This morning's "Daily State" report was penned by Robert Barone (Ph.D., Economics, Georgetown University), a Principal of Universal Value Advisors (UVA) based in Reno, Nevada and a fellow Investment Committee member with Dave Moenning at CONCERT Wealth Management. We are pleased to be able to offer Robert's views this morning. Dr. Barone's firm focuses on core value investing using Benjamin Graham's "Margin of Safety" approach. We hope you enjoy Robert's take on the state of the oil crash.

What To Expect From Falling Oil Prices

U.S. equity markets appear to be reacting as if there won't be enough oil. The fact is, at least temporarily, there appears to be more supply than demand, even at prices more than 40% off their recent highs. As prices fall, the world will use more, and that will actually spur economic activity.

Markets Do Correct

Sometimes, markets just need to correct, and use a current event or trend as a triggering mechanism. But, bear markets in equities usually occur when recessions are approaching. There is no looming recession on the horizon, at least for the U.S. Labor markets are strong and tight. Industrial production is at record levels. Leading indicators are up; inflation is benign. Corporate profits are high. Holiday consumption appears buoyant, no doubt spurred by falling oil prices.

The Importance of Oil and Gas

Clearly, with falling prices, there will be some fallout in the oil and gas industry and its periphery. Some market commentators worry about the impact that such fallout will have on the economy, employment, and capital spending. No doubt some small drillers and marginal enterprises will be impacted, perhaps even file BK. Capital spending in the industry will fall precipitously, both in the U.S. and worldwide. (That seems to be the objective of OPEC in keeping production levels high.) So, it is critical to examine the importance of this industry to total economic activity.

In 2013, Gross Output (GO) was approximately $30 trillion. This measures all aspects of economic life and includes all B to B sales (not just value added or final output which is what GDP measures). For comparative purposes, 2013's GDP was $16.8 trillion. Business spending represents about 52% of GO, Consumption 38%, and Government 10%. Looking at the Bureau of Economic Analysis' Input/Output table for 2013, the Oil and Gas industry directly produced 2.0% of GO. In addition, other industries sold about 0.4% of GO to the oil and gas industry. So, while it is important, a recession in 2.4% of the economy isn't going to stall the other 97.6%, especially when nearly every aspect of that 97.6% will directly benefit from lower oil prices.

Who Benefits from falling Oil Prices?

In the short-run, at least, a dramatic fall in the price of oil benefits consumers in most developed countries. No doubt, some countries that are export dependent on oil, will suffer. Middle East, Canada, Mexico, Venezuela, Russia, Brazil all come to mind. But, most of the rest of the world are oil importers and stand to benefit. 

The U.S. consumer, in particular, will benefit from falling prices, as, of all major industrial countries, the U.S. is the most dependent on autos and trucks for transportation. For U.S. consumers, the fall in the price of oil is equivalent to a huge tax cut, or to a one-time rise in wages. Every penny of price decline at the pump is worth about $1.5 billion per year to U.S. consumers, according to Gluskin-Sheff's David Rosenberg. 

As of 12/12/14, according to AAA, the national average price of regular unleaded gas was $2.600. A year earlier, that price was $3.253 indicating that the price had fallen $0.653, or about 20%. Given that crude prices are down more than 40% over the past year, and likely headed lower, an equivalent fall in the price at the pump would put prices there at about $1.95, and would be worth about $200 billion to U.S. consumers, and is equivalent to a 1.5% rise in Disposable Income. It appears likely that pump prices will get to $1.50 in some parts of the country by spring, and if they average that level, American consumers will have received an injection of $260 billion. And that is just at the pump. Imagine the total benefit that all non-energy producing businesses will receive, from airlines and trucking to the pizza delivery service. Just think of a) expanding profit margins in these businesses and/or b) falling prices to consumers for those services. (I know the Fed doesn't like falling prices, but if such prices fall because costs have gone down and profit margins have been maintained, then there is no reason for wages to fall, and the middle-class employee benefits from the falling price, even without a wage increase.)

Conclusions

Given such benefits, it is really hard to see how the issues in the oil and gas industry could tip the U.S. into recession. It is equally hard to see how the next 12 months' growth rate in GDP won't be 4% or better. How does this translate into equity market prices? "Buy the dips!"

Robert Barone, Ph.D.

Robert Barone, Ph.D.

Robert Barone (Ph.D., Economics, Georgetown University), an advisor representative of Concert Wealth Management, is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, a Registered Investment Advisor. Dr. Barone is available to discuss client investment needs. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources that Universal Value Advisors believes to be accurate and credible but makes no guarantee to their complete accuracy. A more detailed description of Concert Wealth Management, its management and practices is contained in its "Firm Brochure" (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

Read More of Robert Barone's Work

Turning To This Morning

In addition to the ongoing decline in oil prices (crude futures are down again in the early going), the big stories in the markets this morning involve Russia, China and Europe. Russia's central bank surprised the markets yesterday afternoon by hiking rates a jaw-dropping 6.50 percent, bring the key rate to 17.0 percent. The move was an effort to stabilize the ruble, which had crashed to an all-time low against the U.S. dollar, as well as the Russian stock market, which fell more than 10 percent yesterday alone. However, both the ruble and the Russian stock market are falling again today. Next, the HSBC Flash PMI index for China fell into the contraction zone, coming in at 49.5. This was the first contractionary reading in seven months. In Europe there are two stories worth noting. First, the Flash PMI for the Eurozone improved in December for both the manufacturing and services sector indices. In addition, Germany's investors sentiment upticked for a second straight month. However, Bundesbank president Weidmann publicly rejected the idea of the ECB buying sovereign bonds (aka sovereign QE), saying that there is no need for the ECB to expand its stimulus - even if the collapse in oil prices triggers deflation. Here at home, there continues to be speculation about the status of the "considerable time" language in the FOMC statement, which is scheduled for tomorrow. Finally, with oil prices continuing to fall, U.S. stock futures have been volatile and now point to a red open on Wall Street. In addition, it is worth noting that the yield on the 10-year is trading down hard to just 2.031%.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    Japan: -2.01%
    Hong Kong: -1.55%
    Shanghai: +2.32%
    London: +0.64%
    Germany: -0.06%
    France: -0.48%
    Italy: -0.18%
    Spain: -1.27%

Crude Oil Futures: -$1.86 to $54.06

Gold: +$7.50 at $1215.20

Dollar: lower against the yen and pound, higher vs. euro

10-Year Bond Yield: Currently trading at 2.031%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -16.13
    Dow Jones Industrial Average: -106
    NASDAQ Composite: -34.92

Thought For The Day:

We either make ourselves miserable, or we make ourselves happy. The amount of work is the same. -Carlos Castaneda

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of the Oil Crash
      2. The State of Fed/ECB/BOJ Policy
      3. The State of the U.S. Economy
      4. The State of China's Economy

The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Negative
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 2 years)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

• Key Near-Term Support Zone(s) for S&P 500: 2000
• Key Near-Term Resistance Zone(s): 2040

The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...

• Trend and Breadth Confirmation Indicator (Short-Term): Negative
• Price Thrust Indicator: Negative
• Volume Thrust Indicator: Negative
• Breadth Thrust Indicator: Negative
• Bull/Bear Volume Relationship: Moderately Positive
• Technical Health of 100 Industry Groups: Neutral

The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

• S&P 500 Overbought/Oversold Conditions:
        - Short-Term: Oversold
        - Intermediate-Term: Neutral
  
• Market Sentiment: Our primary sentiment model is Neutral .