Gushing

All of a sudden, the world looks pretty good, doesn't it?  Spooz are up on the week (raise your hand if you saw that one coming 48 hours ago), Q2 GDP was revised waaaaay up, and even crude oil broke its steep downtrend with its best day in about 6 years.   The good news is positively gushing!

The GDP figures will no doubt come as a comfort to the Fed, and take some of the edge off of the recent worries about a corrosive deflationary episode.   Not only did the quarterly real growth figure come in at a handsome 3.7%, but the deflator also spiked above 2%.  As it is now, the Q2 figure is shaping up as one of the better ones of the post-crisis era.

Of course, we'll still have the usual hand-wringing about underused labour, a remaining output gap, etc.   To get a sense of what the models are saying about this, Macro Man plotted the CBO's estimate of potential nominal GDP with the actual readings from the BEA.  Sure enough, you can see the wide gap emerge over the crisis and slowly close in the ensuing years.

But how useful are these estimates of potential GDP, anyways?   Common sense would suggest that the trajectory of growth before the crisis was unsustainable with most inputs at equilibrium- otherwise we wouldn't have had a crisis.  Macro Man plotted the historical difference between the level of nominal GDP and the CBO estimate of potential to get a sense of the historical trends of this implicit output gap.

As you can see, since the mid-70's the CBO's estimate of potential GDP has generally outstripped the actual level of GDP, in many cases by a sizable margin.  While there is no guarantee that the Fed employs similar estimates of potential growth, such a systematic error would appear to cast a few doubts on the whole output gap framework.  At the very least, the overoptimistic GDP assumptions explain the generally execrable state of US public finances for most of the last 40 years.

In any event, some combination of the number, the rally in equities, and oversold technical conditions have finally breathed a spot of life into the oil market.   The trajectory of the crude price since midyear has resembled nothing so much as a cliff diver in Acapulco (like you used to get on weekend TV thirty-some odd years ago); yesterday, however, saw a decisive rejection of the last-gasp move below 40.

There's been some quality discussion of the fundamental dynamics of crude in the comments section over the last couple of days, and Macro Man doesn't have a whole lot of fresh insight to add to that particular debate.  From a technical perspective, however, the downmove looked a little tired earlier this week, so it didn't come as a complete shock to see the reversal.  Although CTAs are nowhere near being challenged on their positions, it would still be reasonable to expect a further correction higher.  Even a 38% correction would take October crude (pictured above) to $47 or so; a 50% retracement would have the price pushing $50.

What about energy equities?  Obviously there is a lot of idiosyncratic risk based on debt profile, cost of production, etc., so for any specific stock it is probably unwise to generalize.  To get a sense of the "beta" for energy stocks, however, Macro Man decided to have a little fun with ExxonMobil (XOM.) He plotted the ratio of that stock price to the SPX going back to the early 80s; unsurprisingly, the last few years have been pretty darned rough on XOM, taking it back close to its average relative price in the 1990's.

Obviously, this is a simple measure that does not capture the total return of the two series.  Nevertheless, as a simple proxy for what the market is willing to pay for non-idiosyncratic energy exposure (XOM is about as non-idiosyncatic as it gets!) relative to the index as a whole, it has some utility.

"But surely," Macro Man can hear you saying, "this ratio simply reflects the oil price?"   Well, yes and no.   In broad strokes, yes, of course it does, but there can certainly be periods when XOM can out- or under-perform crude on a relative basis.   In late 2008, for example, XOM handily outperformed the SPX even as crude was taking another swan dive, as it was first part of the "equity market crack" trade, and then seen as a safe haven with a nice dividend cushion when it was all going to hell in a handbasket.

What's interesting about this chart is that XOM led the weakness in crude over the past few years, rather than vice versa, and if anything still looks a little "cheap" by this measure.  With a dividend yield nearly twice that of the 10y Treasury, it pays OK, as well!  Obviously this is a pretty shallow analysis, but it does lead Macro Man to wonder when it would make sense to don the Kevlar gloves and have a look at equities in the energy sector.  It's been a long, hard road for them...but at some point they'll be priced where a gusher of their own looks close to inevitable.

(As an aside, Macro Man had to laugh at the advert that popped up when he looked at a dividnd yield history of XOM.  Talk about quick on the draw- one upday in crude and it's already pimping 'The oil boom'!  Somehow, the cowboy hat/goatee/cheesy half smile is what makes it click.)