Tuesday, March 31, 2015

First Quarter of 2015 Ends Flat - Oil Down

There were lots of ups and downs this quarter in the stock markets. Reviewing some research from S&P, Morningstar, Ned Davis Research and others, we have noticed that stocks overall are in a muddling range. This means that they are beginning to get overvalued on a P/E basis, but that is based on last quarter's earnings. We really haven't had the full impact of lower oil prices on our economy. Lower oil prices have created some extra cash flow for consumers, but the compounding effect or the length of time that oil prices remain low is what matters. Businesses who are dependent on energy prices will also benefit and that should positively impact their earnings. Think trucking companies, airlines, shipping and the automobile industry.

When we as consumers receive week after week of low gasoline prices, then it will eventually show up as free cash flow to us. Depending on how often you fill up will determine the excess cash flow that you retain. Depending on the number of automobiles in your household (that you are paying for) determines your free cash flow. A typical two car family might see $120 to $150 per month in extra cash flow. When you multiply this out by each American household, then you can see how quickly this will multiply. Add month after month of this type of savings and you will eventually spur economic growth. There is little doubt about this fact.

Now consider the businesses who rely on gasoline like trucking firms. They could be saving $120 to $150 a week per truck. Multiply that times their entire fleet, then you can see a clearer picture. This will positively impact their bottom lines over time. As a result, even though stocks might appear overvalued a little bit right now, I believe that this will correct itself after earnings are released.

The underlying geopolitical issue going on here in my humble opinion is that Saudi Arabia had a plan of keeping their production high to try and cause Iran major pain. However, with this nuclear agreement between the U.S. and Iran, this has changed the impact that Saudi Arabia may have by keeping production high. If some deal is reached, no matter the deal, then the likelihood is that Iran will be free to sell their oil again. This will give them much needed cash flow for their economy and the Saudi's plan will no longer be much of an impact to Iran.

I suspect that oil prices may continue to decline a little bit more and may even dip down in the thirty dollar range, but after that happens, I expect a vigorous snap back. In other words, I think we will see a quick drop down, then an equally quick pop back up. The OPEC members will have had enough and they will cut production at that point and or shut refinery operations until they get their price of oil back up to a reasonable range for profits.

So, enjoy the low gas prices while you can. I suspect by the third or fourth quarter we will see gas prices trend back up.