MONEY Oil

Two Big Reasons You Won’t Be Spending More On Gas Anytime Soon

Shaybah oilfield complex, in the Rub' al-Khali desert, Saudi Arabia, November 14, 2007.
Ali Jarekji—REUTERS Shaybah oilfield complex, in the Rub' al-Khali desert, Saudi Arabia.

Chinese demand doesn’t seem to be improving, and Saudi Arabia is actually boosting production.

The beleaguered oil industry was hit with a double dose of bad news on Tuesday, which initially sent oil prices down. On the supply side, Saudi Arabia continues to make good on its refusal to cut its production, instead, it actually boosted production close to an all-time high. Meanwhile, weaker than expected demand in China doesn’t appear to be improving as factory data from the world’s top oil importer slipped to an 11-month low. Unless these two trends reverse course both could continue to put pressure on oil prices in the months ahead.

Gushing supplies

Saudi Arabia is making it abundantly clear that it has no intention of cutting its oil production to reduce the current glut of oil on the market. This past weekend its OPEC governor, Mohammed al-Madi, said that the market can forget about a return of triple digit oil prices for the time being. That statement was backed up by the country’s oil production data, which according to a Reuters report is now up to 10 million barrels per day. Not only is that near its all-time high, but its 350,000 barrels per day more than the country told OPEC it would produce last month. In fact, as we can see in the following chart the Kingdom’s oil output has steadily risen over the past few decades and is nearing its previous peak from the 1980s.

Saudi Arabia Crude Oil Production Chart

Typically the Saudi’s are the first to cut oil production when the market has too much supply. However, this time it’s more concerned with keeping its share of the oil market that it’s willing to flood the market with cheap oil in order to slow down production growth from places like the U.S., Canada, and Russia. This is leaving the world short of places to put the excess oil asstorage space is quickly running low due to weaker than expected demand.

China continues to slow

To make matters worse, China, which is the world’s second largest economy and top oil importer, continues to see its economic growth slow suggesting its demand for oil could be even more tepid in the months ahead. The latest data out of China shows that factory activity is now at an 11-month low. This was after the HSBC/Markit Purchasing Managers’ Index was at 49.2 for March, well below the 50.7 mark from February. Not only is that below the 50.6 that economists had expected, but it’s now below the 50-point mark that separates growth from a contraction.

That’s bad news for oil prices because as the following chart shows China’s rapidly expanding economy has been a key driver of its surging oil demand over the past decade.

China Oil Consumption Chart

With China’s economic growth slowing down it’s leading to a slowdown in its demand for oil. That leaves robust global oil supplies with nowhere to go at the moment as demand for oil in Europe has been weakened by its own economic issues while the U.S. no longer needs as much imported oil thanks to efficiency gains as well as its own robust output. This will put pressure on oil prices as increased demand for oil from China was seen as a key for an oil price rally.

Investor takeaway

So much for peak oil as Saudi Arabia has now pushed its production close to its all-time high with no signs that it plans to tap the brakes. That’s coming at the worst possible moment as the oil market is oversupplied by upwards of two million barrels per day at the moment due to weaker than expected demand in China. Worse yet, Chinese demand could start to contract as its economic machine is notably showing down. This means that investors in oil stocks are in for more volatility as the market continues to work through its supply and demand issues.

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MONEY Macroeconomic trends

8 Surprising Economic Trends That Will Shape the Next Century

crowd of people
Douglas Mason—Getty Images

Here are the stories that will matter in the years ahead.

Forget monthly jobs reports, GDP releases, and quarterly earnings. As I see it, there are eight important economic stories worth tracking right now that could have a big impact in the coming decades.

1. The U.S. population age 30-44 declined by 3.8 million from 2002 to 2012. That cohort is now growing again. By 2023 there will be an estimated 5.8 million more Americans aged 30 to 44 than there are now, according to the Census Bureau. This is important, because this age group spends tons of money, buys lots of homes and cars, and start lots of new businesses.

2. U.S. companies have $2.1 trillion cash held abroad. Much of this is because we have an inane tax code that taxes foreign profits twice: Once in the country they’re earned in, and again when companies bring that money back to the United States. If Congress ends this rule and switches to a territorial tax system — in which countries can bring foreign-earned cash back to their home country without paying another layer of taxes, as every other developed country allows — there could be a flood of new dividends, buybacks, and investments in America. It’s huge, pent-up demand waiting to be spent.

3. U.S. infrastructure is in disastrous shape. Roads, bridges, dams, and other public infrastructure have been neglected for years. The American Society of Civil Engineers estimates that $3.6 trillion in new investment is needed by 2020 to bring the country’s infrastructure up to “good” condition. Will this happen soon? Of course not. This is Congress we’re talking about. But the good news is that this work must eventually be done. You can’t just let critical bridges and water structures fail and say, “Damn. That Brooklyn Bridge was nice while we had it.” Things will have to be repaired. Sooner rather than later would be smart, because we can borrow now for zero percent interest. But someday, it will happen. And it’ll be a huge boon to jobs and growth when it does.

4. The whole structure of modern business is changing. I’m not sure who said it first, but this quote has been floating around Twitter lately: “In 2015 Uber, the world’s largest taxi company owns no vehicles, Facebook the world’s most popular media owner creates no content, Alibaba, the most valuable retailer has no inventory, and Airbnb, the world’s largest accommodation provider owns no real estate.” Fundamental assumptions about what is needed to be a successful business have changed in just the last few years.

