Recession 2016: In Some States, A Very Deep Economic Downturn Has Already Arrived

Recession 2016 - Public DomainDid you know that there are some U.S. states that have already officially fallen into recession?  Economic activity all over the planet is in the process of slowing down, and there are some areas of the country that are really starting to feel the pain.  In particular, any state that is heavily dependent on the energy industry is hurting right now.  During the years immediately following the last recession, the energy industry was the primary engine for the growth of good paying jobs in America, but now that process is completely reversing.  All over the U.S. energy companies are going under, and thousands upon thousands of good jobs are being lost.

On Sunday evening, Bloomberg published an article entitled “The U.S. States Where Recession Is Already a Reality“. The following is an excerpt from that article…

As economists size up the chances of the first nationwide slump since 2009, pockets of the country are already contracting. Four states — Alaska, North Dakota, West Virginia and Wyoming — are in a recession, and three others are at risk of prolonged declines, according to indexes of state economic performance tracked by Moody’s Analytics.

The three additional states that are “at risk of prolonged declines” are Louisiana, New Mexico and Oklahoma.  What all of those seven states have in common is a strong dependence on the energy industry.  Last year, 67 oil and gas companies in the United States filed for bankruptcy, and approximately 130,000 good paying energy jobs were lost.

If the price of oil does not go back up, this could be just the beginning.  It is being reported that a whopping 35 percent of all oil and gas companies around the planet are at risk of falling into bankruptcy, and the financial institutions that have been backing these energy companies are getting very nervous.

Of course things could shift dramatically for oil and gas companies if World War 3 suddenly erupts in the Middle East, and that could literally happen at any time.  But for the moment the outlook for the energy industry continues to be quite dreary.

Let us also keep in mind that the problems for the U.S. economy are not limited to the energy industry.  According to CNBC, corporate profits in the United States have now declined for three straight quarters, and this is the very first time this has happened since the last recession…

With 87 percent of the S&P 500 reporting, total blended fourth-quarter earnings have shown a decline of 3.6 percent, according to FactSet. Assuming the trend holds up, it will mark the first time profits have fallen for three straight quarters since 2009.

But the road ahead doesn’t get any easier.

FactSet is now projecting that earnings will decline 6.9 percent in the first quarter, a stunning move lower over time considering that in September the expectation was for 4.8 percent growth.

As corporate profits fall, layoffs are starting to increase.  Just the other day we learned that the number of job cuts in this country shot up 218 percent during the month of January according to Challenger, Gray & Christmas.

It is starting to look very much like 2008 all over again, and I am convinced that it will soon be much, much harder to find work in America.

Here are some more numbers that indicate that the U.S. is heading into a major economic slowdown…

U.S. exports were down 7 percent on a year over year basis in December.

U.S. manufacturing activity has been in contraction for four months in a row.

U.S. factory orders have fallen for 14 months in a row.

The Restaurant Performance Index in the United States has dropped to the lowest level that we have seen since 2008.

Orders for Class 8 trucks in the United States dropped by 48 percent on a year over year basis in January.

But the mainstream media continues to try to convince all of us that everything is going to be just fine.  Earlier today, CNN ran an article entitled “U.S. recession fears fade after market rally“, and the Wall Street Journal published an article entitled “The U.S. Economy Is in Good Shape” that got a tremendous amount of attention.

Well, if the U.S. economy is in such great shape, then why are some of the biggest retailers in the entire nation shutting down stores at a frightening pace.  The following list of store closures comes from one of my previous articles

-Wal-Mart is closing 269 stores, including 154 inside the United States.

-K-Mart is closing down more than two dozen stores over the next several months.

-J.C. Penney will be permanently shutting down 47 more stores after closing a total of 40 stores in 2015.

-Macy’s has decided that it needs to shutter 36 stores and lay off approximately 2,500 employees.

-The Gap is in the process of closing 175 stores in North America.

-Aeropostale is in the process of closing 84 stores all across America.

-Finish Line has announced that 150 stores will be shutting down over the next few years.

-Sears has shut down about 600 stores over the past year or so, but sales at the stores that remain open continue to fall precipitously.

Perhaps things look fine for the moment in New York City or Washington D.C. or San Francisco or wherever it is that these “reporters” write their articles.

