It was a very important week as OPEC agreed to a framework for a production deal to be finalized this November. This deal would stabilize oil prices above $40 per barrel which could lead to prices moving above $50 per barrel once supply/demand comes into balance and global inventories fall.
Saudi Arabia capitulated on its strategy of over-producing in an attempt to drive down prices and put the marginal producer out of business as their way to control future prices for decades. Unfortunately, one the biggest victims of this strategy was Saudi Arabia itself. The country and its OPEC partners went into huge fiscal deficits, cutting services and wages for its people which became untenable. The region was operating at over a $35O billion fiscal deficit with prices below $40 per barrel and foreign reserves depleting rapidly. Something had to give.
Whether the deal was to cut production 1 or 3 million barrels per day was not the story. Rather it was that there was a mindset shift in one of the most visible commodities in the world, which will have a ripple effect in other commodities. There will be a shift in how we view future inflationary expectations as well as future corporate profit growth. Remember, S& P profits have been flat to down for a few years due solely to sharp declines in energy and industrial commodity prices and earnings. Even a flattening in profits in these sectors will lead to 6-8% growth in S & P earnings next year, but I expect much more.
This event also represents an inflection point regarding inflationary expectations. It ended fears of deflation while changing the dynamics of pricing in other commodities. There is a mindset shift occurring. No longer will the buyer control the marketplace, as has occurred over the last few years. The Fed may be right after all, that low energy prices are transitory but the upside in oil prices is limited too as shut-in production and incremental new drilling will occur as prices move into the mid 50s per barrel. This will not happen overnight but this event will represent a major inflection point for future inflationary expectations and profits.
The investment ramifications are clear. This event reinforces my belief that we are at the beginning of a surge in corporate profits led by the more cyclical components of the economy. Remember, I am looking for global fiscal easing on top of continued accommodative monetary policy over the next few years. Add to that improved pricing power and you end up with a surge in corporate profits. I would expect an increase in corporate borrowing to fund more normal inventory levels, a steepening in the yearly curve and an overall acceleration in global economic activity. There will be a mindset shift in business as well as by consumers caused by all of these events. No longer can you wait to buy for less. Notwithstanding Inflation will stay contained by the competitiveness of globalization and the rise in the "disrupters."
Right now you have the best of all worlds: the beginning of fiscal ease on top of continued monetary ease to stimulate global growth; the prospect of rising volume and pricing with cost containment leading to a surge in profits; low nominal and real interest rates; a skeptical investor with record cash levels with historically low levels of equity investment and the beginning of a major mindset shift by businesses and consumers alike.
The new winners will be the past losers and vice versa. Don't own bonds of any duration. Paix et Prospérité excels during periods of change such as this and we have outperformed the averages by well over 100% in the third quarter and year to date. I expect our best absolute and relative performance is yet to come. We will stick with best in class with specific plans to grow volume, cash flow, invest in the future and are shareholder friendly. Companies for all seasons.
All European banks are unable to make money due to the negative rate policy of the ECB. Deutsche Bank is not a Lehman Brothers or a Bear Stearns. It will not create systemic risk as it is not the lack of liquidity that is the problem. It is the poor operating profit environment for all European financials.
The Presidential Race
Finally, I truly wish both nominees would focus on their economic policies and plans to reinvigorate the U.S. economy. We need to change the tax code, reduce regulation and red tape, promote fair trade and raise the standard of living for all. I don't want the status quo to be the best we can do. I want real change from top to bottom.
Remember to review all the facts; take a powerful pause and reflect; consider the proper asset allocation, risk controls and mindset shifts; do in-depth independent research on each investable idea and... as always, Invest Accordingly!
William A. Ehrman is managing partner at Paix et Prosperite LLC.