The Impact of Plunging Oil Prices On The Financial Markets



Jed Clampett: Listen to the story about a man name Jed. A poor mountaineer barely kept his family fed. An’ then one day, he was shooting at some food. An’ up thru the ground came a bubbling’ crude. Oil that is! Black gold! Texas tea!

David Scranton:  Welcome once again to The Income Generation. The show where we focus on financial topics and information relevant to today’s generation of retirees and near-retirees. Information to help you sort through all the hype and confusion out there and to help you make educated decisions about your financial future. I’m your host, David Scranton.

Now if you’re part of The Income Generation which basically means you’re over age 50, then you probably got just a little bit nostalgic watching that clip at the top of the show. But we didn’t open today show with Jed Clampett just for the sake of nostalgia. We did it as a fun way to highlight the topic that’s going to dominate a lot of our discussion for the next hour. Hillbillies, no not Hillbillies, I’m talking about oil black gold Texas tea. You certainly don’t need me to tell you that oil is a very big topic of discussion in the news these days. And it’s always been to a certain extent, but since the first of the year probably only the presidential race has grabbed more headlines and gotten more attention than oil. Why? Because the impact of plunging oil prices on the financial markets is more dramatic than anything we’ve seen in years. Naturally, the oil industry has a long history of booms and busts but by some estimates, it’s now in the deepest downturn since the 1990s if not earlier. The reason is simple. The price of a barrel of oil has fallen by more than 60% since June of 2014. Meanwhile, the stock market had one of its worst beginnings of the year in the month of January in history. With record levels of volatility and the S&P 500 plunging by more than 6%, obviously there are a lot of different things influencing the markets right now, but most analysts have pinpointed the oil situation as a major cause of investor nervousness. So how long will this last will oil be the cause of the next major market crash? Is this current situation just another temporary downturn, or is it something more permanent for the oil industry? Something, that might just possibly have major long-term repercussions for both investors, as well as the global economy, those are all big important questions. And I can’t think of anybody better qualified to talk about them, than our guest today, Gary Sernovitz.

Gary Sernovitz: So we are clearly dealing with, in the oil business a source of supply at a cost and at volume and at responsiveness that no one ever thought was imaginable.

David Scranton:   Rusty Braziel.

Rusty Braziel: Prices will go up, back up either when demand response and demand increases or when supply drops. So a lot of what folks are waiting these days for is when and if supplies are going to drop, and presumably that would increase prices back to maybe not where they were, but certainly above 30 or $40.

David Scranton:   Oil has been called the lifeblood of the global economy. And that’s a fairly accurate description. It’s also been said that oil and finance have proven themselves to be the only two industries able to topple the world into an economic recession. That’s also fairly accurate. If you watch this show in the past, you may have heard me talk about my concerns about deflation and how a deflationary spiral could trigger a new resection here in the United States. Well, I believe you can make the case that Wall Street’s worries over oil prices right now are at least partly a sign that the financial markets are worried about deflation also and ultimately about a possible recession. In fact, not long before we recorded the show. A new report shows that US companies are growing more and more concerned about the possibility of recession in the coming year than any time since 2009. According to this report, the number of CEOs who’ve mentioned the word recession is up 33% from a year ago. Slow GDP growth in the last quarter of 2015 is partly to blame. But the bigger concerns side in the report was you guessed it, oil. Companies and shareholders are increasingly worried that the steep drops and energy prices and layoffs in the industry are going to bleed into the larger economy. Since the current downturn began an estimated 250,000 oil workers have lost their jobs. Keeping the big picture in mind the irony in all of this is that cheaper fuel really should be a good thing for the global economy in the long run. As one recent article put it cheaper oil should act like a shot of adrenaline to global growth, in fact by some estimates the current price cut with oil down around $30 a barrel or so, shift some $1.3 trillion from producers to consumers. And if this continues, the Bank of America Merrill Lynch estimates, it will set the stage for one of the largest transfers of wealth in human history. Shifting some $3 trillion a year from oil producers to consumers but again, that’s just one potential long-term outcome. Only time will tell if it plays out that way or if oil will eventually return to 90 or $100 a barrel. That’s the level at which had been pretty much the norm over the last decade. And we’ll talk more about that later with Gary Sernovitz. Either way, the current situation is a questionable one with a lot of uncertainty and a lot of potential risks for investors both large and small. So if you’re retired or near retirement, if you’re part of The Income Generation, you need to understand those risks and that starts with understanding just why the market seems more focused on the downside of cheap oil than on the potential economic benefits. Why they appear more worried about deflation despite the fact that cheap oil is giving consumers more spending money. So that’s my focus on today’s market breakdown.