But for ordinary Americans that operate in the real world, the pain of this new economic downturn is already exceedingly apparent.  Here is more from Bloomberg

Dale Oxley doesn’t need to hear about rising odds of a U.S. recession to dread the future. For the West Virginia homebuilder, the downturn has already arrived.

Everyone is going to have to tighten their belts,” said Oxley, the 48-year-old owner of a Charleston-area construction company. “The next couple of years are going to be difficult.”

Unfortunately for hard working Americans like Oxley, what we have seen so far is just the tip of the iceberg.

We have entered a long downturn that is ultimately going to be even more painful than the last recession was.

And everything changes if Saudi Arabia and Turkey get trigger happy and decide to invade Syria.  If that happens, it could very well be the spark that sets off World War 3 and a full-blown meltdown of the global financial system.

If The Economy Is Fine, Why Are So Many Hedge Funds, Energy Companies And Large Retailers Imploding?

Demolition - Public DomainIf the U.S. economy really is in “great shape”, then why do all of the numbers keep telling us that we are in a recession?  The manufacturing numbers say that we are in a recession, the trade numbers say that we are in a recession, and as you will see below the retail numbers say that we are in a recession.  But just like in 2008, the Federal Reserve and our top politicians will continue to deny that a major economic downturn is happening for as long as they possibly can.  In this article, I want to look at more signs that a dramatic shift is happening in our economy right now.

First of all, let’s consider what is happening to hedge funds.  For many years, hedge funds had been doing extremely well, but now they are closing up shop at a pace that we haven’t seen since the last financial crisis.  The following is an excerpt from a Business Insider article entitled “Hedge funds keep on imploding” that was posted on Wednesday…

BlackRock is winding down its Global Ascent Fund, a global macro hedge fund that once contained $4.6 billion in assets, according to Bloomberg’s Sabrina Willmer.

“We believe that redeeming the Global Ascent Fund was the right thing to do for our clients, given the headwinds that macro funds have faced,” a BlackRock spokeswoman told Business Insider.

The winding down of the Ascent fund is the second high-profile hedge fund closing in 24 hours. The Wall Street Journal reported Tuesday that Achievement Asset Management, a Chicago-based hedge fund, was closing.

And those are just two examples.  Quite a few other prominent hedge funds have shut down recently, and many are wondering if this is just the beginning of a major “bloodbath” on Wall Street.

Another troubling sign is the implosion of so many energy companies.  Just like in 2008, a major crash in the price of oil is hitting the energy sector really hard.  Just check out these stock price declines…

-Cabot Oil & Gas down 37.27 percent over the past 12 months

-Southwestern Energy down 68.11 percent over the past 12 months

-Chesapeake Energy down 73.98 percent over the past 12 months

A number of smaller energy companies have already gone out of business, and several of the big players are teetering on the brink.  If the price of oil does not rebound significantly very soon, it is just a matter of time before the dominoes begin to fall.

We are also seeing tremendous turmoil in the retail industry.  The following comes from Investment Research Dynamics

The retail sales report for October was much worse than expected.  Not only that, but the Government’s original estimates for retail sales in August and September were revised lower.  A colleague of mine said he was chatting with his brother, who is a tax advisor, this past weekend who said he doesn’t understand how the Government can say the economy is growing (Hillary Clinton recently gave the economy an “A”) because his clients are lowering their estimated tax payments.  Businesses lower their estimated tax payments when their business activity slows down.

The holiday season is always the best time of the year for retailers, but in 2015 there is a lot of talk of gloom and doom.  Most large retailers will not start announcing mass store closings until January or February, but without a doubt many analysts are anticipating that once we get past the Christmas shopping season we will see stores shut down at a pace that we haven’t seen since at least 2009.  Here is more from the article that I just quoted above

Retail sales this holiday season are setting up to be a disaster.  Already most retailers are advertising “pre-Black Friday” sales events.  Remember when holiday shopping didn’t begin, period, until the day after Thanksgiving?  Now retailers are going to cannibalize each other with massive discounting before Thanksgiving.  Anybody notice over the weekend that BMW is now offering $6500 price rebates?   The collapsing economy is affecting everyone, across all income demographics.

Last week we saw the stocks of Macy’s, Nordstrom and Advance Auto Parts do cliff-dives after they announced their earnings.  I mentioned to a colleague that the Nordstrom’s report should be the most troubling for analysts.  Nordstrom in their investor conference call said that they began seeing an “unexplainable slowdown in sales in August in transactions across all formats, across all catagories and across all geographies that has yet to recover.”  

