Commodity Crash Fans Fear

12/14/2015


While recent action in the Dow Transports is worrisome, for now we are maintaining a mostly invested posture. Our buy lists have 84% to 85.2% in stocks. As a partial hedge, the remainder is in a short-term bond fund.

More trouble

After OPEC, a cartel of petroleum exporters, met on Dec. 4 and decided not to trim production, the price of oil dropped more than 10% to its lowest level in seven years. Oil prices have dropped more than 30% since the start of the year — and more than 60% since July 2014.

Nearly all commodities have been caught in the downdraft, reflecting worries about excess supply and soft demand. Benchmark iron ore prices have hit their lowest level in more than a decade, while copper prices are near five-year lows. The Thomson Reuters/Core Commodity CRB Index, representing a diversified basket of commodities, has fallen 23% this year to its lowest level since 2002.

On balance, most analysts say, lower commodity prices help the U.S. economy, because the U.S. is still a net importer of commodities. In November, economist Daan Struyven of Goldman Sachs estimated that a 50% drop in oil prices should boost aggregate U.S. economic output by 0.4% and create 400,000 to 500,000 extra jobs.

But Wall Street worries that the recent price drop is more trouble than it's worth. For one thing, the energy sector had been one of America's few bright spots. Now it is shrinking, with big job cuts and sharp capital-spending declines in both the materials and energy sectors.

For another, the energy sector is expected to see a surge in debt defaults over the next year. As a result, investors are exiting high-yield bond funds in droves, making it tougher for lower-quality companies of all kinds to obtain financing. Historically, weakness in high-yield bonds has been a bearish omen for stocks.

Also, the commodity price collapse is adding to the pressure on resource-dependent nations in Latin America, the Middle East, and Africa. Already facing slowdowns because of the strong U.S. dollar and sluggish demand from China, many worry that 2016 will be an even tougher year for emerging-market economies.

Conclusion

Together, the energy and materials sectors represent less than 10% of the market value of the U.S. stock market. But the recent action of stocks beyond these two sectors has also been worrisome. The action of the Dow Transports, now threatening a breakdown below their August closing low of 7,466.97, has been especially discouraging.


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