5. California is one of the most important agricultural states, growing 99% of the nation’s artichokes, 94% of broccoli, 95% of celery, 95% of garlic, 85% of lettuce, 95% of tomatoes, 73% of spinach, 73% of melons, 69% of carrots, 99% of almonds, 98% of pistachios, and 89% of berries (the list goes on). And the state is basically running out of water. Jay Famiglietti, senior water scientist at the NASA Jet Propulsion Laboratory, wrote last week: “Right now the state has only about one year of water supply left in its reservoirs, and our strategic backup supply, groundwater, is rapidly disappearing. California has no contingency plan for a persistent drought like this one (let alone a 20-plus-year megadrought), except, apparently, staying in emergency mode and praying for rain.” This could change rapidly in one good winter, but it could also turn into a quick tailwind on food prices. It could also be a huge boost for desalination companies.

6. New home construction will probably need to rise 40% from current levels to keep up with long-term household formation. We’re now building about 1 million new homes a year. That will likely have to rise to an average of 1.4 million per year, which combines Harvard’s Joint Center for Housing Studies’ projection of 1.2 million new households being formed each year and an annual average of 200,000 homes being lost to natural disaster or torn down. This is important because new home construction is, historically, one of the top drivers of economic growth.

7. American households have the lowest debt burden in more than three decades. And the largest portion of household debt is mortgages, most of which are fixed-rate. So when people ask, “What’s going to happen to debt burdens when interest rates rise?”, the answer is “Probably not that much.”

8. America has some of the best demographics among major economies. Between 2012 and 2050, America’s working-age population (those ages 15-64) is projected to rise by 47 million. China’s working-age population is set to shrink by 200 million, Russia’s to fall by 34 million, Japan’s by 27 million, Germany’s by 13 million, and France’s by 1 million. People worry about the impact of retiring U.S. baby boomers, but the truth is we have favorable demographics other countries can’t even dream about. This is massively overlooked and underappreciated.

There’s a lot more important stuff going on, of course. And the biggest news story of the next 20 years is almost certainly something that nobody is talking about today. But if I had to bet on eight big trends that will very likely make a difference, these would be them.

For more:

MONEY Oil

3 Reasons Gas Prices Could Rocket Higher

150304_INV_GasPricesHigh
Scott Olson—Getty Images Members of the United Steelworkers Union and other supporting unions picket outside the BP refinery.

Unfortunately, the days of $2 gas appear to be in the rearview mirror.

Well, we had a nice run. After 123 straight days of falling gasoline prices, sending it below $2 a gallon in many states, we’ve come back to reality a little bit. In fact, gas prices have now risen each and every day for about a month. Unfortunately, gas prices could go a lot higher because of three storm clouds that appear to be on the horizon, which could combine to send gas prices rocketing higher.

Storm cloud No. 1: Rising oil prices

The dramatic drop in the price of oil in late 2014 caused gas prices to come down as well. We see this correlation in the following chart:

Brent Crude Oil Spot Price Chart

 

As we see there, the price of oil is down 45% over the past year, while the price of gasoline is down 32%. However, we can also see that both have bounced off of their bottoms from earlier this year. That’s because the price of oil has stabilized and is now starting to head higher as the oil market starts to see signs that it is working out some of its supply/demand imbalance issues.

Because those issues are being addressed, the oil market is now starting to point to a higher oil price later this year. That’s a recipe for higher gas prices, which is just what the U.S. Energy Information Administration is predicting, as we can see on the chart below.

Storm cloud No. 2: The big switch

One other thing you might have noticed from that above chart is that the price of gasoline is notably more lumpy than the price of oil. It’s something most of us notice at the pump each year as gas prices almost always rise in the spring. That’s because summer driving season is upon us, which leads to more demand for gasoline.

However, what really drives the price of gas up isn’t so much increased demand for gasoline in the summer, but the fact that oil refineries need to shift gears in the spring to focus on refining summer-blend fuels as opposed to winter-blend gasoline and home heating oil. Along with this switch, refiners also tend to undergo routine maintenance in the spring, which reduces their refining capacity. This adds up, and over the past few years on average, this has added $0.54 per gallon to the cost of gasoline each spring.

Storm cloud No.3: The picket line

This year, there’s a new wrinkle that could throw a wrench in the spring refinery maintenance season. The refining industry is currently at odds with the United Steelworkers union as the two have failed to reach an agreement on a new contract. As the dispute grows, workers at a dozen U.S. refineries have walked off the job, putting 19% of U.S. refining capacity at risk. The strike could continue to expand, as neither party is giving much ground on the disputed issues. This could lead to up to 63 refineries, which represent two-thirds of refining capacity, being affected by the strike.

So far, the strike has only resulted in one refinery in California being shut down, and that’s just because it was already undergoing maintenance, and its owner decided not to run the plant. However, shortly thereafter, an explosion at another California refinery took that facility offline, too, and cut the state’s refining capacity by 25%. This resulted in gas prices spiking in Los Angeles by $0.50 per gallon. This suggests that should the growing labor dispute lead to refineries across the nation shutting down, it could cause a big spike in what we pay at the pump.

