By Daniel M. Ryan
It isn't only certain controversial substances that people become habituated to. The investment world shows quite clearly that people become habituated to trends. As a bull (or bear) market continues longer and stronger, the more normal it seems – and the more it's taken for granted. This habituation explains why the most notorious feature of business cycles – credit cycles – proceed the way they do.
It's nice to believe that prudence, tolerance of uncertainty, and consequent aversion to going out on limbs is reinforced by careful study and attentiveness to the past…but in the real world, it's reinforced (and attenuated) by memory and experience. Although the adaptive-expectations model has been superannuated by the rational-expectations one, there was a certain glimmer of sense in the former model. Unfortunately for modelers, there's no way to work in a function that maps to castles in the air that suddenly seem buildable when the trees seem to grow into the clouds.
As election season heats up, there's been more attention paid to the price of oil, even though the high price of petroleum products has been a recurrent item all through the year. About seven months ago, when a barrel of West Texas Intermediate fetched about $95/barrel, I wrote that oil was in a bubble. The 25% test I used, to come up with what would be an overoptimistic forecast in normal times, wound up looking unduly conservative as of Canada Day. That same barrel of oil reached over $145 US shortly afterwards, making for a greater than 50% gain over the last six months.
An accelerating rise in the price of any investment, or speculative instrument or commodity, tends to froth up people who imply that prudence is no longer in fashion. In the case of equities, the usual trend-surfer is the person who claims that old-fashioned valuation measures are plainly obsolete. It's been long known as the "New Era delusion." At the end of the multi-decade bull market, as of about 1999, it was claimed that the old P/E ratio measure was obsolete because it did not account for earnings growth. Nowadays, there's a kind of New-Era saw with respect to the bond market, which has arguably been in a multi-decade bull market since about 1981: the current negative real rates that bondholders are enduring are not that bad, because inflation won't be a real problem until a wage-price spiral takes off. Since there isn't one in the offing, there's no need to worry over the fact that the 10-year U.S. government T-bond's yield (about 3.95%) is lower than the current rate of U.S. inflation (5.0%.) This kind of New-Era'ing, which ironically draws on the old Keynesian assumptions that prevailed in the swing(e)y ‘60s, suggests that March 21st's multi-year bottom for its rate (3.39%) marked the end of the U.S.-T-Bond bond bull. (Data used in this paragraph comes courtesy of the Bureau of Labour Statistics, the Federal Reserve, and Yahoo! Finance.)
With commodities, though, there's a curious inversing of the New-Era rose-colored glasses. Commodity bubbles, especially wild bull markets in oil and precious metals, tend to result in prognostications about a "New Era of Scarcity." Oil bubbles amplify the popularity of declinists, such as this fellow who doomstered back when oil had sliced through $110/bbl. Commodity bubbles' New Era thinkers predict mass shortages and global starvation. And, of course, the precious metals' New Era prognosticators predict hyperinflationary collapse…some with anecdotes from previous hyperinflations which vary in salaciousness content.
The most popular New-Era doomstering, of course, comes when oil is on a tear. Oil and geopolitics are intermingled, and forecasting geopolitical troubles is always a good draw. Consider the current scare story floating around, which had an effect on the price of oil last Friday: Iran may be close to nuclear capability. Interestingly enough, though, this item pushed up the West Texas Intermediate spot price by only $1.02 for the entire day. It closed just above $125/bbl, or more than twenty dollars below its all-time high. (Data gotten from Bloomberg's spot oil price list.. All oil prices given here are in U.S. dollars.)
America's position is both better and worse than in the days of old. The American consumer is far more price-flexible than back in the olden days when petroleum products were highlighted in economics textbooks as the epitome of a price-inelastic commodity. Estimated demand for petroleum products dropped slightly in 2006, and didn't rise in 2007. As for this year, there's a lot of indirect evidence that demand is back in decline mode. Try trading in a SUV for a subcompact (or a motorcycle or motorscooter) and you'll see it.
The worse part, though, comes from the emergence of Asian economies, particularly China's. In that region of the world, demand for petroleum products is still growing at a fast clip, although the Chinese government's recent decision to stop subsidizing petroleum products should cut into that rise. So should an anticipated Chinese growth slowdown, if that anticipation is correct. Globalization, salutary as it is in general, has made national conservation efforts less effectual in dropping oil prices.
Although geopolitical disasters do happen, it looks like the big near-decade bull market in oil is going to be derailed until inflation becomes more serious a problem. If so, then American life and consumption patters will return to normal – and various plans to cope with sky-high petroleum prices will fade to the back burner. This fade-away will include the proposals to open up the ANWR reserve to drilling.
It will also affect the current pushes towards alternate energy. Unfortunately for its proponents, alternate energy has yet to shake off the alarmism which kick-started the field. That's why returns to energy normalcy usually turns long-term "energy independence" plans into short-term fashions. Like gold bulls, alternate-energy proponents will still have to keep dancing with the gloomsters that brung ‘em.
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