Oil : Has "peak oil" peaked?

The International Energy Agency (“IEA”) slashed its 2008 oil demand projections by 240,000 barrels a day and its 2009 oil demand projections by 440,000 barrels a day late last week. Clearly, we didn’t need the IEA to tell us that demand for oil has declined since the price of Oil is over $60 per barrel off its June 2008 peak based on WTI’s close of $77.99 on Friday. The obvious question is, where does Oil go from here?

We believe the longer term supply side argument remains intact. Despite the massive investment over the last five years in exploration, worldwide oil production has not been able to keep pace with demand growth, which ostensibly (along with a weak US$ and inflationary global monetary policy) drove the price of Oil well above its marginal cost. Nonetheless, it is likely that the “Trend” in oil remains lower, in the intermediate term.

In theory, commodities should be priced based on their marginal cost and we believe fundamentally that oil will trade back to that level of $60/$65 per barrel. There is also a case to be made that in a recessionary scenario and in an environment where investors are seeking liquidity due to margin calls, that oil overshoots to the downside.

As oil and other commodities decline, many opportunities will arise that you should be proactively focused on. Howard Penney has been discussing on his portal, and in our morning meetings, the potentially massive benefit on year over year cost comparisons for restaurants. Other industries that are key beneficiaries to declining energy costs are airlines, chemicals, and energy intensive manufacturing industries like paper and packaging, etc…

Attached below are our new levels for Oil:
1. Friday’s closing price of $77.99 is immediate term “Trade” oversold
2. Oversold bounce resistance to be sold into = $90.88
3. Downside “Trend” (intermediate term) target = $71.57

Daryl Jones
Managing Director
Chart courtesy of

State of The Consumer II: Numbers Don’t Lie

By my math, the year/year deficit in consumer spending in 2009 rivals the size of the US apparel/footwear industry in its entirety. Here’s how I get there…

Seems rough out there for the consumer, huh? I’m really sorry to say this, but you ain’t seen nothin’ yet. I know this seems like my typical ‘doom and gloom, margins are going away’ rant. But I spent the better part of this weekend going through the math. Many people don’t realize this, but real consumer spending is actually trending up yy. My model suggests that discretionary spending will finally turn negative in 1Q09. This would be the first time in 66 quarters consumer spending will have gone negative.

I think we’re also looking at discretionary spending down about $170bn next year. The icing on the cake is that the yy delta (prior year’s increase less current year’s decrease) is tracking close to $245bn. As a frame of reference the entire apparel and footwear retail industry is about $300bn. I have a one word answer for this. BANKRUPTCY. I outlined my list of bankruptcy candidates several times over the past few months. But that list is growing. I’ll be back with more meat on the bone there shortly.

I realize that I’m not the only person that has a detailed consumer model. So let’s take a look at some key assumptions, and you can come up with how you’d tweak it one way or another.

1. Gross personal income reflects a 7% unemployment rate, which takes total income growth down by 400-500bp sequentially over 3 quarters.

2. Zero change to the personal tax rate, which averages at 12% across the US.

3. Sub-1% savings rates is unsustainable given negative wealth effect from state of housing and equity markets. (Check out my prior post).

4. Personal interest payments head higher by 0.1% per quarter due to higher debt levels and interest rates.

5. Oil stays at $80, and gas/distillate stay at current levels. YY comps get easier in 4Q.

6. We went through all consumption categories we deem ‘Essential’ such as food, medical, housing, etc… and input growth forecasts based on my fellow analysts’ assumptions.

Tweaks to the many assumptions in our model would alter the $245bn yy delta in spending (2.5% of consumer’s wallets). But even if the geniuses at the Treasury, Fed or in the new political regime find a way to cut it in half, that would still represent 40% of the apparel/footwear retail space.

State of the Consumer: History 101

One thing I’ve learned at Research Edge is how to be a student of history, and understand how the sins of the past shaped the challenges we face today. The evolution of the wealth effect is classic.

One of the biggest drains on the consumer today is the fact that the personal savings rate is hovering near zero. Yes, we debate academically as to how it is calculated, and how it could technically go below zero (which it has). But let’s look at the big picture here. The chart below says it all.

1. Starting in the Regan/Volcker years and all the way through the end of the Clinton era (when the tech bubble burst), we had a 20-year uber-bull market for equities driven in part by systematic cuts in interest rates to drive consumer spending and keep the economy cranking forward.

2. Once we saw George W. come into office, the equity markets took a pause, but the housing market went parabolic.

3. Put those two together and what do you get?? What I’d consider a 27-year wealth effect. By the way, that’s within 5 years of the average age of a Wall Street analyst. Sad.

4. While this freight train rolled on, the consumer took down the savings rate from the peak of 11.2%, to less than 1% today. As a frame of reference, China’s savings rate is near 40%.

5. Now what? Housing values are deflating, and equity markets do nothing but go down. My sense is that consumers take whatever they can and actually save a bit for once. In fact, it was fascinating to see that the tax rebate checks that hit this summer went almost entirely to beef up savings (the rate temporarily bumped to 2.5%) and repay debt.

As sure as the sun will shine, this savings rate needs to head higher. The order of operation will need to be 1) survive (buy essentials, etc…), 2) pay down debt/save money, 3) buy a $500 cashmere sweater at Saks.

NKE: Ultimate Pricing Power

Nike has taken ‘surgical pricing’ to the tune of 5-10% -- but the 5,000% increase on a new Nike Dunk takes pricing to a new level. $5,405, and dipped in gold. A better return than being levered long.

Eye on Free Market Capitalism...

555 12th Street NW, Suite 620 N, Washington, DC 20004

October 9, 2008

Capitalism Without Guilt: The Moral Case for Freedom

Who: Yaron Brook, executive director of the Ayn Rand Center for Individual Rights

What: A talk defending the profit motive and presenting the moral case for laissez-faire capitalism. A Q&A will follow.

Where: National Press Club, 529 14th Street NW, Washington, D.C.

When: Wednesday, October 22, 2008, at 6:30 PM

The public and media are invited. Admission is FREE.

Morgan Stanley (MS) confirms their clients have a say...

In our 9/17/08 note (Morgan Stanley (MS): "Rumors and Fear"), we called out the obvious that John Mack's blaming of the short sellers for his stock price decline was ridiculous and alarmist all at once. Prime Brokerage clients (hedge funds) don't like to be blamed for being the customer, nor do they appreciate having the CEO of MS engineer a short selling ban alongside his cronies at the SEC.

The result of his reactive behavior? Here's what MS disclosed on this front in their 10Q this week: "Subsequent to August 31, 2008, the company’s prime brokerage business experienced significant outflows as clients withdrew some of their cash balances and reallocated positions. These outflows will negatively impact prime brokerage’s operating results in Q4 of fiscal 2008."
  • Our price target for MS moved down a penny from Thursday. We're now at $9.02/share.
(Chart courtesy of

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