I think that a chart would be helpful to give you an idea of how bad things have already gotten.  Jim Quinn shared this in an article that he just posted, and it shows the change in retail sales once you remove the numbers for the auto industry.  As you can see, the numbers have never been this dreadful outside of a recession…

Retail Sales Ex-Autos

But stocks went up 247 points on Wednesday so everything must be great, right?

Wrong.

The stock market has never been a good barometer for the overall economy, and this is especially true these days.

In 2008, stocks didn’t crash until well after the U.S. economy as a whole started crashing, and the same thing is apparently happening this time around as well.

One of the things that is keeping stocks afloat for the moment is stock buybacks.  In recent years, big corporations have spent hundreds of billions of dollars buying back their own stocks.  The following comes from Wolf Richter

IBM has blown $125 billion on buybacks since 2005, more than the $111 billion it invested in capital expenditures and R&D. It’s staggering under its debt, while revenues have been declining for 14 quarters in a row. It cut its workforce by 55,000 people since 2012. And its stock is down 38% since March 2013.

Big-pharma icon Pfizer plowed $139 billion into buybacks and dividends in the past decade, compared to $82 billion in R&D and $18 billion in capital spending. 3M spent $48 billion on buybacks and dividends, and $30 billion on R&D and capital expenditures. They’re all doing it.

Later in that same article, Richter explains that almost 60 percent of all publicly traded non-financial corporations have engaged in stock buybacks over the past five years…

Nearly 60% of the 3,297 publicly traded non-financial US companies Reuters analyzed have engaged in share buybacks since 2010. Last year, the money spent on buybacks and dividends exceeded net income for the first time in a non-recession period.

Big corporations like to do this for a couple of reasons.  Number one, it pushes the price of the stock higher, and current investors appreciate that.  Number two, corporate executives are usually in favor of conducting stock buybacks because it increases the value of their stock options and their own stock holdings.

But now corporate profits are falling and it is becoming tougher for big corporations to borrow money.  So look for stock buybacks to start to decline significantly.

Even though it is taking a bit longer than many would have anticipated, the truth is that we are right on track for a massive financial collapse.

All of the indicators that I watch are flashing red, and even though things are moving slowly, they are definitely moving in the same direction that we saw in 2008.

But just like in 2008, there will be people that mock the warnings up until the day when it becomes completely and utterly apparent that the mockers were dead wrong.

 

Why The Price Of Oil Is More Likely To Fall To 20 Rather Than Rise To 80

Oil - Public DomainThis is just the beginning of the oil crisis.  Over the past couple of weeks, the price of U.S. oil has rallied back above 50 dollars a barrel.  In fact, as I write this, it is sitting at $52.93.  But this rally will not last.  In fact, analysts at the big banks are warning that we could soon see U.S. oil hit the $20 mark.  The reason for this is that the production of oil globally is still way above the current level of demand.  Things have gotten so bad that millions of barrels of oil are being stored at sea as companies wait for the price of oil to go back up.  But the price is not going to go back up any time soon.  Even though rigs are being shut down in the United States at the fastest pace since the last financial crisis, oil production continues to go up.  In fact, last week more oil was produced in the U.S. than at any time since the 1970s.  This is really bad news for the economy, because the price of oil is already at a catastrophically low level for the global financial system.  If the price of oil stays at this level for the rest of the year, we are going to see a whole bunch of energy companies fail, billions of dollars of debt issued by energy companies could go bad, and trillions of dollars of derivatives related to the energy industry could implode.  In other words, this is a recipe for a financial meltdown, and the longer the price of oil stays at this level (or lower), the more damage it is going to do.

The way things stand, there is simply just way too much oil sitting out there.  And anyone that has taken Economics 101 knows that when supply far exceeds demand, prices go down

Oil prices have gotten crushed for the last six months. The extent to which that was caused by an excess of supply or by a slowdown in demand has big implications for where prices will head next. People wishing for a big rebound may not want to read farther.

Goldman Sachs released an intriguing analysis on Wednesday that shows what many already suspected: The big culprit in the oil crash has been an abundance of oil flooding the market. A massive supply shock in the second half of last year accounted for most of the decline. In December and January, slowing demand contributed to the continued sell-off.