If you do any research on the following question, you get a lot of conflicting answers. And that question is; what is the relationship between oil prices and the stock market? Well like anything related to the financial markets, and the economy. It’s a complicated issue there is no single simple answer. In fact, you could make the case that what’s going on right now makes no sense at all. Why? Because of the simple theory that if oil prices fall the market should celebrate because it means consumers have more discretionary spending money and that should be good for the economy. As I said in my opening that may be a long term outcome but it isn’t what’s happening right now. Right now there is not an inverse relationship between falling oil prices and rising stock market, but a parallel relationship instead. As oil prices have plunged so has the market, but that’s not completely unusual either. Historically the markets do sometimes rack negatively to falling oil prices and there are some tangible reasons for this and emotional reasons as well. And I’ll explain both in today’s market break down. The tangible reasons are pretty simple to understand. Basically it’s a domino effect. The oil industry looms very large in the financial markets in as oil companies profits have plummeted Oil Company shares have also plummeted.   And that’s played a big part and dragging down the stock market as a whole.   There is also a lot of leveraged debt within the industry which makes matters even worse. When oil prices were high many banks, including some of the biggest on Wall Street loaned energy companies money for drilling. And a lot of them have since had to set money aside to cover potential losses. It is estimated the oil and gas industry has about $500 billion and outstanding debt. But as I always stress market performance is based more on emotion than on hard numbers. It’s driven mainly by fear and greed and we’re seeing much more the former now than the ladder and here’s why I think that is. One reason that oil is typically seen as an indicator of the economy is simple. Most goods and services are delivered to their end retailer by cargo planes by ships or trucks all which run on some derivative of oil. Therefore when global demand for oil starts to decrease, it is one indication that global demand for goods and services is also decreasing. Of course, the real indicator of that is whether or not our GDP gross domestic product has increased or decreased. But the problem with that is that those numbers typically aren’t available for weeks after the quarter has ended. So meanwhile the financial markets may view what’s happening with oil prices as an early glimpse of a poor GDP report. I believe another issue has to do with speculators and oils traded. You see in the stock market overall, most people don’t short stocks at any given time in the stock market, you might have 90% investors who are buying long and maybe only 10% who are shorting the market. But oil has traded in the futures market and by definition for everyone, taking a long position. There’s Also, someone taking a short position. This effectively creates a 50/50 balance between longs in the shorts. And because there are more pure speculators and oil market taking short positions. It means that downside swings within the market are much more heavily weighted. When things start to slide, the oil market speculators may start taking equity in their futures accounts to short more and more and more, similar to doubling down in the casino. The bottom line is that when things start to slide in the futures market they can slide a lot further and a lot faster than the stock market overall. As we’ve seen recently. So why are there so many speculators shorting oil right now? Well, part of it may have to do with the unusually mild winter we’ve seen so far and much of the country. Typically oil companies’, means retail home heating companies go long on futures early in the year because they want to lock in a price. But if it’s been a warm winter, they may be in a position where they don’t want or don’t need to take delivery of all that oil that they’ve pre-ordered. In that case, they may be opting to reverse these long futures positions by buying short. In essence, this negates the transaction and the oil company locks in the loss. Now they would have taken the same loss, even without negating the transaction, but at least this saves them from having to take delivery of a lot of oil that they don’t have room to store, and their customers don’t really need. And that brings up another point by most accounts the main reason oil prices are so low is simply that supply greatly outweighs the demand right now. In the United States advanced drilling technologies, namely Fracking have helped cause a huge glut. In fact, the United States has added more oil to the global market than the total production of any country and OPEC beside Saudi Arabia. The International Energy Agency predicts that global oil supply could outstrip demand by 1.5 million barrels per day. So combining all these factors, a huge oil surplus, speculative shorting the price and the potential implications of falling prices for the GDP, you can start to understand why the market seems so fearful. You can understand why they appear less optimistic about cheap oil, helping to trigger inflation, instead more worried about it being a sign of deflation. Adding to those worries are some of the historically unprecedented factors I’ve talked about on previous shows, mainly the lingering effects of six years of quantitative easing. Remember quantitative easing was supposed to help spur the economic recovery by giving people incentives to spend and borrow money. How? By giving them low-interest rates in a thriving stock market that made them feel wealthy, but it didn’t work that way. Regardless of those incentives, a lot of Americans have opted to focus on saving and paying down debts over the past six or seven years. So if Americans weren’t motivated to spend by low-interest rates and a climbing market Wall Street may now thing low fuel prices aren’t going to do the trick either. At least not anytime soon, and if that’s the case, then deflation is a very legitimate concern. Now, you certainly can’t blame consumers for any of this. You’ve experienced two devastating stock market crashes in the last 16 years. You lived through the collapse of the housing market in the worst financial crisis in the country since the Great Depression.   It’s understandable and sensible that you be cautious. It’s even more understandable if you’re aware of another important factor connected to what’s going on in the markets today and this is stock market history. As I’ve talked about before history indicates that the stock market is long overdue for another significant drop. This would be the third drop of this long-term secular bear markets cycle that started back in the year 2000. Add that to the fact that all the market instability is being blamed on oil right now and this situation seems ever more unstable. Here’s another simple fact, you should know. The 2009 report demonstrated that nearly every stock market crash and resection of the last 50 years has occurred shortly after the large and abrupt change in the price of oil in many cases the cause and effect were just as I explained. The markets interpreted the price change as a sign that demand for goods and services was dropping and that recession was on the way. What’s more, there has only been one other time in history when the price of oil has crashed by more than $40 in less than a six month period. That was during the second half of 2008 at the peak of the financial crisis. So getting back to my original question, what is the relationship between oil prices and the stock market? Well, again, it’s complicated, but clearly, there is a relationship and only time will tell just how current one plays out.


