Economic Update - January 2015

It was an interesting end to 2014 with oil prices down as much as they are.  Almost nobody would have guessed just 6 months ago that crude oil would be near $50 per barrel.

We must be clear on what lower energy prices mean.  It is a benefit to the consumer, as it costs less to fill up a gas tank.  Let’s just hope that most Americans use this benefit to pay down debt or add to savings, instead of finding something else to spend it on.

The reason I say this is because, first of all, it may not last for long.  Second, it could be a sign that a recession is coming.

I understand that the lower prices may be partially due to higher supplies, or higher expected supplies.  But it seems likely that weakening demand is also a major factor.  Japan and much of Western Europe are already in recession or worse, so this would make sense.  The big question is whether there is weakening demand in the United States.

We shouldn’t confuse cause and effect here.  Lower oil prices won’t cause a recession.  Instead, they can be a warning sign of a looming recession.

There may be some oil companies and investors that lose a lot of money.  Maybe some people will lose jobs.  But this isn’t the point.  The point is that oil was a bubble that has popped.  Like most bubbles, we can assume that central bank monetary policy probably played a role in the bubble in the first place.

It just so happens that a popping oil bubble is good for most Americans because of the benefits of lower energy prices.  It won’t be good when other bubbles pop, particularly the bubble in the stock market.

The Fed has had a tight monetary policy since the end of October, despite the continued low interest rates.  The monetary base has leveled off.  This is going to lead to a bust at some point, especially if the Fed keeps a neutral monetary stance.

Long-term interest rates continue to stay low.  The 10-year yield is down to about 2%.  A flattening yield curve, even if not inverted, is another sign of a possible slow economy.

I continue to advocate a good majority of financial investments be in a permanent portfolio setup.  Even with interest rates low, the 25% in long-term government bonds is important due to the possibility of another recession.  Rates could go even lower, driving bond prices higher.

I am not saying that a recession is imminent, but I am saying it is a decent possibility.  You should be prepared.  Most people weren't prepared for what hit in 2008.  You should be prepared financially and mentally.  If you know what is coming, or at least know what is possible, then you will likely adapt easier when it hits.