At this point so much oil has already been stored up that companies are running out of places to put in all.  Just consider the words of Goldman Sachs executive Gary Cohn

“I think the oil market is trying to figure out an equilibrium price. The danger here, as we try and find an equilibrium price, at some point we may end up in a situation where storage capacity gets very, very limited. We may have too much physical oil for the available storage in certain locations. And it may be a locational issue.”

“And you may just see lots of oil in certain locations around the world where oil will have to price to such a cheap discount vis-a-vis the forward price that you make second tier, and third tier and fourth tier storage available.”

[…] “You could see the price fall relatively quickly to make that storage work in the market.”

The market for oil has fundamentally changed, and that means that the price of oil is not going to go back to where it used to be.  In fact, Goldman Sachs economist Sven Jari Stehn says that we are probably heading for permanently lower prices

The big take-away: “[T]he decline in oil has been driven by an oversupplied global oil market,” wrote Goldman economist Sven Jari Stehn. As a result, “the new equilibrium price of oil will likely be much lower than over the past decade.”

So how low could prices ultimately go?

As I mentioned above, some analysts are throwing around $20 as a target number

The recent surge in oil prices is just a “head-fake,” and oil as cheap as $20 a barrel may soon be on the way, Citigroup said in a report on Monday as it lowered its forecast for crude.

Despite global declines in spending that have driven up oil prices in recent weeks, oil production in the U.S. is still rising, wrote Edward Morse, Citigroup’s global head of commodity research. Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia. The market is oversupplied, and storage tanks are topping out.

A pullback in production isn’t likely until the third quarter, Morse said. In the meantime, West Texas Intermediate Crude, which currently trades at around $52 a barrel, could fall to the $20 range “for a while,” according to the report.

Keep in mind that the price of oil is already low enough to be a total nightmare for the global financial system if it stays here for the rest of 2015.

If we go down to $20 and stay there, a global financial meltdown is virtually guaranteed.

Meanwhile, the “fracking boom” in the United States that generated so many jobs, so much investment and so much economic activity is now turning into a “fracking bust”

The fracking-for-oil boom started in 2005, collapsed by 60% during the Financial Crisis when money ran out, but got going in earnest after the Fed had begun spreading its newly created money around the land. From the trough in May 2009 to its peak in October 2014, rigs drilling for oil soared from 180 to 1,609: multiplied by a factor of 9 in five years! And oil production soared, to reach 9.2 million barrels a day in January.

It was a great run, but now it is over.

In the months ahead, the trickle of good paying oil industry jobs that are being lost right now is going to turn into a flood.

And this boom was funded with lots and lots of really cheap money from Wall Street.  I like how Wolf Richter described this in a recent article

That’s what real booms look like. They’re fed by limitless low-cost money – exuberant investors that buy the riskiest IPOs, junk bonds, leveraged loans, and CLOs usually indirectly without knowing it via their bond funds, stock funds, leveraged-loan funds, by being part of a public pension system that invests in private equity firms that invest in the boom…. You get the idea.

As all of this bad paper unwinds, a lot of people are going to lose an extraordinary amount of money.

Don’t get caught with your pants down.  You will want your money to be well away from the energy industry long before this thing collapses.

And of course in so many ways what we are facing right now if very reminiscent of 2008.  So many of the same patterns that have played out just prior to previous financial crashes are happening once again.  Right now, oil rigs are shutting down at a pace that is almost unprecedented.  The only time in recent memory that we have seen anything like this was just before the financial crisis in the fall of 2008.  Here is more from Wolf Richter

In the latest reporting week, drillers idled another 84 rigs, the second biggest weekly cut ever, after idling 83 and 94 rigs in the two prior weeks. Only 1056 rigs are still drilling for oil, down 443 for the seven reporting weeks so far this year and down 553 – or 34%! – from the peak in October.

Never before has the rig count plunged this fast this far:

Fracking Bust

What if the fracking bust, on a percentage basis, does what it did during the Financial Crisis when the oil rig count collapsed by 60% from peak to trough? It would take the rig count down to 642!

But even though rigs are shutting down like crazy, U.S. production of oil has continued to rise

Rig counts have long been used to help predict future oil and gas production. In the past week drillers idled 98 rigs, marking the 10th consecutive decline. The total U.S. rig count is down 30 percent since October, an unprecedented retreat. The theory goes that when oil rigs decline, fewer wells are drilled, less new oil is discovered, and oil production slows.