Welcome back. I’m here today with Rusty Braziel, who is the CEO of RBN energy and also the author of the new book entitled The Domino Effect. Rusty, welcome to the show.

Rusty Braziel: Thank you, David,, good to be with you.

David Scranton:   Oh, good to have you. First of all, your book The Domino Effect covers an in-depth analysis of both natural gas and crude oil and how oil prices become affected by market factors. Let’s start there so our audience understands the factors that play in the industry.

Rusty Braziel: Right, of course, it’s all about supply and demand right, so when supply is too high. If it’s more supply than the market can absorb, prices go down prices will go up, back up either when demand response and demand increases or when supply drops. So a lot of what folks are waiting these days for is when and if supplies are going to drop and presumably that would increase prices back to maybe not where they were, but certainly above 30 or $40.

David Scranton:   Now some of this, of course, is on the demand side and there’s been a lot of publicity lately about the supply side being problematic. The fact that especially Saudi Arabia keeps pumping oil but the demand side also has a recent report just about a week ago that said that OPEC is actually predicting a reduced demand for oil products. So how much of this do you think is demand side versus supply side?

Rusty Braziel: Well I, you know, I would say it’s 75 or 80% supply side and 20% demand side. So what’s happened over the past few years is that United State shale production has increased substantially. 5 million barrels a day or so because of all of that increase in supply for at least some period of time, there was enough increased demand in the world to absorb it, most coming from China. When the Chinese economy started to slow down and US production kept increasing that’s what finally pushed oil prices over the brink, if you will, and drove prices down below $30.

David Scranton:   Now it’s interesting because that the demand side argument has been China as you just mentioned. But the other part of it is that a lot of people speculated that the reason that oil prices are dropping in part is because it’s a symptom of some type of deflation that seems to be right around the corner, any thoughts on that?