Bottom line

Unfortunately, the days of $2 gas appear to be in the rearview mirror. Even without the rally in the oil price over the past few weeks, gas prices would have headed higher because of the normal spring switchover at refineries. However, this year, the price of gas could be under even more pressure to rise because of the possibility of a continued increase in the price of oil, and the possibility that the refinery strike causes a big portion of refining capacity to be taken offline.

I know that’s not the greatest of news, but if gas prices do spike, at least you’ll know why. And it’s a good reminder that instead of complaining about gas prices, an investment in the oil industry could offset some of the extra costs we’ll be paying at the pump and take away a bit of the sting of spiking prices.

MONEY Food & Drink

5 Reasons Why McDonald’s Will Win in 2015

McDonald's golden arches signs
Kristoffer Tripplaar—Alamy

McDonald's may not look so hot now, but it's in great shape to beat the market in 2015.

It’s so easy to kick a mustard- and ketchup-colored clown when it’s down, and McDonald’s MCDONALD'S CORP. MCD -0.51% has certainly earned the dissing.

It’s coming off of five consecutive quarters of negative comps, and lately it’s been blasted for everything from the quality of its grub to operational snags.

Instead of piling on, let’s take a look at a few of the things that either have been going right or should start to go right for McDonald’s this year.

1. Domestic comps are growing again

The market wasn’t impressed when McDonald’s announced that global comparable sales decreased 1.8% in January. It’s just something that the market has grown used to since the chain’s fundamentals began to slip in late 2013. However, the entirety of that decline was the result of fallout in Asia as a supplier scare in China and brand perception issues in Japan weighed on the overall performance.

The world’s largest burger chain held up better closer to home. Sales in the U.S. rose 0.4%, with an even better 0.5% year-over-year uptick at the register in Europe. Boo birds will argue this still means sales aren’t keeping up with inflation, but let’s frame this correctly. This is the first month in more than a year that McDonald’s has posted comps that are north of breakeven.

2. The new CEO could be a game changer

The Don Thompson era is coming to a close, and now the board is tasking Steve Easterbrook with turning the chain around as its new CEO. Yes, he’s an internal hire. That may not seem very exciting at a time when McDonald’s needs to think outside of the Happy Meal box, but he seems like the perfect candidate.

Easterbrook helped turn around the chain’s operations in Europe before moving back to head up the restaurant’s marketing department. He seems to have a firm grasp on the right message to woo back customers, and January’s bounce could be the first sign.

3. Higher wages could benefit McDonald’s

Consumer-facing chains are under fire for their low wages, and it wouldn’t be a surprise if we see restaurant operators start to pay more this year. This will naturally inflate prices, but McDonald’s may have a technological advantage in the form of automation.

McDonald’s and its franchisees have been investing in machines that perform many mundane tasks. Smoothie machines get going at the press of a button. Updated drive-thru windows have soda fountain carousels that sort out cups and fill them with beverages as they are ordered. Smaller chains can’t afford these high-tech automations, but it also means that McDonald’s will be able to get by with fewer employees in the future.

4. The improving economy will raise all chains

Have you noticed the drive-thru lane at your local McDonald’s getting longer in the morning? I have. With job creation on the rise again we’re seeing more rushed commuters hitting the road, taking lunch breaks, and having more money at the end of the day to take their families out to dinner.

This is a trend that should be beneficial to all chains. McDonald’s will be there.

5. The fundamentals are strong

McDonald’s may not seem cheap for a mature and slow-growing company. The stock is trading at 19 times this year’s expected earnings and a still steep 18 times next year’s target. However, there’s something to be said about a company with a predictable stream of fat royalty payments from franchisees. Net profit margins at McDonald’s hovered around a juicy 20% for several years before last year’s stumble, according to S&P Capital IQ data.

Along the way we have a company donning a chunky yield of 3.5% with a history of annual hikes dating back to when it started paying out dividends 39 years ago. McDonald’s may not look so hot now, but it’s in great shape to beat the market in 2015.

MONEY investing strategy

The Track Records of Wall Street’s Top Strategists Are Worse Than You Think

fever graph on screen
Richard Drew—AP

Listening to Wall Street's top strategists is no better than random guessing.

This is embarrassing.

There are 22 “chief market strategists” at Wall Street’s biggest banks and investment firms. They work at storied firms such as Goldman Sachs and Morgan Stanley. They have access to the best information, the smartest economists, and teams of brilliant analysts. They talk to the largest investors in the world. They work hard. They are paid lots of money.

One of their most important — and certainly highest-profile — jobs is forecasting what the stock market will do over the next year. Strategists do this every January by predicting where the S&P 500 will close on Dec. 31.

You won’t be shocked to learn their track record isn’t perfect. But you might be surprised at how disastrously bad it is. I certainly was.

On average, chief market strategists’ forecasts are worse than those made by a guy I call the Blind Forecaster. He’s a brainless idiot who assumes the market goes up 9% — its long-term historic average — every year, regardless of circumstances.

Here’s the average strategist’s forecast versus actual S&P 500 performance since 2000:

Some quick math shows the strategists’ forecasts were off by an average of 14.7 percentage points per year.

How about the Blind Forecaster? Assuming the market would rise 9% every year since 2000 provided a forecast that was off by an average of 14.1 percentage points per year.