But production isn’t slowing yet. In fact, last week the U.S. pumped more crude than at any time since the 1970s. “The headline U.S. oil rig count offers little insight into the outlook for U.S. oil production growth,” Goldman Sachs analyst Damien Courvalin wrote in a Feb. 10 report.

Look, it should be obvious to anyone with even a basic knowledge of economics that the stage is being set for a massive financial meltdown.

This is just the kind of thing that can plunge us into a deflationary depression.  And when you combine this with the ongoing problems in Europe and in Asia, it is easy to see that a “perfect storm” is brewing on the horizon.

Sadly, a lot of people out there will choose not to believe until the day the crisis arrives.

By then, it will be too late to do anything about it.

 

Boom Goes The Dynamite: The Crashing Price Of Oil Is Going To Rip The Global Economy To Shreds

Boom Goes The Dynamite - Public DomainIf you were waiting for a “black swan event” to come along and devastate the global economy, you don’t have to wait any longer.  As I write this, the price of U.S. oil is sitting at $45.76 a barrel.  It has fallen by more than 60 dollars a barrel since June.  There is only one other time in history when we have seen anything like this happen before.  That was in 2008, just prior to the worst financial crisis since the Great Depression.  But following the financial crisis of 2008, the price of oil rebounded fairly rapidly.  As you will see below, there are very strong reasons to believe that it will not happen this time.  And the longer the price of oil stays this low, the worse our problems are going to get.  At a price of less than $50 a barrel, it is just a matter of time before we see a huge wave of energy company bankruptcies, massive job losses, a junk bond crash followed by a stock market crash, and a crisis in commodity derivatives unlike anything that we have ever seen before.  So let’s hope that a very unlikely miracle happens and the price of oil rebounds substantially in the months ahead.  Because if not, the price of oil is going to absolutely rip the global economy to shreds.

What amazes me is that there are still many economic “experts” in the mainstream media that are proclaiming that the collapse in the price of oil is going to be a good thing for the U.S. economy.

The only precedent that we can compare the current crash to is the oil price collapse of 2008.  You can see both crashes on the chart below…

Price Of Oil Since 2006

If rapidly falling oil prices are good economic news, that collapse should have pushed the U.S. economy into overdrive.

But that didn’t happen, did it?  Instead, we plunged into the deepest recession that we have seen since the Great Depression.

And unless there is a miracle rebound in the price of oil now, we are going to experience something similar this time.

Already, we are seeing oil rigs shut down at a staggering pace.  The following is from Bloomberg

U.S. oil drillers laid down the most rigs in the fourth quarter since 2009. And things are about to get much worse.

The rig count fell by 93 in the three months through Dec. 26, and lost another 17 last week, Baker Hughes Inc. data show. About 200 more will be idled over the next quarter as U.S. oil explorers make good on their promises to curb spending, according to Moody’s Corp.

But that was just the beginning of the carnage.  61 more oil rigs shut down last week alone, and hundreds more are being projected to shut down in the months ahead.

For those that cannot connect the dots, that is going to translate into the loss of large numbers of good paying jobs.  Just check out what is happening in Texas

A few days ago, Helmerich & Payne, announced that it would idle 50 more drilling rigs in February, after having already idled 11 rigs. Each rig accounts for about 100 jobs. This will cut its shale drilling activities by 20%. The other two large drillers, Nabors Industries and Patterson-UTI Energy are on a similar program. All three combined are “likely to cut approximately 15,000 jobs out of the 50,000 people they currently employ,” said Oilpro Managing Director Joseph Triepke.

Unfortunately, this crisis will not just be localized to states such as Texas.  There are tens of thousands of small and mid-size firms that will be affected.  The following is from a recent CNBC report

More than 20,000 small and midsize firms drive the “hydrocarbon revolution” in the U.S. that has helped the oil and gas industry thrive in recent years, and they produce more than 75 percent of the nation’s oil and gas output, according to the Manhattan Institute for Policy Research’s February 2014 Power & Growth Initiative Report. The Manhattan Institute is a conservative think tank in New York City.

A sustained decline in prices could lead to layoffs at these firms, say experts. “The energy industry has been one of the job-growth areas leading us out of the recession,” said Chad Mabry, a Houston-based analyst in the energy and natural resources research department of boutique investment bank MLV & Co. in New York City. “In 2015, that changes in this price environment,” he said. “We’re probably going to see some job losses on a fairy significant scale if this keeps up.”