Rusty Braziel:  I don’t, I, I’ll be honest with you. I’m not an expert on inflation and deflation. I think I’m an expert on Oil prices and oil markets and what’s going on in oil markets is in fact not surprising at all, as you said, the book is about, both natural gas it’s also about natural gas liquids propane and butane that are also big parts of this market. So six or seven years ago, shale phenomena that what we call the shale revolution in the United States came to natural gas. When it came to natural gas, natural gas prices crashed and they’ve stayed low ever since. For a few years producers started to shift their drilling budgets to drill for what’s called wet gas. Wet gas contains lots of natural gas liquids, propane’s and butane’s and in production increased for those commodities for a few years. And guess what happened, exactly the same thing production increased and prices crashed it was just inevitable that the exact same thing would happen to crude oil that’s what has happened. So in other words, this is not anything surprising or anything new. And that’s what the book talks about the fact that this is all happening for a series of reasons and those series of reasons can not only be understood. They can be predicted.

David Scranton:   Great, how much of this do you think has to do with how speculators deal with oil, referring to the recent price drop you know, it’s interesting, the stock market which you choose more the side I usually focus on in the show. The stock market is you know, most people 90% of investors are so are long and stocks very few people are actually short. But the oil markets and the way it’s traded in the futures market as you well know, for every person long there has to be someone short and as a result when you’re full Chrome is right in the middle. It seems like if something gets out of whack by just a little bit. It can have a more profound effect. To what degree do you think that plays in with the degree to which we have seen recent volatility and prices?

Rusty Braziel:  It’s been a big factor. So what was happening back about two months ago, up until maybe three weeks ago, was that every bit of bad news came into the market and most of the news that was coming into this market was bad, very high inventories, Saudis pumping more, Iran coming back into the market the shorts got into the market and pounded it down. So the market never would should have really dropped based on fundamentals down below $30 down to 26 bucks never should have happened that way, but it was the shorts that basically caused the market to overreact. Then we when we started getting a little bit of good news. When we started to see the noises being made from OPEC and Russia about the possibility of some sort of deal when we started to hear a little bit of good news about demand, then the shorts got spooked they closed out their positions, made a lot of money by the way, and prices started run back up as they close those positions out. So a lot of the exaggeration that we’ve seen in the market, not only driving down below 30 but frankly right now driving back about 40 it’s happened because of those financial players.

David Scranton:    You know with, fracking and with shale, you know, how much more capacity do we have as a country? How close are we in your professional opinion to becoming energy independent?

Rusty Braziel:  That is a very hard equation to calculate because energy independent, well doesn’t include gas, natural gas. Does it include natural gas liquids, is it? Are we only talking about crude oil? Now we’re exporting crude oil.  The reality is that we’re still importing a significant amount of the crude oil that we use. A lot of that crude comes from Canada. So are we going to say that we’re going to stop importing crude oil from Canada? That’s pretty unlikely if that’s your definition of energy independence. So the real answer to it is that if you include all of North America and if you include all hydrocarbons. We’re not far away from energy independence right now. But if you’re only talking about crude oil and you’re only talking about crude oil that we produce in the United States and that’s your definition of energy independence it’s a long way away.

David Scranton:  Okay you think, as final question do you think we’re closer on the oil side to that energy independence or closer on the natural gas side?

Rusty Braziel:   Oh, natural gas, we’re already there and the first cargo of liquefied natural gas left Shiners Doc, just a few weeks ago. There’ll be a lot more liquefied natural gas being shipped out of the United States, we can produce more natural gas, in the United States that we can use, as a matter of fact, we’re doing that right now and that’s the reason prices for natural gas are as low as they are. So we’re already there on natural gas. We’re already there on natural gas liquids, propane, and butane. Only crude oil is the commodity where we’re still importing significant barrels.

David Scranton:   Rusty it’s been great, I’ve learned a lot. I thank you very much for being on the show today.

And go out and purchase The Domino Effect. You know to me this concept of energy independence is so important, I’m surprised it’s not even more of a political hot topics in the elections, which we’re looking at right around the corner. Stay with us. We’ll be right back.

Welcome back to The Income Generation. I’m here with Gary Sernovitz, he’s Managing Director of Lime Rock, which is a private equity firm focusing on oil and gas. He’s also the author of the new book entitled Green and Black. Gary, welcome to the show.

Gary Sernovitz:   Thanks for having me, David.

