Thursday, February 11, 2016

Oil and financials lead market declines

The impact of oil company stock declines has clearly begun to wear on financials in the last month. That fact is well known.  Both sectors are dragging the entire market down.

Oil and energy in general are a large sector of the U.S. and world economies.  As the price of oil declined in 2015, the markets wanted to think that the positive offset of lower consumer prices would not lead to any significant impact on the U.S. economy or financial markets.  The last two months of continued oil price declines far beyond what was widely expected have for the moment put an end to that effort to put an optimistic spin on what is going on.

The decline in oil prices is now seen is an indicator of slowing global growth.  Whether that is broadly true or not is unknown, but it is surely the fear.  Supply is no longer seen at the major culprit. The focus has now shifted to demand.  The oil business in the U.S. and globally is a major source of well paying jobs and that is under stress, and the decline in jobs is becoming significant.  The profitability of companies in the energy businesses is forecast to continue to decline and the many tangential businesses that are vendors to that industry will suffer as well.

The consumer is apparently taking the money that would otherwise be spent on energy and prudently saving it, or spending on somewhat mundane but necessary things like education expenses, debt reduction, retirement plans, and, more constructively, cars and trucks although that seems to be topping out.  More expansive spending of this oil price windfall is not happening, and the once expected heightened money supply churn is obviously not occurring either.

How is this causing such market stress for financial stocks, especially in the banking sector?  Reading market commentary today, there can be seen lots of comment on the flattening yield curve and the possibility of or in some places reality of negative interest rates.  That will crimp the profitability of banks' lending books and deposit gathering costs, and the situation is getting more difficult.  This could be a structural problem that will play out over the much longer term.  That is, however, unlikely to be the cause of the extreme pressure that bank stocks have been under in recent days.  The achilles heel of bank stocks has always been credit, and that is the concern of the market's lead steers.  What seemed like routine financing of many energy related companies is now beginning to look like it could be a problem, not for the huge companies so much as for the many mid-sized companies that are more credit dependent.

Banks in general are well capitalized, but investors seem to be taking no chances.  By most measures many bank stocks look like major bargains, but the market is only thinking defensively for now.  We watch, and probably wait patiently.


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