It's not the direction of oil's decline, it's the ferocious and relentless velocity of the beast. It's not the direction of interest rates, it's the speed with which they will be taken up. We got good news on both fronts today, and that's why we were able to get a rally that sprawls all over our screens.
First, lets deal with the Federal Reserve. We know that the economy is getting better and better. We see that from the employment numbers and from retail sales. We know that it is just a matter of time before rates have to go higher.
But the Fed decided to be patient about raising rates, and that slow deliberate action sent the market soaring. Once again, people are shocked and awed that the Fed looked around and decided things are pretty uncertain out there. Of course, it didn't say it in its release. The Fed Chair, Janet Yellen, is craftier than that. Saying it explicitly would be like yelling fire in a crowded theatre of bulls. It would have crushed them. Yellen, like Bernanke, knows to be transparent. She genuinely can prattle about low inflation and wages that are anemic, but she doesn't have to state the obvious: the velocity of the oil decline is wiping out whole economies, which could cause severe deflation, and an unraveling of a lot of the good work the Fed has done. Let's just say: Fed one, bears nothing.
That's why the market was able to rally today, with the averages. Oil took a breather. It didn't get hammered again, and the ramifications of that are hugely positive, even as it is counterintuitive to the rest of us.
Yes, we can all agree that oil's price decline is terrific for the U.S. consumer, and we are a consumer-led country, with 70% of our growth related to spending. Lately, the production of oil has been so voluminous that if the price falls enough, there could be a real bust in those 16 oil-producing states. You don't want sunflower oil to be the principal export of North Dakota. You want crude to be. But last I looked, North Dakota's suffering isn't equal to the pleasure at the pump in the other 34 states.
So yes, we want oil to sell off, but we want it gradually. We want it to work its way down. I am going to lay out why in very clear language, so you understand how you can stop worrying, and learn to love occasional spikes in something we hate paying more for.
First, it is Russia. We know that if oil keeps going down in price at a pace that is super fast, then Russian banks could be stretched to the point of breaking. The Russian economy could go into a severe recession, if not a depression, because Russia's riches depend on energy exports.
It would be one thing if Russia weren't engaged in cold war mongering over Ukraine. We could argue that if Russia goes down, a bunch of Western Europe banks, particularly those in Austria and Italy, will go down with it. That would put added pressure on an already slowing Europe. That's not good for anyone at this point, least of all China, give that 25% of its exports go to Europe.
But the situation is much worse. From all accounts, Vladimir Putin is loved in his country. As much as Germany and the United States want regime change, we aren't going to get it. We could get something far worse and far more dangerous in Ukraine that transcends the economy. At one point or another, Putin could commit financial suicide in the name of Russian hegemony. If that happens, Europe could go into a depression, and we are all back in the soup.
If the decline of oil slows down, it slows down the pressure on the ruble, which takes the pressure off Putin. That reduces the geopolitical risk of not just a collapse of a couple of banks, but an actual hot war. We know from that somewhat obscure stock sage Edwin Starr, "war huh yeah, what is it good for, absolutely nothing."
Second positive? The giant sucking wounds that could be Petrobras (PBR.A) or Pemex, the Brazilian and Mexican oil companies. Sure, we can celebrate the fact that the President's making nice with Cuba, and the communists could be in their waning days on that little island. But we could see wholesale expropriation of Petrobras by its 60% owner, the Brazilian government, if oil keeps breaking down with alacrity. Even the possibility that it can go up for more than a day or two takes the pressure off of Petrobras, which also takes the pressure off the foreign holders of the debt of Petrobras, which is thought to be in the tens of billions of dollars.
The Mexican government is counting on Pemex to help grow the economy. Plus, Pemex is indebted to the tune of $100 billion. This liability is so large, it could crush the whole darned government. But a break in the oil price decline gives the Mexican government and Pemex some breathing room. It's a godsend for that otherwise pretty healthy country.
Basicall,y you avoid a run on the real and the peso, the currencies of Brazil and Mexico. That's good news for lots of emerging market investors, even, as you can imagine they aren't worth bailing out.
Third positive? I need you to watch the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), a corporate bond ETF, which has been falling precipitously of late. This is an index of high yielding bonds that has a ton of oil-related debt in it. This index is under severe pressure of late, and that's a sign of distress that often leads to calamities. This isn't a canary in a coal mine, signaling something is wrong. It's a gosh-darned mine collapse that's occurring, and a lift in oil may be the trick to get some shore-up.
Finally, there's our own producers. You have seen the stocks. You don't need me to riff on the declines of some of the distraught oil companies out there, the ones used to be in the teens that are now in the twos.
You get oil going down one way, quickly, then potential buyers, either of individual shares or of actual acquirers don't even attempt to bottom-fish. Investors are afraid of Chapter 11. Acquirers just wait patiently for it.
But if oil can actually take a breather, I mean literally just stop going down so quickly, then the bedraggled oil companies can hedge some of their risk in the oil market. They can sell off properties to meet bank debt, or bond payments. Well-heeled acquirers might say, enough, I better scoop up this Permian play or that Eagle Ford company, before another company does so.
I am by no means suggesting that oil has bottomed, even though I have seen a ton of bottom-fishers. Many stock buyers have presumed that the price of the stocks reflects $40 oil, not $56 oil. I am not saying that any of these black holes have been filled positively, or that Goldilocks has beaten the bears' heads in. I am saying that the Federal Reserve and the oil futures have given the world some breathing room. The bulls rejoiced, while the bears got caught short in a rip-your ursine face off rally. This rally will last as long as oil stabilizes, or even goes higher, before it resumes its decline again.