Bearish on Oil? Don’t Be…

The AP article starts off: Oil prices fell below $78 a barrel Tuesday amid the strengthening dollar and continued doubts about global demand for crude.
If "doubts about global demand for crude" only succeeds in taking oil prices down a couple of dollars per barrel, I have to wonder why the financial media continues to take a bearish stance toward oil. Oil prices have been climbing the proverbial "Wall of Worry". Inventories rise, and yet so do oil prices.
Oil is becoming a "store of value." Buy it, store it and sell it at higher prices seems to be the consensus. That doesn’t bode well for the oil bears, unless another cash crunch forces traders to liquidate positions. I expect oil and energy prices to remain strong.
*****Earnings may not have recovered to pre-crisis levels, but cash flow has. Bloomberg reports that the 2010 P/E for the S&P 500 is 14, based on company estimates. The trailing P/E sits at 25. Both imply stocks are fairly valued at best, and may even be overvalued.
But if we look at cash flow, defined as earnings plus the cost of depreciation and asset write-downs, stock valuations look much better. Bloomberg reports that valuations based on cash flow are 37% lower than its 12-year average and 50% lower than in 2007.
Bloomberg goes on to say that the discrepancy between earnings and cash flow is because companies are still grappling with expenses related to the financial crisis. Just today, Citigroup (NYSE:C) reported a $7.6 billion quarterly loss because of TARP repayment expenses. Another example would be companies that have laid off workers will also be subject to severance expenses.
Ultimately, the bullish take on this data is that companies have cut expenses to the proper level and, if cash flow remains consistent, are positioned for a boost in earnings. Investors will be listening closely this earnings season to see if companies offer improved guidance for earnings going forward.
*****China is once again tapping its foot on the growth brake pedal. China’s stimulus efforts led to a surge in lending during 2009. And there are some outspoken hedge fund managers, like Jim Chanos, who claim that a massive property bubble has resulted, and China’s economy is about to crash.
And if China were to relentlessly pursue growth at all costs, Chanos and the other China bears might be right. Unfortunately for them, China is pretty good at managing its own credit expansion. Just in the last two months, China has raised the interest rate on its bonds and raised the capital requirements for banks. Today it raised bond interest rates again.
These interest rate moves make loans more expensive, and the higher reserve requirements mean banks can’t lend as much.
These are pre-emptive moves by China, and should be applauded by investors for two reasons. One, they show that China has the will and the means to manage its growth. Two, these moves show that China is aware of (and is addressing) foreign investors’ concerns over credit expansion.
China depends on foreign investment. And it is proving to be a reliable shepherd. I believe investing in China is one of the best decisions any investor can make. My readers have made some sweet profits from Chinese stocks, and more are on the way.
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