Underperforming the Blind Forecaster isn’t due to 2008, which forecasters like to write off as an unforeseeable “black swan.” Excluding 2008, the strategists’ error rate is 12 percentage points per year, versus 11.6 percentage points per year for the Blind Forecaster. Our idiot still wins.

The Blind Forecaster wasn’t a good forecaster, mind you. He was terrible. He missed bear markets and underestimated bull markets. In only one of the last 14 years was his annual forecast reasonably close to being accurate. But he was still better than the combined effort of 22 of Wall Street’s brightest analysts.

And the Blind Forecaster required no million-dollar salary. He worked no late nights. He attended no conference calls, meetings, or luncheons. He made no PowerPoint presentations, and never appeared on CNBC. He has no beach house, and was granted no bonuses. He works free of charge, offering his services to anyone who will listen.

Amazingly, these stories aren’t rare. In 2007, economists Ron Alquist and Lutz Kilian looked atcrude futures, a market used to predict oil prices. These markets were actually less accurate at predicting oil prices than a naïve “no-change” forecast, which assumes the future price of oil is whatever the current price is now. The no-change forecast was terrible at predicting oil prices, of course. But it was better than the collective effort of the futures market.

This raises two questions: Why do people listen to strategists? And why are they so bad?

The first question is easy. I think there’s a burning desire to think of finance as a science like physics or engineering.

We want to think it can be measured cleanly, with precision, in ways that make sense. If you think finance is like physics, you assume there are smart people out there who can read the data, crunch the numbers, and tell us exactly where the S&P 500 will be on Dec. 31, just as a physicist can tell us exactly how bright the moon will be on the last day of the year.

But finance isn’t like physics. Or, to borrow an analogy from investor Dean Williams, it’s not like classical physics, which analyzes the world in clean, predictable, measurable ways. It’s more like quantum physics, which tells us that — at the particle level — the world works in messy, disorderly ways, and you can’t measure anything precisely because the act of measuring something will affect the thing you’re trying to measure (Heisenberg’s uncertainty principle). The belief that finance is something precise and measurable is why we listen to strategists. And I don’t think that will ever go away.

Finance is much closer to something like sociology. It’s barely a science, and driven by irrational, uninformed, emotional, vengeful, gullible, and hormonal human brains.

If you think of finance as being akin to physics when it’s actually closer to sociology, forecasting becomes a nightmare.The most important thing to know to accurately forecast future stock prices is what mood investors will be in in the future. Will people be optimistic, and willing to pay a high price for stocks? Or will they be bummed out, panicked about some crisis, pissed off at politicians, and not willing to pay much for stocks? You have to know that. It’s the most important variable when predicating future stock returns. And it’s unknowable. There is no way to predict what mood I’ll be in 12 months from now, because no matter what you measure today, I can ignore it a year from now. That’s why strategists have such a bad record.

Worse than a Blind Forecaster.

Check back every Tuesday and Friday for Morgan Housel’s columns.

The more you know about the most common mistakes that investors make, the better your likelihood of building lasting wealth. Click here for more commentary on how I think about investing and money.

Contact Morgan Housel at mhousel@fool.com. The Motley Fool has a disclosure policy.

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MONEY Markets

Oil Prices: Freaking Investors Out for 150 Years and Counting

Oil derricks moving up and down
Getty Images

The entire oil and gas industry has pretty much maneuvered from crisis to crisis since its inception.

Whenever I read or watch financial media coverage of oil prices lately, the image that comes to mind is a bunch of kids who just ate half their weight in candy, washed it down with a gallon of Red Bull, and then run around the playground at warp speed. They both move so fast and sporadically that is almost impossible to keep up with them.

Here is just a small example of headlines that have been found at major financial media outlets in just the past week:

  • Citi: Oil Could Plunge to $20, and This Might Be ‘the End of OPEC’
  • OPEC sees oil prices exploding to $200 a barrel
  • Oil at $55 per barrel is here to stay
  • Gas prices may double by year’s end: Analyst

What is absolutely mind-boggling about these statements is that these sorts of predictions are accompanied with the dumbest thing that anyone can say about commodities: This time it’s different.

No it’s not, and we have 150 years worth of oil price panics to prove it.

Oil Prices: From one hysterical moment to another

The thought of oil prices moving 15%-20% is probably enough to make the average investor shudder. The assumption is that when a move that large happens, something must be wrong with the market that could change your investment thesis. Perhaps the supply and demand curves are a little out of balance, maybe there is a geopolitical conflict that could compromise a critical producing nation.

Or maybe, just maybe, it’s just what oil prices do over time.

Ever since 1861 — two years after the very first oil well was dug in the U.S. — there have been:

  • 88 years with a greater than 10% change, once every year and a half
  • 69 years with a greater than 15% change, or once every 2.25 years
  • 44 years with a greater than 25% change, once every 3.5 years
  • 13 years with a greater than 50% change, once every dozen years or so

Also keep in mind, these are just the change in annual price averages. So it’s very likely that these big price pops and plunges are even more frequent than what this chart shows.

Investing in energy takes more stomach than brains

It’s so easy to fall into the trap of basing all of your energy investing decisions on the price of oil and where it will go. On the surface it makes sense because the price of that commodity is the lifeblood of these companies. When the price of oil drops as much as 50% over a few months, it will likely take a big chunk out of revenue and earnings power.