David Scranton:   It’s a pleasure, you know, your book I know talks a lot about shale, fracking and the future of energy in general. But before we get to that, I want to talk about oil prices in your professional opinion, what the heck has been going on with oil prices over the last several months and why?

Gary Sernovitz:   You know what well I always tend to think of the oil price and the shale revolution as pretty inextricably twinned. If you think about, you know, Saudi Arabia is given a lot of the credit for sort of, you know, causing the collapse in oil prices 18 months ago and that Thanksgiving in 2014. But they were really responding to the huge really unprecedented and almost unimaginable kind of increase in production from the US due to the shale revolution. So we are clearly dealing with, in the oil business, a source of supply at a cost and at a volume and responsiveness that no one ever thought were unimaginable. And so what are happening now as the markets dealing with a very natural process of absorbing this, you know, oversupply and the businesses restructuring it totally.

David Scranton:   That’s the supply side, but there was a report that came out recently by OPEC which actually projected that they see the demand for oil actually decreasing. So I guess my question is, how much of this do you think is a supply side over abundance versus a decreasing demand?

Gary Sernovitz:   I think it’s almost all historically over the last year and a half, about supply. Last year you actually had demand for almost 2% which was a pretty stunning increase in demand of which oil usually grows about 1 to 1.2% a year. This year I think OPEC like everyone else thinks you know oil is going to return to its more normal sort of demand growth of about 1%. So you know so I think the deceleration of demand is more of a return to normalcy rather than anything unusual and people should expect oil to grow kind of 1, 1.5% over the next, you know, kind of foreseeable future. But the US over kind of 2011 2012 up to 2014 was actually growing its own supply more than global demand was growing, which was which is obviously unsustainable if the rest of the world wasn’t restricting production in some way.

David Scranton:   Okay, now on the demand side. Do you see that the drop in the price of oil is being some kind of symptom of deflationary pressures worldwide?

Gary Sernovitz:    I think it’s really, you know, my view and obviously you can have a lot of experts and they’re going to have a lot of different views. I think my view is the price of oil is really related to the specific outcomes of the shale revolution and the US finding a way to extract oil and gas in very at, you know, really increasing technologically driven low cost on a, you know, every month the wells get better and better and cheaper and cheaper. So I think while you have, you know, sort of a global phenomenon of commodities declining based on sort of the onetime effective China, you know, kind of going away, really, when you look at oil. There’s a lot of very specific oil industry factors that are probably as much of a cause is sort of the more global, you know, kind of issues.

David Scranton:   Okay, I’m asking now to go back for a minute to your days at Goldman when you were an oil stock analyst. And the question is, as you know, you know, stocks in general, there are probably nine people who are long stocks for every one person that’s short the stock market. But oil is different because oil is traded in the futures market is a commodity by definition for every person long there’s a person short. So it seems to me that when the supply and demand factors, get out of whack. That means the price of oil can be a lot more volatile than even the price of stocks, for example. What are your comments on that?

Gary Sernovitz:    Yeah, I mean, I think the, you know, the comical thing about, you know, the oil futures is they’re almost always wrong. I mean if you look at the last five years where the oil futures were trading five years out. They have been wrong as much on you know to below as too high is too low. You know, every year. So, wow, the market, you know, is efficient in some theoretical way and what the futures in five years is the price you can sell or buy in the case of the futures market. It’s actually not historically a great predictor of what actual oil prices are going to be in the in the next five years. That’s clearly a result of a lot of people using, you know, oil futures as a way to trade, you know, on global economy on dollar strength as a way to hedge stocks or bonds. So you’re absolutely right and sort of that’s you know that does a, you know the speculation does play a role in how prices are set.

David Scranton:   Absolutely. Now we are in the United States number two in oil production out of all the OPEC countries only second only to Saudi Arabia in, what, how much of that factor that increase that we’ve had domestically in terms of our production comes from fracking?

Gary Sernovitz:    All of it. I mean if you look at where the US declining almost          30 straight years until 2008, 2009 when we started to increase now effectively doubled US production most you know, all that coming from onshore fields and Texas, North Dakota, you know, primarily, but also some other places like Colorado. So it’s been really an incredible sort of turnaround for the US production and there’s really, you know, shocked the young on the supply side to global oil markets and tend to that are having trouble absorbing it.

