damage Done?
The yearly change in forward earnings did turn slightly negative during June last year. And it is up just 1.1% y/y through the week of January 21.
However, the S&P 500 isn’t in a profits recession excluding the earnings of the Energy sector. The Energy sector is weighing down earnings as measured by both Standard & Poor’s (SP) and Thomson Reuters (TR).
Let’s have a look at several measures of aggregate earnings:
(1) NIPA profits. According to the National Income & Product Accounts (NIPA), after-tax corporate profits based on tax returns rose to a record high of $1.84 trillion (saar) during Q2-2015, a solid gain of 8.5% y/y (Fig. 3). It did dip 3.3% q/q during Q3-2015, but was still up 1.3% y/y.
NIPA also calculates after-tax profits from current production. It has been essentially flat since Q2-2012. Nevertheless, corporate cash flow has been edging higher into record territory, totaling $2.12 trillion (saar) during Q3-2015.
(2) S&P net income. SP compiles a series for the total net operating income of the S&P 500. It peaked at a record annualized rate of $1.1 trillion during Q3-2014. It’s been down each quarter since then by 14.7% through Q3-2015 to the slowest pace since Q4-2012. All of that apparent profits recession is attributable to the decline in the net income of the Energy sector.
Let’s Drop the “Headwind Fear” From Our Thinking
Yes, the Energy sector was a major drag on overall S&P 500 earnings last year. SP’s data show that S&P 500 earnings dropped 14.1% y/y during Q3. However, removing Energy turns this figure to a positive 3.4%. TR’s story is less pronounced, but directly the same. S&P 500 earnings dropped 0.7% with Energy, but rose 6.8% excluding it, according to TR’s account for the same period.
Furthermore, consider the following:
Energy related elements now carry a much lower earnings share. The price of Brent is now, having fallen 72% since the summer of 2014.
The good news?
Even if oil prices should fall further, that wouldn’t have as much of an impact on S&P 500 earnings as oil price declines of similar size did last year. That’s because the earnings share of the S&P Energy sector dropped from a cyclical high of 14.9% on August 4, 2011 to a record low of 3.3% as of mid-January.
The Bottom Line?
The markets are feeling the trepidation over what this next earnings season will bring as data begin to flow shortly for Q1 results. I stand by the same thesis present for months:
The impact of the energy collapse is about complete. We should see a round-trip of the worst by end of Q2/early Q3.
The media will mistakenly focus on the “earnings recession” when the bulk of that “setback” is all in energy comps.
Corrective windows and/or periods of price panic – even a hoped for summer swoon – should all prove valuable for long-term investors with cash holdings. (pray we get them all by the way – fear is good for values)
This focus on an “earnings recession” feels like 1994/1995 all over again.
It also feels like Greece, Grexit, the PIIGS, Brazil, Ebola and Zika fears…all falling into the “Armageddon Now” turns into “Armageddon Later” box.
A few charts can also be helpful for the data above:
The Big Picture Summary
That first chart above gives you a sense of the pace of output reduction in barrels of oil per day from the US.
Yes, it is falling – but on a 9.5MBD peak, those are pretty paltry reductions when considering how many rigs have been idled. Note also that those 5,000+ capped wells will come online once a major price bounce unfolds.
The second charts shows the latest ISM data – improving.
The article it was in was making a big point of how bad it was – hence the red arrow they placed on the chart. I have added the horizontal, hand-drawn line to show a point. It is about mid-range of the last 5 years. Ho-hum, but surely not the end of the world.
That third chart is just here to remind us that fear remains rampant. There are over $8 trillion sitting idle in bank accounts. Under the KISS method, it is simple: Fear is causing money to sit in bank accounts. Fear is crimping the movement of money. The movement of money causes GDP growth.
Fiscal changes, tax/investment policy changes and emotional outlook changes will do wonders to thaw this “subpar recovery” sooner than many now perceive.
How do we know the perception of the future is dire?
That lost chart is all you need to see – the equity spread is where it was in the 70’s. A pretty darn good time to be a long-term investor back then – when the DOW was 575.
Ignore the “economic” aspect of the news.
Think demographics instead.
The latter drives the former – it is not the other way around.
In the meantime, pray for more corrections this quarter.