‘Stocks continue to react favorable to the ongoing decline in oil prices. The recent drop in crude oil below $15 per barrel in the spot market reinforces the prospect that inflation will become less of a problem in the months — if not years — ahead, Itis worth noting, however, that at prices below $15, some North Sea production becomes ‘uneconomic, as does some of this country’s large output from its numerous “stripper” wells. As a ‘consequence, there is a chance that some of the higher cost oil production in the North Sea will be output during coming months. In the absence of offsetting increases elsewhere, this would reduce supply. Although available supply is substantially in excess of immediate and foreseeable needs for the short to intermediate term, any announcement of a significant cutback in North Sea output would likely spark at least a reflex rally in the oil markets. This, in tum, would almost assuredly have a negative impact on stock and bond prices. Even though the benefits of the decline in oil prices are real and will have far reaching consequences as they spread through the economy ,the facts is that markets rarely move in a straight line for a very long and a reaction to the current advance is probably overdue.

Our technical analysis indicated that the current move will top out on an intermediate term basis the 16801700 area, in any case. So, with stocks already nosing into the lower end of that range, some type of reaction would be perfectly normal. We are impressed, however, by the absence of heated speculation to us that although stocks may be searching for a temporary high, it will not be a longstanding one. Look for volatility and turbulence ahead, but stocks are on solid ground as a ‘consequence of the drop-in oil prices and are reasonably priced on the basis of longer-term valuation models. In part, the case for reasonable valuations for stock prices also rests on the roughly 25% decline in the value of the dollar in the past year. The benefits thereof, like those of falling oil prices, are starting to spread through the economy, making American manufacturers more competitive in world markets and boosting the reported profits derived from exports and overseas based operations

Article extracted from this publication >> March 7, 1986