David Scranton:   Excellent. Well, Gary I really appreciate your feedback today you’ve added lots of words of wisdom to our show and for our viewers. And I have to tell you though I thought I had a fairly long subtitle in my own book but I’m going to cheat now because your subtitle is even longer than mine. So we’re wrapping up today with Gary Sernovitz, author of the book Green and Black and the subtitle which is very accurate, although it is long, is the complete story of the shale revolution the fight over fracking and the future of energy. Gary thanks again.

Gary Sernovitz:    Thank you for having me.

David Scranton:   And for our viewers. Stay with us. As soon as we come back we’ll be one on one between me and Morgan talking more about oil and how oil affects the stock market. And that relationship, we’re seeing right now, that may make no sense to any of us. We’ll try to clarify that right after the break. We’ll be right back.

Morgan:  Another iconic TV show, where oil was the central theme. David this is really a topic that lends itself to some big picture discussion as you mentioned at the top of the show.

David Scranton: Well, a big part of it is because you know oil is such a popular topic today and it’s a huge industry. It’s one of the biggest industries in our country.

Morgan:  And you wanted to devote an entire show to oil and not just focus on the big picture.

David Scranton:  In large part because of the media, the media. So recently, it’s been putting such a big emphasis on oil and an emphasis on whether this drop in oil prices is a good thing for the economy or whether it’s a bad thing for the economy. And I felt like to some degree that question had to be answered here today.

Morgan:  You know what, it is confusing and it’s really central to what’s happening with all the financial markets, correct.

David Scranton:  Absolutely. And you know, I think the bottom line is that people are saying its common sense that gee with oil prices being low right now. People are saving money at the pump. I’m sure you feel it. I’m sure you feel someplace where you save some money at the pump and things are and things are going better but yet you read the headline saying well it’s a bad thing for the markets.

Morgan:  Let’s talk about that a little bit more because it is so confusing. There’s so much speculation about this in the media and I think a lot of its contradictory. What are we supposed to think?

David Scranton:  Well I think people need to take a common sense approach here and say well if it makes sense for oil, cheap oil that is to be a stimulator for the economy and it seems to be sending a wrong, another message to Wall Street right now. They have to ask why? They’ve got to see why is it, what is it that’s causing this? Things that we are answering on today’s show.

Morgan:  Now you spoke briefly in the market breakdown about the lingering effects of quantitative easing and how that’s having an effect here. It really doesn’t seem to add up to a lot, does it?

David Scranton:  No, you know quantitative easing cause the problem from the beginning. And over stimulated economy and a big problem that I like to say is it’s kind of like pharmaceutical company. Imagine a pharmaceutical company comes out with a new drug for example, and they don’t test the drug in advance. Well, if you come out with a new drug and you don’t test it. People are going to get hurt physically, people are going to die. It’s a terrible experience. And that’s what they did was unprecedented levels of quantitative easing. The Federal Reserve came out with an untested strategy and now I think we’re about to pay the price for all of that.

Morgan:  Just throwing out there without knowing the effect that is scary. And in this instance, you think quantitative easing is at least partly to blame for the markets focusing more on the negative side of cheap oil rather than the positives.

David Scranton:   Yes, I think it’s because the economy got overinflated when the economy gets over inflated for a period of time. Eventually, we have to go into some kind of recessionary cycle. That’s what happens. You go from boom to bust and back to boom again. So when oil prices as result were coming down. People are saying, well, maybe that’s what’s happening. Maybe the economy got over stimulated.

Morgan:  So you think oh, my gosh I’m saving so much money at the pump. This is great. I’m going to have so much more disposable income and that’s not really what’s happening.

David Scranton:   No, But I mean you the average American today has an extra 2% in their paycheck net neck why because of what they’re saving at the pump what they’re saving and costs of home heating fuel and so on. Um, you must see that in your own life.

Morgan:  Well, I definitely feel it. I’m saving money and it’s much cheaper at the pump now than it used to be. But, you know, I’m not redoing my flooring anytime soon. I don’t feel like I’ve saved that much?

David Scranton:   Well that was my question. So are you going out? Are you boring more money?  Are you spending money on certain items that maybe you weren’t doing six months ago?

