Stocks, oil and ten year bonds: why I'm scratching my head
For much of this year, whenever I've glanced at financial market prices, I've been left feeling more than a little confused.
There are three key numbers which I've often used as a shorthand way to understand what is happening in the global economy. And at the moment, they aren't behaving as I'm used to.
Those three indicators are the price of oil, the yield (or interest rate) on US government ten year bonds and the level of the S&P 500 - the key index of the US stock market.
Now, of course, this is an imprecise way of examining the health of the global economy.
But as a quick guide to what is happening at any given moment, these numbers have usually served me well.
The three numbers all tell us something different.
Oil (and in the analysis below I'm talking about the "West Texas Intermediate"[WTI] benchmark rather than the more typical European "Brent" benchmark) is still a key global commodity which gives important clues - in the absence of changes in supply - about global demand.
The US ten year yield is perhaps the world's most important interest rate. It is the "risk free rate" from which may other assets are priced.
The yield moves inversely to US government bond prices, i.e. as the price of the bonds goes up, the yield goes down, and vice versa.
In general - and I'm over simplifying here - if the price of the bonds is high (and the yield low) that's a negative sign for the US economy - it suggests the economy is performing poorly and official interest rates are expected to remain low.
Finally, the S&P 500 is perhaps not the best indicator of US economic strength but as a closely watched stock market it does tell us something important about investor expectations.
It is not a bad measure of the health of large US companies, many of which have a global footprint.
What has been confusing me this year is the interaction of these three numbers.
In each case I've picked an unscientific (indeed almost arbitrary) round number - $50 a barrel for oil, 2.0% for the US ten year and 2,000 for the S&P.
At present oil is below $50, the ten year yield is less than 2.0% and the S&P is above 2,000.
If a time traveller with nothing better to do had journeyed back to early 2008 and told me these would be the present levels, I wouldn't have believed them.
In fact I'd have found the level of those numbers to be more implausible than the claim that the person was from the future.
To understand why, consider how these numbers relate to each other and what - given knowledge of two of them - one would expect the third to be. Let's look at three more usual scenarios.
In the first, oil is below $50 and the S&P above 2,000. That combination suggests the global and US economies are doing well.
Given the high level of US stocks, one would assume the low oil price was due to a rise in supply.
In such a world though, one would expect US ten year yields to be much higher - if the economy was doing so well, why would the markets price in such low interest rates?
In the second scenario, oil is below $50 and the ten year is yielding less than 2.0%.
This is a world hit by weak global demand which has depressed the oil price, and is making investors reasonably confident that interest rates are going to remain low.
One would expect that stock prices would reflect this, and the S&P would be below 2,000.
The third scenario sees the US ten year below 2.0% and the S&P 500 above 2,000.
From the vantage point from early 2008, that sounds like a future where the US economy has enjoyed a decent recovery driven by low interest rates.
The US stock market has risen as the Federal Reserve has held interest rates low, and this situation is expected to continue.
But in that world one would have expected the oil price to be higher.
The current situation - S&P above 2,000, ten year yields below 2.0% and oil sub-$50 - is causing me to scratch my head.
I'm left with three possibilities.
The first is that I'm simply wrong on the nature of the relationships between the three variables.
It may that something like quantitative easing or the big rise in US shale oil production has caused the simple historical relationships to break down.
Early 2015 is not, after all, early 2008.
"All things being equal" is a common phrase in economics, but things rarely are.
Or the US could be in a macroeconomic "sweet spot".
It may be that low oil prices (driven by an increase in supply) are both supporting demand and giving the Federal Reserve more space to hold interest rates lower by weakening inflationary pressure.
That may be the world we have - high stocks, high bonds and low oil.
But there's a third possibility too - that one of those three prices is wrong.
Either bond yields need to go up, stock prices come down or oil rise.
Any of these - financial relationships changing, a macro sweet spot or some mispricing - could be right.
It will be a while before it becomes clear.
But in the meantime, my own shorthand way of understanding the global outlook isn't working any more.