If the price of oil makes a major comeback, the carnage will ultimately not be that bad.

But if it stays at this level or keeps going down for an extended period of time, it is inevitable that a whole bunch of those firms will go bankrupt and their debt will go bad.

That would mean a junk bond crash unlike anything that Wall Street has ever experienced.

And as I have written about previously, a stock market crash almost always follows a junk bond crash.

These are things that happened during the last financial crisis and that are repeating again right in front of our eyes.

Another thing that happened in 2008 that is happening again is a crash in industrial commodity prices.

At this point, industrial commodity prices have hit a 12 year low.  I am talking about industrial commodities such as copper, iron ore, steel and aluminum.  This is a huge sign that global economic activity is slowing down and that big trouble is on the way.

So what is driving this?  The following excerpt from a recent Zero Hedge article gives us a clue…

Globally there are over $9 trillion worth of borrowed US Dollars in the financial system. When you borrow in US Dollars, you are effectively SHORTING the US Dollar.

Which means that when the US Dollar rallies, your returns implode regardless of where you invested the borrowed money (another currency, stocks, oil, infrastructure projects, derivatives).

Take a look at commodities. Globally, there are over $22 TRILLION worth of derivatives trades involving commodities. ALL of these were at risk of blowing up if the US Dollar rallied.

Unfortunately, starting in mid-2014, it did in a big way.

This move in the US Dollar imploded those derivatives trades. If you want an explanation for why commodities are crashing (aside from the fact the global economy is slowing) this is it.

Once again, much of this could be avoided if the price of oil starts going back up substantially.

Unfortunately, that does not appear likely.  In fact, many of the big banks are projecting that it could go even lower

Goldman Sachs, CitiGroup, Societe General and Commerzbank are among the latest investment banks to reduce crude oil price estimates, and without production cuts, there appears to be more room for lower prices.

“We’re going to keep on going lower,” says industry analyst Brian Milne of energy manager Schneider Electric. “Even with fresher new lows, there’s still more downside.”

OPEC could stabilize global oil prices with a single announcement, but so far OPEC has refused to do this.  Many believe that the OPEC countries actually want the price of oil to fall for competitive reasons…

Representatives of Saudi Arabia, the United Arab Emirates and Kuwait stressed a dozen times in the past six weeks that the group won’t curb output to halt the biggest drop in crude since 2008. Qatar’s estimate for the global oversupply is among the biggest of any producing country. These countries actually want — and are achieving — further price declines as part of an attempt to hasten cutbacks by U.S. shale drillers, according to Barclays Plc and Commerzbank AG.

The oil producing countries in the Middle East seem to be settling in for the long haul.  In fact, one prominent Saudi prince made headlines all over the world this week when he said that “I’m sure we’re never going to see $100 anymore.”

Never is a very strong word.

Could there be such a massive worldwide oil glut going on right now that the price of oil will never get that high again?

Well, without a doubt there is a huge amount of unsold oil floating around out there at the moment.

It has gotten so bad that some big trading companies are actually hiring supertankers to store large quantities of unsold crude oil at sea…

Some of the world’s largest oil traders have this week hired supertankers to store crude at sea, marking a milestone in the build-up of the global glut.

Trading firms including Vitol, Trafiguraand energy major Shell have all booked crude tankers for up to 12 months, freight brokers and shipping sources told Reuters.

They said the flurry of long-term bookings was unusual and suggested traders could use the vessels to store excess crude at sea until prices rebound, repeating a popular 2009 trading gambit when prices last crashed.

The fundamentals for the price of oil are so much worse than they were back in 2008.

We could potentially be looking at sub-$50 oil for an extended period of time.

If that is indeed the case, there will be catastrophic damage to the global economy and to the global financial system.

So hold on to your hats, because it looks like we are going to be in for quite a bumpy ride in 2015.

