Farrell: Beyond The Swine Flu

There isn't anything I can add to the debate/worry over the swine flu scare. Hopefully it won't become the pandemic that the extreme case suggests.

What I am thinking about today is oil and refining companies. Secretary General el Badri of OPEC said publicly that he would like to see $70 oil before too long, and he might get it if the "green shoots" of economic recovery continue to pop up. OPEC discipline on production would be needed, but they seem to be more coordinated on that score than usual. Merrill Lynch feels that $62 oil will be the average for 2010, which would coincide with a very modest to weak economic recovery. Goldman Sachs apparently suggested last week that the July oil contract should be shorted as they see $45 soon with a recovery to $65 by the end of the year. I checked the futures market and I see the January 2010 contract trading at $59 and the April 2010 at $61.

My own feeling is that oil will go to the marginal cost of production, which is around $60. I think the major oil companies are trading as though oil will be a good bit lower, and if the economy shows signs of recovering in the second half of the year, the oil stocks may be a good place to be invested. Right now, Jacques Rousseau of Soleil/Back Bay Research is skeptical about the refining sector. He sees demand down over 6% from a year ago as additional supply comes on the market as seasonal maintenance ends. Gasoline inventories are 7% higher than a year ago, and Jacques feels the stock prices could be vulnerable. Those with East Coast exposure like Sun could be the most threatened.

While the TED spread has hovered around the 95 basis point spread for a few weeks, it's not because LIBOR hasn't come down. LIBOR is at a new low of 1.05%, and that is a remarkable difference from the over-5% it traded at after the Lehman collapse. The other side of the equation, the three-month US Treasury bill, is at an absurdly low 10 basis points; thus the 95 basis point difference between the two. That low a level shows a renewed level of confidence in intra-bank lending. I think the low Treasury rate is due more to the banks hoarding cash as the stress-test results loom and will soon enough return to a more normal level and the TED spread will attempt to approach its historical difference of 50 basis points.

In addition to the stress-test results being revealed to one extent or another on May 4th, this week will see the first estimate of Q1 GDP. The over/under bet seems to pivot around -5%. Soleil's Lyle Gramley is on the more negative side of the divide, feeling that Q1 will be closer to the negative 6.3% of Q4 2008. The big thing to look for (to me) will be the level of inventory reduction, which could be a huge swing factor later in the year. If inventories are depleted to a great extent, then that could be the reload that might push GDP up later in the year. The GDP report is this Wednesday. Tuesday will see the Case-Shiller home price index, and expectations are for another dismal reading of a negative 19%. There are other indications that housing might be bottoming, so this is bound to be controversial.

As usual, initial unemployment claims come out Thursday. Last quarter's average was 615,00 new claims a week. They lately have been running about 650,000 a week and have shown the very faintest signs of stabilizing. It would be necessary for claims to fall back towards 600,000 to have confidence the economy is bottoming. The four-week moving average, now around 646,000, is indicating a stabilization. As I mentioned last week, this number will take on a more important role as an early indication of the economy's direction.