As you can see from this data, though, the frequency of major price swings is simply too much for the average investor to try to time the market. Heck, even OPEC, the organization that is supposed to be dedicated to regulating oil prices through varying production is bad at predicting which way oil prices will go.

The reality is, being an effective energy investor doesn’t require the skill to know where energy prices are headed — nobody has that skill anyways. The real determining factor in effectively investing in this space is identifying the best companies and holding them through the all the pops and drops.

Let’s just use an example here. In 1980, the price of oil — adjusted for inflation — was at a major peak of $104. From there it would decline for five straight years and would never reach that inflation adjusted price again until 2008. For 15 of those 28 years oil prices were one-third what they were in 1980. If we were to use oil prices as our litmus test, then any energy investment made in 1980 would have been a real stinker.

However, if you had made an investment in ExxonMobil in 1980 and just held onto it, your total return — share price appreciation plus dividends — would look a little something like this.

XOM Total Return Price Chart

So much for all those pops and drops.

What a Fool believes

The entire oil and gas industry has pretty much maneuvered from crisis to crisis since its inception, we just seemed to have forgotten that fact up until a few months ago because we had two years of relative calm. The important thing to remember is that the world’s energy needs grow every day and the companies that produce it will invest and make more money off of it when prices are high and less money when prices are low.

Based on the historical trends of oil, analysts will continue to go on their sugar-high proclamation streak and say that oil will go to absurd highs and lows so they can get their name in a financial piece, and they will try to tell you that this time it’s different because of xyz. We know better, and they should as well.

There’s 150 years of evidence just waiting to prove them wrong.

MONEY Greece

What the Turmoil in Greece Means for Your Money

The head of radical leftist Syriza party Alexis Tsipras waves to supporters after winning the elections in Athens January 25, 2015. Tsipras promised on Sunday that five years of austerity, "humiliation and suffering" imposed by international creditors were over after his Syriza party swept to victory in a snap election on Sunday.
Marko Djurica—Reuters The head of radical leftist Syriza party, Alexis Tsipras.

Expect lower stock prices.

Faced with an apocalyptic unemployment rate of 28%, voters in Greece have drawn the line on austerity measures that have mired the country in a crisis rivaling that of the Great Depression. In the worst case, the move could lead to Greece’s exit from the European monetary union. In the best case, it will produce much-needed debt relief for the country’s ailing economy. But either way, it’s prudent to assume the turmoil will roil equity markets both here and abroad.

The issue came to a head earlier this week when Greece’s “radical left” Syriza party won a plurality of votes in the latest election. Led by 40-year-old Alexis Tsipras, Syriza campaigned on a platform to ease the “humiliation and suffering” caused by austerity. This includes debt relief and rolling back steep spending cuts enacted by Greece’s former government in exchange for financing from the International Monetary Union and other members of the European Union.

To say Greece has paid dearly for these cuts would be an understatement. The consensus among mainstream economists is that austerity during a time of crisis exacerbates the underlying issues. We saw this in Germany after World War I when France and Great Britain demanded it pay colossal war reparations. We saw it throughout Latin America following the IMF’s structural adjustments of the 1980s and 1990s. And we’re seeing it now in Greece and Spain, where unemployment has reached levels not seen in the developed world since the Great Depression.

The problem for Greece is that Germany and other fiscally conservative European countries aren’t sympathetic to its predicament. They see Greece’s travails as its just deserts. They see a fiscally irresponsible country that exploited its membership in the continent’s monetary union in order to borrow cheaply and spend extravagantly. And they see an electorate that isn’t willing to accept the consequences of its government’s actions.

To a certain extent, Greece’s critics are right. Over the last decade, its debt has ballooned. In 2004, the country’s debt-to-GDP ratio was 97%. Today, it is 175%. This is the heaviest debt load of any European country relative to output.

It accordingly follows that the European Union stands once again at the precipice of fracturing. If the Syriza party sticks to its demands and Greece’s neighbors won’t agree to relief, then one of the few options left on the table will be for Greece to exit the monetary union and abandon the euro. Doing so would free the country to pursue its own fiscal and monetary policies. It would also almost inevitably trigger a period of sharp inflation in a reinstituted drachma.

This isn’t to say global investors should be petrified at the prospect of even the most extreme scenario — that of Greece abandoning the euro. In essence, the euro is nothing more than a currency peg that fossilized the exchange rates between the continent’s currencies in 2001. By going off it, Greece would essentially be following in the footsteps of the Swiss National Bank, which recently unpegged the Swiss franc from the euro after a drop in the latter’s value made maintaining the peg prohibitively expensive.

A more complicated question revolves around the fate of Greece’s sovereign debt. Seceding from the monetary union won’t eliminate its obligations to creditors. It likely also won’t change the fact that the country’s debt is denominated in euros. Thus, if Greece were to exit the euro and experience rapid inflation, the burden of its interest payments would get worse, not better. This would make the prospect of default increasingly attractive if not necessary in order to reignite economic growth.

But investors have shouldered sovereign debt repeatedly since the birth of international bond markets. Just last year, Standard & Poor’s declared that Argentina had defaulted after missing a $539 million payment on $13 billion in restructured bonds — restructured, that is, following the nation’s 2002 default. Yet stocks ended the year up by 11.5%. The same thing happened when Russia defaulted in 1998. Despite triggering the failure of Long Term Capital Management, a highly leveraged hedge fund that was ultimately rescued by a consortium of Wall Street banks, stocks soared by 26.7% that year.

