The energy complex has extended losses in recent weeks, bringing renewed selling pressure on global financial risk asset markets. Crude oil prices fell to as low as $46 on January 12, from $57 on December 19. There is much debate amongst investors and market-watchers about exactly what falling crude oil prices is foreshadowing about the future. The optimists and bulls believe that falling energy prices are a positive development for the economy and markets because they constitute a tax cut for consumers (i.e. fiscal stimulus) that will further underpin U.S. GDP growth that is already strengthening significantly in recent quarters. The pessimists and risk-asset bears state that falling commodity prices are telling us that global deflation risks are accelerating, insinuating that global central bankers are essentially pushing-on-a-string, and that the monetary policy accommodation-driven bull market of the past five years has run its course.
Regarding this debate, Global Markets Intelligence (GMI) Research continues to find itself aligned with the optimists and bulls. We believe that the significant and largely unforeseen collapse in crude oil prices represents a welcome windfall tax cut not just for U.S. consumers, but the global economy as a whole, including numerous specific commercial industries. Furthermore, declining commodity prices in general are very likely to impart downward pressure on brewing inflation pressures arising from steadily tightening U.S. labor market conditions. This means that when the time finally comes for the Federal Reserve to normalize monetary policy by putting upward pressure on short-term interest rates, they will be tightening policy by a lesser degree than many market participants envisioned as recently as just six months ago. The prospect of increased fiscal stimulus derived from the crude oil-based tax cut, combined with relatively easier intermediate-term U.S. monetary policy than what was previously assumed by many investors, ourselves included, should result in an economic and market environment that is unequivocally bullish, in our view.
To the extent that relatively low global energy market commodity prices can reinforce sustained non-inflationary GDP growth, then market interest rates will remain historically low, leaving high quality equity securities as the predominant asset class of choice for intermediate to long-term oriented investors. Concerning stock market valuation, a price/earnings (P/E) ratio of 16 to 17-times forward expected earnings appears quite reasonable, in our view. Conversely, should the U.S economy start to heat up, requiring first a normalization, and then more than an inconsequential tightening of monetary policy, then the prospects of sustained PE-multiple expansion starts to diminish as the bond market competes more effectively with stocks on an asset allocation basis. For the moment, the latest rendition of the not-too-hot, not-too-cold U.S. Goldilocks economy appears to us to be the most likely outcome for the financial markets in 2015.