Todd Harrison: Is Crude 2014 the Second Coming of Sub-Prime 2007?
The ramifications and reverberations of an oil crash are profound.
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"Oil is incredibly important right now. If oil falls to around $40 a barrel then I think the yield on ten year treasury note is going to 1%. I hope it does not go to $40 because then something is very, very wrong with the world, not just the economy. The geopolitical consequences could be - to put it bluntly - terrifying." Jeff Gundlach
The great debate these days surrounds the level of oil. The bulls will offer that it is a de-facto tax cut for consumers. They'll further posit that the stock market acts great despite the oil crash, so when oil stabilizes and eventually rallies, the tape will scream higher.
That could happen; we must allow for all outcomes nestled within the probability spectrum.
The "other side" to that argument is that crude 2014 is sub-prime 2007. While many will view that as a stretch, there are several striking parallels. Few folks--including the esteemed Ms. Yellen--foresaw the writing on the wall in 2007. Old school readers will remember the 2008 analogy, "buy the cancer, sell the car crash," that went something like this:
The credit crisis has already infected the economy, starting with the homebuilders, spreading to the financials, engulfing financials in drag such as General Electric (GE), General Motors (GM) and Ford (F) and will eventually phase through retail, technology, credit card companies and commodities. That's the orderly scenario, a stair-step through industries until debt is destroyed and a more sustainable economic foundation takes root. It's akin to credit cancer and once it spreads through our entire financial body, we'll be in a position to enjoy the globalization-themed "outside-in" recovery that awaits. The other option is an outright car crash, a collision where credit seizes, capital markets freeze, price discovery permeates and social mood shifts as we come to terms with the new world order.
Yes, we're talking apples and oranges here--to a degree-- but we can be sure the next crisis won't look like the last crisis.
The thing about 'proactive policy' is the unintended consequences and moral hazard it leaves in it's wake. The seeds of sub-prime were sewn by the policy response to the tech bubble. Alan Greenspan pushed the bar tab with hopes someone else would pick it up. Ben Bernanke did, and now it's Ms. Yellen's turn.
While crude is a different animal--an asset-class vs. an under-pinning--the ramifications and reverberations of an oil crash are equally profound.
There is the economic impact, starting with the drillers and rippling toward energy-dependent economies and industries.
There is the mechanical impact, with 15-20% of the junk bond market tied to energy. which matters in a leveraged, interconneted world.
And there is the socioeconomic arena, with Russia jumping out as a symptom of social mood the world over.
Entering 2015, I wrote that the single greatest trick the devil ever pulled was convincing the world that crude losing 50% in six-months was a good thing. Thus far, the Pavlovian response to ECB and FOMC rehtoric has trumped the discounting of any or all of the above risks.
In a few weeks, the ECB QE will be unveiled, or such is conventional wisdom, and the Greek elections will take place, which remains the biggest known bogie on the board.
The bigger question is whether crude is greasing the tectonic plates under our financial footing, unbeknownst to many paid to manage such risks.
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