Given all this, the biggest impact on investors, particularly in the United States, is likely to make its way through the currency markets. When fear envelopes the globe, investors flee to safety. And in the currency markets, safety is synonymous with the U.S. dollar. Over the last year, for instance, speculation about quantitative easing by the European Central Bank, coupled with the scourge of low oil prices on energy-dependent economies such as Russia and Mexico, has increased the strength of the dollar. This will only grow more pronounced if the U.S. Federal Reserve raises short-term interest rates later this year.

The net result is that American companies with significant international operations will struggle to grow their top and bottom lines. This is because a strong dollar makes American goods more expensive relative to competitors elsewhere. Consumer products giant Procter & Gamble PROCTER & GAMBLE COMPANY PG -1.04% serves as a case in point. In the final three months of last year, P&G’s sales suffered a negative five percentage point impact from foreign exchange. As Chairman and CEO A.G. Lafley noted in Tuesday’s earnings release:

The October [to] December 2014 quarter was a challenging one with unprecedented currency devaluations. Virtually every currency in the world devalued versus the U.S. dollar, with the Russian Ruble leading the way. While we continue to make steady progress on the strategic transformation of the company — which focuses P&G on about a dozen core categories and 70 to 80 brands, on leading brand growth, on accelerating meaningful product innovation and increasing productivity savings — the considerable business portfolio, product innovation, and productivity progress was not enough to overcome foreign exchange.

With this in mind, it seems best to assume revenue and earnings at American companies will take a hit while Europe works toward a solution to Greece’s problems. In addition, as we’ve already started to see, the hit to earnings will be reflected in lower stock prices. There’s no way around this. But keep in mind that we’ve been through countless crises like this is in the past, and the stock market continues to reward long-term investors for their patience and perseverance.

MONEY Oil

Why Oil Prices May Not Recover Anytime Soon

A worker waits to connect a drill bit on Endeavor Energy Resources LP's Big Dog Drilling Rig 22 in the Permian basin outside of Midland, Texas, U.S., on Friday, Dec. 12, 2014.
Brittany Sowacke—Bloomberg via Getty Images

Things could get worse for the oil industry before they get better.

Oil prices have collapsed in stunning fashion in the past few months. The spot price of Brent crude reached $115 a barrel in June, and was above $100 a barrel as recently as September. Since then, it has plummeted to less than $50 a barrel.

Brent Crude Oil Spot Price Chart

There is a sharp split among energy experts about the future direction of oil prices. Saudi Prince Alwaleed bin Talal recently stated that oil prices could keep falling for quite a while and opined that $100 a barrel oil will never come back. Earlier this month, investment bank Goldman Sachs weighed in by slashing its short-term oil price target from $80 a barrel all the way to $42 a barrel.

But there are still plenty of optimists like billionaire T. Boone Pickens, who has vocally argued that oil will bounce back to $100 a barrel within 12 months-18 months. Pickens thinks that Saudi Arabia will eventually give in and cut production. However, this may be wishful thinking. Supply and demand fundamentals point to more lean times ahead for oil producers.

Oil supply is comfortably ahead of demand

The International Energy Agency assesses the state of the global oil market each month. Lately, it has been sounding the alarm about the continuing supply demand imbalance.

The IEA currently projects that supply will outstrip demand by more than 1 million barrels per day, or bpd, this quarter, and by nearly 1.5 million bpd in Q2 before falling in line with demand in the second half of the year, when oil demand is seasonally stronger.

That said, these projections are built on the assumption that OPEC production will total 30 million bpd: its official quota. However, OPEC production was 480,000 bpd above the quota in December. At that rate, the supply-and-demand gap could reach nearly 2 million bpd in Q2.

Theoretically, this gap between supply and demand could be closed either through reduced supply or increased demand. However, at the moment economic growth is slowing across much of the world. For oil demand to grow significantly, global GDP growth will have to speed up.

It would take several years for the process of lower energy prices helping economic growth and thereby stimulating higher oil demand to play out. Thus, supply cuts will be necessary if oil prices are to rebound in the next two years-three years.

Will OPEC cut production?

There are two potential ways that global oil production can be reduced. One possibility is that OPEC will cut production to prop up oil prices. The other possibility is that supply will fall into line with demand through market forces, with lower oil prices driving reductions in drilling activity in high-cost areas, leading to lower production.

OPEC is a wild card. A few individuals effectively control OPEC’s production activity, particularly because Saudi Arabia has historically borne the brunt of OPEC production cuts. Right now, the powers that be favor letting market forces work.

There’s always a chance that they will reconsider in the future. However, the strategic argument for Saudi Arabia maintaining its production level is fairly compelling. In fact, Saudi Arabia has already tried the opposite approach.

In the 1980s, as a surge in oil prices drove a similar uptick in non-OPEC drilling and a decline in oil consumption, Saudi Arabia tried to prop up oil prices. The results were disastrous. Saudi Arabia cut its production from more than 10 million bpd in 1980 to less than 2.5 million bpd by 1985 and still couldn’t keep prices up.

