Patience is a virtue

Outlook:

The calendar is light in the US today (auto sales) but the rest of the week is chockfull of potentially market-moving data. We may think we are tired of employment stories but tomorrow’s ADP private payrolls will still get a lot of attention. And everyone should be gearing up for core PCE on Thursday as well as payrolls on Friday. Remember that the dollar often rises on the Wednesday ahead of payrolls.

Off on the sidelines, Saudi Arabia plans to issue its first global bond sometime soon and underwriters are lining up at the door. The FT reports the premium the Saudis will have to pay could be as high as 200 points over 5-year Treasuries, although 100 points is probably more like it. This would put the Saudi yield at 2.34 to 3.34% (compare to Qatar at 3.05%). Moody’s says “Saudi Arabia won’t have any problems accessing international bond markets” although the timing is tricky with oil near $30.

We never claim to understand the bond market, but we say Saudi Arabia issuing a global bond at only 100-200 points over the US is madness. The Saudis are spending on the military like drunken sailors.

The public deficit will be $87 billion this year and “Officials have already said that Saudi Arabia’s public debt, which reached just 44bn riyals at the end of 2014 — about 1.6 per cent of GDP — could hit 50 per cent of GDP by 2020.” Reserves are down to $640 billion from $737 billion in 2014, “leading some to question whether the riyal’s peg to the US dollar is in jeopardy.” Selling off a piece of Aramco would fund the government for a year, although it’s not on the drawing board.

The Saudis could avoid going to the bond market by sitting down with Russia and Iran and OPEC and making a deal to cut production. And why would anyone like the sovereign risk of a country managed by a Bronze Age religious legal system? Even if you wanted to buy the Saudi sovereign risk, is 100-200 points over the US the right number? We wouldn’t touch it with a bargepole.

Bloomberg has a story on why low oil prices are actually bad for the world economy. Big Western companies need emerging markets to sell their stuff to, like Apple. Emerging markets account for 40% of global GDP so when they fall, they take the developed world with them. Sovereign defaults loom (think Venezuela).

We say bah, humbug. While it may be true that falling oil prices are deflationary, we do not have deflation and in fact, core CPI’s are rising everywhere and not just in the US. Bloomberg provides a dandy chart showing that if you exclude the energy sector, stock markets are okay, too. “While earnings growth for the benchmark S&P 500 Index is forecast to come in negative year-over-year and earnings growth for the MSCI Europe has been stagnant for an astonishing 48 months, the picture brightens considerable once energy is taken away. Excluding the sector, year-on-year earnings growth in both the U.S. and Europe reach 5 and 4 percent respectively.”

It’s conceivable that the seeming de-coupling of the AUD and CAD from oil prices is an early warning that we have been placing far too much importance on the oil price collapse. It is, after all, a very simple supply-and-demand story. There is nothing mysterious or new about it except maybe the strange and irrational behavior of the Saudis. That doesn’t mean oil as a leading factor is going away anytime soon. It may mean that all those correlation stories (oil correlated with everything including the kitchen sink) will start going away. We wasted a full year and paid a fortune to a statistician to evaluate various market correlations, and while the study has not been refreshed for a while, take our word for it—most of them are not valid over long periods of time. Correlations pop up in times of stress but without an underlying cause-and-effect, lack staying power. The single exception is the yen and the Nikkei.

Alas, until we get back to some basic economics, we are stuck with out-of-left-field effects. This seems to be true for the euro/dollar, too. We can’t find a single reason for the euro to be testing upside resistance unless it’s Mr. Draghi warning us not to expect too much in March. And yet we know, or think we know, the ECB would really prefer a weaker euro, or rather a euro just at the point of weakness that doesn’t also harm the ECB’s credibility. We think we see a downward slope to the euro on the big-picture chart, but you can go broke waiting for it to materialize. Be patient.