That was an Interesting Two Months!

Maybe the word interesting is a slight understatement or maybe it is more direct and articulate than we really understand. In looking at the start of the year we can see a couple of things happening and in the following couple of notes we will uncover what we are all feeling.




We can start with volatility. Most people associate volatility with negative experiences; however, it should be noted that this metric can be both positive and negative at times. Consider the Canadian and U.S. dollar relationship over the past time period. The chart below tells part of the story:

Source: Bloomberg and VIP Wealth Solutions


The other part of the story is the movements that happen during the day. We all see the day end or month end results, but it is what is happening wire to wire that is perhaps providing more information. Below we have created a graph showing the frequency of movements in the DOW index. The details of the chart shows how many days the DOW traded in specific ranges.


Since the start of 2015 there were zero days that the DOW intraday had an index point of less than 50 points. There were however, 9 days that the DOW had a movement of 200 to 250 points. What this tells us, is that the DOW is experiencing more days with larger intraday movements. Simply put, it is experiencing increasing volatility. We have posted both the graph and the data below for observation.




It is important to note that when the DOW index moves 100 points, it is equal to about a 1% move.


Oil – or maybe a look at energy en masse?


A lot of what is being talked about is the change in the exploration and production of oil. We think that most of this talk is, for the time being, spot on. Consider some of the realities of the changes that have happened:


Offshore oil wells usually cost about $100 million to drill. It takes as long as 10 years and additional billions of dollars to begin producing from new offshore oil fields.


Newer shale wells cost only several million dollars and it takes just a few weeks for oil production.


This means that when oil price recovers, shale oil wells can come on line faster and can be aggressively exploited whenever the economics make sense.


This shale activity will last until there is no more oil in shale deposits. So the big question is, how much oil is there in shale? The Institute of Energy Research suggests that the U.S. has 4 times the recoverable oil in shale deposits as Saudi Arabia’s proven reserves. So there is a lot of supply that can be quickly accessed.


At this point, it is important to look at the current oil inventory as well (no pun intended). The chart below shows the Department of Energy weekly statistics on the total oil inventory data (excluding the Strategic Petroleum Reserve). The chart pretty much says it all. Inventories are on a steep move higher. When the supply of something goes up the price should correspondingly go down.

Source: Bloomberg and VIP Wealth Solutions


Is this the new normal? We think it is for now. The U.S. has a lot of oil and is now self-sufficient.


Can this change? Indeed. The Saudi’s could blink and cut production; however, Saudi Arabia is a bit of a one trick pony. A look at the CIA World Factbook (not Facebook J) for 2012 suggest that 90% of Saudi Arabia’s exports are petroleum and petroleum based products. We expect Saudi Arabia to remain competitive in the world market share of oil and will keep the taps open. However, Saudi Arabia is ruled by an authoritarian regime – a king. If the king wakes up one morning and wants to change things, so it shall be.


Is the world cheap?


Humm? We suspect that it is and it shall remain a relative question because what is cheap today may seem expensive tomorrow. Historically speaking, are the markets cheap in today’s terms? The chart below illustrates the long term price earnings multiple of the S&P 500. Looking at the chart, one would not suggest that it is expensive; however, it has clearly moved into the top end of its 10 year historical range. Given the range, one could say it is approaching expensive.

Source: Bloomberg and VIP Wealth Solutions


At this point it would be fair to overlay the TSX index for some relative context. The blue line is the S&P 500 and the red line is the S&P TSX index.


Source: Bloomberg and VIP Wealth Solutions


We could continue, and internally we do. Daily, we try finding good companies with sustainable positioning. We also have to pay attention to the broader indexes because they tell a bit of a different story from time to time. Today the story appears to be getting expensive. What makes it less expensive? More earnings and or lower stock prices. Here is a visual:



Our experience has shown us that in extreme markets, the pendulum typically swings further than most people think it will.


The Banks


Finally, here is one relationship that has us scratching our heads a bit. We are always worried about what the next shoe might be when something bad happens in capital markets. The major Canadian banks just reported earnings and, for the most part, the numbers were better than expected. The relationship below is one we keep scratching our heads about. Historically, Canadian banks have had a strong and tight relationship with the price of oil. However, today that relationship appears to have changed. Perhaps the Canadian banks have changed over the years with greater exposure to global markets and less reliance or direct exposure to the energy space. Either way, it is one of the relationships we are following closely to see how the Canadian economy plays out. We know that historically the markets need strong financial support to move forward. In the chart below, the red line is the Canadian bank index and the blue line is the price of oil.

Source: Bloomberg and VIP Wealth Solutions


Final Word


Based on some of the data above and what we see happening daily, it is hard to believe that this volatile state will remain as such. In every economic and capital market environment over the past 20 years there has been one constant, and that constant is change.