Morgan:  I don’t think so. I don’t really feel any different.

David Scranton:   So it’s really a question of; wait and see. And again, that’s why we’re doing the show today, because I’m really concerned about that wait and see attitude. I’m concerned that that right now what’s happening is all of our Income Generation members are taking a wait and see type philosophy with the markets and as a result, that’s why they’re not spending. That’s why the economy has really slowed down at this point or at least showing signs of slowing down.

Morgan:   Well, you’ve talked about this on an earlier show that, wealth effect in reverse. What exactly is that?

David Scranton:   Well the wealth effect, of course, is when this quantitative easing drove up financial market values drove up the values of real estate drove up the values the stock market and made people feel more affluent. Well now the wealth effect in reverse is the financial markets are coming back down and people feel poor and when they feel poor they’re less likely to go out and spend money and they don’t spend money. We don’t stimulate the economy we go back and in recession.

Morgan:   A lot, a bit like what I was saying in my personal life. We should feel like we have all this extra money, but we really don’t.

David Scranton:   Yeah, there’s just a sense of it, the average person today just has a sense that things aren’t quite right there, yeah when things were a lot better than they were back in 2008, but they are certainly not like they were in 2005 or six.

Morgan:   So as anything really changed? I know they’ve changed the interest rates a bit but not a lot.

David Scranton:   Well, short-term interest rates as you know went up in December. And a lot of that I believe was just the Federal Reserve getting pressured from Wall Street. It seemed like Wall Street wanted them to raise rates so they raised rates. And I’ve already talked about some negative effects earlier in the show that concerns that I have about them taking that action

Morgan:    And they’d already done that once before, correct?

David Scranton:   I’ve been a long time since they raised short-term rates the face of the first time about 10 years actually had done that. But it’s the first time they’ve raised rates after this extended period of quantitative easing.

Morgan:   So then what are we going to see happening, what is the effect of all of this?

David Scranton:  Well, the problem is this thing we’ve always talked about called the flat yield curve and my concerns about what the flat yield curve might be able to do negatively speaking for our economy.

Morgan:   And what does it do exactly? What is it?

David Scranton:  Well if I yield curve is a fancy term that financial people if you use for the difference between short-term and long-term interest rates. And the premise is that banks need long-term interest rates to be higher than short-term interest rates to lend. And what’s happened since December 16th  when the Fed first read short-term rates is not only did short-term rates go up as a result of that, but also long-term rates came down because a worldwide economic conditions. So the spread between short term and long term has been decreased by about a third since December 16th.

Morgan:   Wow, and we see yet another reason for Wall Street’s pessimism.

David Scranton:  That’s right. Because that’s often a sign or something that could very well trigger us going into the next recession.

Morgan:   And you said the rate hike was badly timed for two reasons.

David Scranton:  The other reason is because of what Janet Yellen said right on December 16th that she really wants to continue to create inflation or to begin to create inflation. She’s been trying to do this through all the quantitative easing since 2008. And the reality is they’ve had a difficult time doing it and when you raise rates. It doesn’t help create inflation if anything has the opposite effect actually helps create deflation.

Morgan:   And that’s bad. Why?

David Scranton:  And that’s bad because when the dollar gets stronger, which is what happens when you create when you raise interest rates of dollars to get a little stronger.

Morgan:   It seems like that’d be a good thing.

David Scranton:  You think but it makes it harder for our companies here in the United States to export goods and services because now other foreign countries need to need to use more of their currency to buy our goods and that’s something else that can very will cause us to nose dive right into a recession.

Morgan:   And people will buy things from other markets instead of our own.

David Scranton:  That’s correct. And that’s obviously not what we want here in the United States.

Morgan:   So based on all this I assume you haven’t changed your mind about 2016 is where we might see the third major market job.

David Scranton:  No, I believe, 2016 could very well be that year. And I’m not setting it stone or anything like that at this point, but it very well could be the year that we have that drop, it could be as big as or more than 50%.

