Bull for President, Oil, and Fed Funds
by
Ross M. Miller
Miller Risk Advisors
www.millerrisk.com
June 7, 2004
This week, things become a two-ring circus. Rigged: The Novel of
Financial Deception makes its debut with Chapter 1 over at RiggedOnline.com
and here I will deal with some of the questions that have been directed at
me in response to earlier commentaries. (Navigation buttons on the
left-hand side of each page facilitate seamless navigation between the two
sites.) In particular, I look at the November presidential elections, how
hoarding affects the supply and demand of oil, and the probabilistic
mathematics of the Fed funds futures.
Let me begin by noting what a huge difference eight weeks have made to
the financial markets. When I started posting these commentaries, the
central concern of the markets appeared to be what would happen after the
November elections—it was taken as given that the
vast right-wing conspiracy would prop everything up until then to keep the
incumbent in office. Between the mess in Iraq and terror-influenced
Spanish election, the concern has shifted from what happens after the
elections to whether we can even survive until then. I have been
asked if I thought that a regime change in the U.S. might be a bad thing
for the stock market, so I'll begin with the quick answer to that
question.
If history is any indication, it does not matter which major-party
candidate wins the election. Indeed, from an economic performance
perspective, Democrats appear to have a slight edge. (Given the relatively
few "modern" elections, changes in political party make-up, and
the emergence of various third and fourth party candidates over the years,
I am wary of drawing any conclusions from this sparse data.) Furthermore,
legislative gridlock, which is extremely likely if the challenger wins,
may be the best of all possible worlds for the U.S. economy, though again
that may be reading too much into the data. A few analysts already take
the ousting of the incumbent as a fait accompli and given the substantial
evidence that a weak economy (and stock market) precedes any change in
administration, they figure that we are in for a rough ride. But this
argument may well reverse cause and effect. While incumbents are clearly
at an electoral disadvantage when the economy and stock market are weak,
it's not obvious that if the incumbent is vulnerable for largely
non-economic reasons that the likelihood of his being voted out of office
will hurt the economy or the stock market. Without wasting any more space
on this matter, my bottom line is that there are better things to worry
about.
Many people are worrying about crude oil, though the past week showed
signs of sanity creeping into the market. Beyond the still-remote
possibility of a supply disruption, there is a fundamental concern that
the demand for oil fueled by global growth, especially in China and India,
will outstrip the extractable supply, which some analysts (who invoke the
name "Hubbert") think may already have happened. Having
fastidiously avoided the myriad geology courses at Caltech because, to
paraphrase Evan Dando, I'm not the outdoor type, I'm the last person to
pontificate on the state of the world's oil reserves. I do, however, have
something to say about the immediate supply and demand situation.
When the financial media write and talk about the increase in the
demand for oil, they invoke images of the billions of people in China and
India suddenly driving SUVs and depleting the world's oil supply like the
last keg at an Aggies-Longhorns game. They ignore the fact that a good
chunk of the current spike in demand is not actually being consumed, but
is being hoarded either as a hedge against a future disruption in supply
or for purely speculative purposes. If you like to think in terms of
equations (and who doesn't), total demand = consumption demand +
speculative demand.
The other thing that the media like to play up is that oil producers
are already pumping at close to capacity and that they might have great
difficulty supplying more oil even if they wanted to. What they overlook
is that in the short-run the supply of oil can temporarily exceed what
producers can pump out of the ground by a large amount. This is possible
because yesterday's speculative demand (the stuff being hoarded) will
become part of today's supply as soon as prices start falling. Of course,
this added supply causes the price to fall farther and faster. Even if the
world has a long-term problem with the supply of crude oil, that does not
preclude a major rout in the energy markets in the short term.
The conceptual limitations of the financial media extend beyond supply
and demand and into the realm of probability. This past week as the Fed
funds rate implied by the July Fed fund futures hit 1.25%, certain
prominent financial media outlets stated that this meant that there was a
100% probability of a 25-basis-point (bip) rate hike when the Fed meets at
the end of June. Leaving aside the simple fact that there isn't a 100%
probability of anything, not even of the sun rising tomorrow morning (the
National Weather Service may bear some of the guilt for this 100%
misinformation—they round their numbers to the
nearest 10%, so a 96% precipitation probability becomes 100%), their math
is just plain wrong. What they fail to consider is that the 1.25% also
includes a real possibility of a 50-bip hike to 1.50%, which must be
balanced by a nearly equal likelihood of no rate hike at all as well as
the miniscule chance of a rate cut. Even now, with the futures pointing to
a rate of 1.27%, which the media interpret this number as representing a
100% chance of a 25-bip hike and just a 8% chance of a 50-bip hike, it is
still possible that the Fed won't hike rates, no matter what probabilities
financial media reports.
To the extremely limited extent that I am able to think like Alan
Greenspan (it makes my head hurt and gives me wrinkles), I am not sure why
he would want to raise rates this month. From his public statements,
Greenie thinks inflation is still contained. He could change his mind when
May's PPI and CPI arrive, but the latest revision of the CPE, a Greenspan
favorite, was encouraging. Furthermore, the economic growth and job
creation numbers are not accelerating and may even have peaked. Still, a
reasonable argument for a hike now is that the markets expect it and
Greenspan will not only get away with it, but would upset the financial
markets if he doesn't play the rate-hike card at the end of the month.
Furthermore, by hiking rates by 25 bips now and then again in August (this
is the consensus view of what constitutes a "measured" removal
of policy accommodation) he has more arrows in his quiver if there is a
"destabilizing event." (The conspiracy theorists out there see
the recent rise in the money supply as a sure sign that the Fed has
advance knowledge of an adverse event of truly monumental proportions that
is in the works.) Given that May's employment numbers were healthy, if not
up to the standards of March and April, I'm not willing to bet against the
Wall Street consensus, but it is just worth noting that whatever the
probability of June rate hike is, it is not 100%, not even by National
Weather Service standards.
One should feel uncomfortable about applying any notion of probability
to the actions of Alan Greenspan and his merry band of Fed Governors. They
are neither roulette wheels nor approaching storm fronts, but rather human
beings who presumably have some control over their actions or can acquire
that control pharmaceutically. Next week, I
will examine why only a fool would think that the world is ruled by
randomness in my commentary, "Rigged, Not Random," which, of
course, ties in with what is going on over at RiggedOnline.
Copyright 2004 by Miller Risk Advisors. Permission
granted to forward by electronic means and to excerpt or broadcast 250
words or less provided a citation is made to www.millerrisk.com.