Other countries in OPEC could try to chip in with their own production cuts to take the burden off Saudi Arabia. However, the other members of OPEC have historically been unreliable when it comes to following production quotas. It’s unlikely that they would be more successful today.

The problem is that these countries face a “prisoner’s dilemma” situation. Collectively, it might be in their interest to cut production. But each individual country is better off cheating on the agreement in order to sell more oil at the prevailing price, no matter what the other countries do. With no good enforcement mechanisms, these agreements regularly break down.

Market forces: moving slowly

The other way that supply can be brought back into balance with demand is through market forces. Indeed, at least some shale oil production has a breakeven price of $70 a barrel-$80 a barrel or more.

This might make it seem that balance will be reasserted within a short time. However, there’s an important difference between accounting profit and cash earnings. Oil projects take time to execute, involving a significant amount of up-front capital spending. Only a portion of the total cost of a project is incurred at the time that a well is producing oil.

Capital spending that has already been incurred is a “sunk cost.” The cost of producing crude at a particular well might be $60 a barrel, but if the company spent half that money upfront, it might as well spend the other $30 a barrel to recover the oil if it can sell it for $45 a barrel-$50 a barrel.

Thus, investment in new projects drops off quickly when oil prices fall, but there is a significant lag before production starts to fall. Indeed, many drillers are desperate for cash flow and want to squeeze every ounce of oil out of their existing fields. Rail operator CSX recently confirmed that it expects crude-by-rail shipments from North Dakota to remain steady or even rise in 2015.

Indeed, during the week ending Jan. 9, U.S. oil production hit a new multi-decade high of 9.19 million bpd. By contrast, last June — when the price of crude was more than twice as high — U.S. oil production was less than 8.5 million bpd.

One final collapse?

In the long run — barring an unexpected intervention by OPEC — oil prices will stabilize around the marginal long-run cost of production (including the cost of capital spending). This level is almost certainly higher than the current price, but well below the $100 a barrel level that’s been common since 2011.

However, things could get worse for the oil industry before they get better. U.S. inventories of oil and refined products have been rising by about 10 million barrels a week recently. The global supply demand balance isn’t expected to improve until Q3, and it could worsen again in the first half of 2016 due to the typical seasonal drop in demand.

As a result, global oil storage capacity could become tight. Last month, the IEA found that U.S. petroleum storage capacity was only 60% full, but commercial crude oil inventory was at 75% of storage capacity.

This percentage could rise quickly when refiners begin to cut output in Q2 for the seasonal switch to summer gasoline blends. Traders have even begun booking supertankers as floating oil storage facilities, aiming to buy crude on the cheap today and sell it at a higher price this summer or next year.

If oil storage capacity becomes scarce later this year, oil prices will have to fall even further so that some existing oil fields become cash flow negative. That’s the only way to ensure an immediate drop in production (as opposed to a reduction in investment, which gradually impacts production).

Any such drop in oil prices will be a short-term phenomenon. At today’s prices, oil investment will not be sufficient to keep output up in 2016. Thus, T. Boone Pickens is probably right that oil prices will recover in the next 12 months-18 months, even if his prediction of $100 oil is too aggressive. But with oil storage capacity becoming scarcer by the day, it’s still too early to call a bottom for oil.

MONEY Jobs

Why Is Employment Picking Up? Thank Government

public construction workers
Reza Estakhrian—Getty Images

After hurting the employment picture for so long, local, state and federal governments are finally adding to payrolls.

The U.S. economy continued its winning streak by adding 252,000 jobs in December, the 11th consecutive month employers hired more than 200,000 workers. The unemployment rate fell to 5.6%, a post-recession low, as various sectors (from business services to health care to construction) added to payrolls.

Boosting hiring isn’t exactly new when it comes to private businesses, which have been bolstering their staffing for every month for almost five years.

What’s different about the recent pickup in employment is the positive effect of governments (state, local and federal). While jobs aren’t being added at rapid pace, they have grown steadily over the past year, and are no longer subtracting from the labor market like they were not too long ago.

Government employment increased by 12,000 in December, compared to a reduction of 2,000 employees in the last month of 2013. Compared to a year ago, state and local governments throughout the country have added a combined 108,000 jobs.

As recently as last January the government shed 22,000 positions. Sustained, incremental growth beats much of the sector’s post-recession record, which saw employment drop off thanks to lower tax revenue and austerity measures.

Government payrolls increased by about 0.5% over the last year — which doesn’t look terribly good compared to the private sector’s 2.1% gain. But when you look at the recent gains against the 0.05% decrease in the twelve months before January 2014, you start to appreciate the recent uptick.

Gov't jobs

What’s going on?

Well, state and local government finances have stabilized and marginally improved over the past couple of years, giving statehouses and municipalities a chance to improve its fiscal situation.

Take this note from a recent National Association of State Budget Officers report which says, “In contrast to the period immediately following the Great Recession, consistent year-over-year growth has helped states steadily increase spending, reduce taxes and fees, close budget gaps and minimize mid-year budget cuts.”

The nation’s economy grew at an annualized 5% rate in the third quarter, after jumping 4.6% in the three months before. The trade deficit fell in November to an 11-month low, thanks in part to lower energy costs, which will help fourth quarter growth.

NASBO expects states’s revenues to increase by 3.1% in the next fiscal year, compared to an estimated 1.3% gain in 2014, with much of that spending dedicated to education and Medicaid.

