Commentary on financial markets – November 2017
- US: excellent Q3 corporate results; D.Trump promises tax cuts
- OPEC oil cartel agrees to extend production curbs
Trading in European and US markets was markedly different in November. While the European stock markets lost ground, the American ones rose and the Dow Jones Industrial Average index surpassed the 24,000-point mark for the first time in history on the last day of November.
Although the European economy is strengthening and unemployment is falling, European stocks suffered losses mainly due to the difficult Brexit and post-election negotiations in Germany. Although Angela Merkel and her CDU won the election, her traditional ally CSU has so far refused to continue the coalition. Angela Merkel is trying to win the CSU to her side, but public opinion is calling for a new election, with as many as 45% of Germans now in favour of a re-vote.
US stocks were driven higher by companies releasing their Q3 earnings results. Approximately 3/4 of the US companies beat analysts’ estimates on the basis of net profit and 2/3 of them on the level of sales with their results. Companies are taking advantage of the current optimistic situation on the financial markets to IPO, i.e. go public. This year, 169 new companies have already been listed within the United States, 73% of which are trading above their underwriting prices. In addition, the tax reform promised by President Donald Trump is due to take place next year.
Oil prices rose in November due to expectations of an extension of the oil production cut agreement by the OPEC cartel. A meeting of cartel representatives took place in Vienna on the last day of November and, as expected, produced an agreement. The cartel will extend the production curbs for another nine months. However, the high US oil production does not allow for a higher oil price. US production is 9.65 million barrels per day, the highest in 30 years:
This time we take a closer look at oil for the first time in the investor school. At the end of November, the US record for daily production in the last 30 years was broken. Thanks to technological advances, it is now worth extracting oil from shale, even though it is more expensive to extract than from the oil sands. It is new technologies that are pushing back the ‘oil peak’.
In the 1950s, the American geologist M.K. Hubbart began to monitor the volume of oil produced in the USA and in 1956 predicted that the largest annual volume would be produced on American territory in 1970. His prediction was astonishingly correct; just one year later in 1971, US oil production actually peaked. Hubbart’s theory was based on the logical assumption that oil is a non-renewable energy source, the world’s supply is finite and gradually depleting. Only technological advances make it possible to find new reserves and extract oil from less accessible places, thus pushing back peak oil in time.
In the graph, the red curve indicates Hubbert’s estimate of oil production in the continental US and the green curve indicates the reality. Hubart really captured the essence of the problem and was able to predict the future very well. Of course, he could not have foreseen that technological advances would also make it possible to extract from oil shale, but his assumption that the total oil reserves on earth are limited anyway and that technology is only delaying the moment for us when oil production starts to decline still holds.
However, we humans today are very dependent on oil and in many areas of life: 95% of all food is grown with the help of oil, 90% of transport is made possible by oil derivatives such as diesel and petrol. And, for the record, it takes oil ten times its weight to produce a computer.
So countries fight each other for oil in the marketplace. Like any other market, it is a price war. On the one hand, rising demand, driven mainly by emerging markets, is pushing up the price, while in developed countries demand is falling slightly. On the other hand, the price is being pushed down by technology, which is increasing supply by allowing more efficient extraction and also extraction from oil shale.
While as recently as the 1990s the developed world consumed more than half of the world’s oil production, by 2025 demand from the developing world will be about double that from the developed world. Of course, it is difficult to predict what the next ten years of technology will do, but it can be expected that they will increasingly reduce our dependence on oil. On the other hand, the world population is growing (most in emerging markets) and technology is less available in the developing world because it is expensive.
So a prudent investor should have in his or her portfolio both stocks of companies that are building their success on technological advances, as well as stocks of oil producers or outright commodity funds focused on oil and other commodities that are limited in quantity on the ground. Only diversification can reduce the overall risk of an investor’s portfolio.