Guess What Happened The Last Time The Price Of Oil Crashed Like This?…

Price Of Oil Causes A Junk Bond Crash - Public DomainThere has only been one other time in history when the price of oil has crashed by more than 40 dollars in less than 6 months.  The last time this happened was during the second half of 2008, and the beginning of that oil price crash preceded the great financial collapse that happened later that year by several months.  Well, now it is happening again, but this time the stakes are even higher.  When the price of oil falls dramatically, that is a sign that economic activity is slowing down.  It can also have a tremendously destabilizing affect on financial markets.  As you will read about below, energy companies now account for approximately 20 percent of the junk bond market.  And a junk bond implosion is usually a signal that a major stock market crash is on the way.  So if you are looking for a “canary in the coal mine”, keep your eye on the performance of energy junk bonds.  If they begin to collapse, that is a sign that all hell is about to break loose on Wall Street.

It would be difficult to overstate the importance of the shale oil boom to the U.S. economy.  Thanks to this boom, the United States has become the largest oil producer on the entire planet.

Yes, the U.S. now actually produces more oil than either Saudi Arabia or Russia.  This “revolution” has resulted in the creation of  millions of jobs since the last recession, and it has been one of the key factors that has kept the percentage of Americans that are employed fairly stable.

Unfortunately, the shale oil boom is coming to an abrupt end.  As a recent Vox article discussed, OPEC has essentially declared a price war on U.S. shale oil producers…

For all intents and purposes, OPEC is now engaged in a “price war” with the United States. What that means is that it’s very cheap to pump oil out of places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. The result? Oil prices will stabilize and OPEC maintains its market share.

If the price of oil stays at this level or continues falling, we will see a significant number of U.S. shale oil companies go out of business and large numbers of jobs will be lost.  The Saudis know how to play hardball, and they are absolutely ruthless.  In fact, we have seen this kind of scenario happen before

Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the US shale oil sector.” Even legendary oil man T. Boone Pickens believes Saudi Arabia is in a stand-off with US drillers and frackers to “see how the shale boys are going to stand up to a cheaper price.” This has happened once before. By the mid-1980’s, as oil output from Alaska’s North Slope and the North Sea came on line (combined production of around 5-6 million barrels a day), OPEC set off a price war to compete for market share. As a result, the price of oil sank from around $40 to just under $10 a barrel by 1986.

But the energy sector has been one of the only bright spots for the U.S. economy in recent years.  If this sector starts collapsing, it is going to have a dramatic negative impact on our economic outlook.  For example, just consider the following numbers from a recent Business Insider article

Specifically, if prices get too low, then energy companies won’t be able to cover the cost of production in the US. This spending by energy companies, also known as capital expenditures, is responsible for a lot of jobs.

“The Energy sector accounts for roughly one-third of S&P 500 capex and nearly 25% of combined capex and R&D spending,” Goldman Sachs’ Amanda Sneider writes.

Even more troubling is what this could mean for the financial markets.

As I mentioned above, energy companies now account for close to 20 percent of the entire junk bond market.  As those companies start to fail and those bonds start to go bad, that is going to hit our major banks really hard

Everyone could suffer if the collapse triggers a wave of defaults through the high-yield debt market, and in turn, hits stocks. The first to fall: the banks that were last hit by the housing crisis.

Why could that happen?

Well, energy companies make up anywhere from 15 to 20 percent of all U.S. junk debt, according to various sources.

It would be hard to overstate the seriousness of what the markets could potentially be facing.

One analyst summed it up to CNBC this way

This is the one thing I’ve seen over and over again,” said Larry McDonald, head of U.S strategy at Newedge USA’s macro group. “When high yield underperforms equity, a major credit event occurs. It’s the canary in the coal mine.

The last time junk bonds collapsed, a major stock market crash followed fairly rapidly.

And those that were hardest hit were the big Wall Street banks

During the last high-yield collapse, which centered around debt tied to the housing sector, Citigroup lost 63 percent of its value in the following 60 days, Kensho shows. Bank of America was cut in half.

I understand that some of this information is too technical for a lot of people, but the bottom line is this…

Watch junk bonds.  When they start crashing it is a sign that a major stock market collapse is right at the door.

At this point, even the mainstream media is warning about this.  Just consider the following excerpt from a recent CNN article

That swing away from junk bonds often happens shortly before stock market downturns.

“High yield does provide useful sell signals to equity investors,” Barclays analysts concluded in a recent report.

Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.

If you have been waiting for the next major financial collapse, what you have just read in this article indicates that it is now closer than it has ever been.

Over the coming weeks, keep your eye on the price of oil, keep your eye on the junk bond market and keep your eye on the big banks.

Trouble is brewing, and nobody is quite sure exactly what comes next.

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