With a more solid financial position, governments across the country are able to spend more on basic items, like construction. Public construction, for instance, increased by 3.2% last November compared to the same time last year, according to the Census Bureau.

Overall government spending has stopped following dramatically and actually picked up in the third quarter on a year-over-year basis.

Expenditure

Of course, government employment still has a ways to go before returning to normal. In the five years after the dot-com inspired recession, public sector employment gained by 4.5%. (It’s fallen by 2.8% since the recession ended in June 2009.) And while state budgets have normalized, Governors aren’t exactly flush with cash.

Says NASBO: “More and more states are moving beyond recession induced declines, but spending growth is below average in fiscal 2015, as it has been throughout the economic recovery.”

Not to mention hourly earnings fell by five cents, to $24.57, a decline of 0.2%.

Still, some employment growth is better than none at all.

Updated with earnings data.

MONEY investing strategy

5 Mental Habits That Make Investors Rich

141106_INV_DreamInvestor
PeopleImages.com—Getty Images

Don't take yourself so seriously.

If I could build a dream investor from scratch, his name would be Paul.

Paul is an optimistic a-political sociopathic history buff with lots of hobbies who takes others’ opinions more seriously than his own.

Let me tell you why he is going to kick your butt at investing.

The sociopath

Psychologist Essi Vidling once interviewed a serial killer. Vidling showed the killer pictures of different facial expressions, and asked him to describe what the people were feeling. The murderer got most right, except pictures of people making fearful faces. “I don’t know what that expression is called, but it’s what people look like right before I stab them,” he said.

Paul couldn’t harm a fly. But a key trait of sociopaths is the ability to remain calm when others are terrified, so much that they don’t even understand why other people get scared. It’s also a necessity to becoming a good investor. In her book Confessions of a Sociopath, M.E Thomas writes:

The thing with sociopaths is that we are largely unaffected by fear … I am also blessed with a complete lack of sentiment … My lack of empathy means I don’t get caught up in other people’s panic.

Paul is like this, too. He doesn’t understand why people investing for 10 years get fearful when stocks have a bad 10 days. Recessions don’t bother him. Pullbacks entertain him. He thought the flash crash was kind of funny. He doesn’t care when his companies miss earnings by a penny. He’s immune to that stuff, which is a big advantage over most investors.

The a-political investor

Paul has political beliefs — who doesn’t?

But he knows that millions of equally smart people have opposite beliefs they are just as sure in. Since markets reflect the combined beliefs of millions of people, Paul knows that there is no reason to expect markets to converge on his personal beliefs, even if he is dead sure it is the truth. So he never lets his politics guide his investment decisions.

Paul knows that political moralizing is one of the most dangerous poisons your brain can come across, causing countless smart people to make dumb decisions. Even when he is bothered by political events, Paul repeats to himself in the mirror: “The market doesn’t care what I think. The market doesn’t care what I think.”

The history buff

Paul loves history. He loves it for a specific reason: It teaches him that anything is possible at any time, no matter how farfetched it sounds. “One damned thing after another,” a historian once described his field.

Paul knows that some people read history for clues on what might happen next, but history’s biggest lesson is that nobody has any idea, ever.

When people say oil prices can only go up, or have to fall, Paul knows history isn’t on their side — either could occur. He knows that when people say China owns the next century, or that America’s best days are behind it, history says either could be wrong.

History makes Paul humble, and prevents him from taking forecasts too seriously.

The hobbyist

Paul likes golf. He enjoys cooking. He reads on the beach. He has a day job that takes up most of his time.

Paul loves investing, but he doesn’t have time to worry about whether Apple is going to miss earnings, or if fourth-quarter GDP will come in lower than expected. He’s too busy for that stuff.

And he likes it that way. He knows investing is mostly a waiting game, and he has plenty of hobbies to keep him busy while he waits. His ignorance of trivial stuff has saved him thousands of dollars and countless time.

The open-minded thinker

Paul knows he’s just one of seven billion people in the world, and that his own life experiences are a tiny fraction of what’s to be learned out there.

He knows that everyone wants to think they are right, and that people will jump through hoops to defend their beliefs. He also knows this is dangerous, because it prevents people from learning. Paul knows that everyone has at least one firm, diehard belief that is totally wrong, and this scares him.

Paul is insanely curious about what other people think. He’s more interested in what other people think than he is in sharing his own views. He doesn’t take everyone seriously — he knows the world is full of idiots — but he knows the only way he can improve is if he questions what he knows and opens his mind to what others think.

The realistic optimist

Paul knows there’s a lot of bad stuff in this world. Crime. War. Hunger. Poverty. Injustice. Disease. Politicians.

All of these things bother Paul. But only to a point. Because he knows that despite the wrongs of the world, more people wake up every morning wanting to do good than try to do harm. And he knows that despite a constant barrage of problems, the good group will eventually win out in the long run. That’s why things tend to get better for almost everyone.

Paul doesn’t get caught up in doom loops, refusing to invest today because he’s worried about future budget deficits, or future inflation, or how his grandkids will pay for Social Security. Optimists get heckled as oblivious goofs from time to time, but Paul knows the odds are overwhelmingly in their favor of the long haul.

I’m trying to be more like Paul.

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