If you’re part of The Income Generation, my generation that is then the following images is probably going to ring the bell. Whether you were driving yourself at the time or in the backseat of your parents’ car, chances are you remember very well the gas lines of the 1970s. If you were an adult back then you may also recall what caused all that hysteria irritation. The oil crisis or first oil shock, it was set off by an embargo created by the Arab members of OPEC. By the end of it the price of a barrel of oil had tripled globally and the United States prices were even higher. Most people would probably agree. We’ve come a long way since then and mainly in a positive direction were oil is concerned. We’ve decreased our dependence on foreign oil. We’ve improved the energy efficiency of our cars and other machines dependent upon oil. It also we’ve cultivated new sources of energy. I’m not guaranteeing we’ll never see gas lines again. But we’ve definitely greatly improved our odds of not having to live through the same kind of oil crisis we went through twice in the 1970s. What’s happening right now in the oil industry is a good indication of that. As a man who asked to buy fuel for a car boat and a couple of houses. I’m certainly happy about lower prices and if you’re working hard to buy groceries, put your kids to college and save for retirement. I betting you’re happy too because every little bit counts. But naturally there are two sides to every coin. The thing that benefits one group or individual often comes at a cost to another. In this case, that’s the oil industry. Now no one likes to pick up the paper and read headlines about job cuts or companies going bankrupt, obviously, but those are the downside consequences of plunging oil prices. And as we explained, they’ve had some direct impacts on market performance. Nose-diving profits for Oil Company’s segment, nose-diving stock values as well, and that’s bad for the overall stock market. I hope that I felt clarify on today’s show why I believe Wall Street’s extreme unease over oil is based not just on these direct impacts, but on a combination of factors. Factors that indicate the markets aren’t just worried about oil or the industry struggles about the future of oil but about the direction of the economy overall. In a world worried about deflation and potential recession. My point in highlighting these other factors is not so much to explain everything that’s been happening, but instead to help formulate some educated answers to those questions, everyone’s been asking. And those questions which I brought up at the top of today’s show, namely, how long will this last? Will it get worse? Is oil going to be the tipping point for the next major sustained Stock Market Plunge? First how long will it last. Well, it could last quite a while. As I mentioned earlier, production hasn’t really slowed domestically or abroad, despite the price drop. US oil reserves already at their highest level and at least 80 years and that supply is only going to increase. So if the current price plunge is based mainly on an overabundance of supply which, in part, it is that doesn’t look as if it will change anytime soon. Some experts have estimated it could be many years before oil returns to the 90 to $100 per barrel range, the average price over the last decade. And again, it could be even longer than that if what we’re seeing is a historic shift for the entire industry. A shift that sees oil loses some of its power as a global economic force. Is it going to get worse?  That certainly seems possible also. If oil prices don’t move up and they remain a constant source of investor on ease, then every bit of bad economic news that comes along is only going to add to that unease. And we’ve seen some bad news lately. Only a week or so before I tape this show, these were just a few of the morning headlines; jobless claims rise more than expected. Dow futures drop 100 on weaker oil and economic data. The last one illustrates my point perfectly and those are just domestic headlines. Let’s not forget all the uncertainty still going on with China’s markets as well as the Eurozone. If oil continues to keep Wall Street on edge, then yes, any number of things could crop up to make matters worse. Is oil going to be the next tipping point for next major sustained stock market plunge? No, not oil per se, but as I hope I’ve demonstrated with today’s show. It’s one of the major factors and what seems to me to be a perfect storm. Its oil combined with the lingering effects of quantitative easing the flat yield curve and the overall economic picture. Its oil combined with other deflationary triggers and with global market instability, as well as the lessons of stock market history. Its oil, yes, but it’s really all these factors that lead me to say that right now it feels a lot like 2007 all over again. And to believe that 2016 may very well be the year that this, third major market collapse possibly as high as 50% or more takes hold. Now will oil be blamed for the crash in hindsight, or will it be correctly seen as just one contributing factor? Who knows? But the more important question is do you really care. Does it really matter what history says after the fact? Absolutely not, all that really matters that you understand the current situation you know the potential consequences and can take the steps to protect yourself beforehand. As you know, for The Income Generation, I believe that defensive income-based financial strategies protected from the volatility of the stock market are going to be the key to dependable retirement planning for the next several years. The oil situation is one of the many reasons why. Thanks for watching.