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Tuesday, April 26, 2016

Addiction to Oil

Financial Review

Addiction to Oil


DOW – 26 = 17,977
SPX – 3 = 2087
NAS – 10 = 4895
10 Y + .02 = 1.90%
OIL + .26 = 42.90
GOLD + 5.70 = 1238.90

The Federal Reserve FOMC meets this week to determine monetary policy; they are not expected to raise interest rates this week, however they might set the stage for a rate hike in June. Earlier this month, Fed Chair Janet Yellen said the U.S. economy was on a solid course with some hints of inflation, so the Federal Reserve was on track for further interest rate hikes.

First quarter GDP, to be released on Thursday, is expected to slump to a paltry 0.7% annual rate from a 1.4% rate in the last three months of 2015. It might be tough for the Fed to sound hawkish if it is followed by a weak GDP report.

Traders are also keeping an eye on the outcome of a Bank of Japan meeting on Thursday, with expectations that Japan could push deeper into negative interest rate territory.

Investors have been assessing first-quarter earnings, FactSet just released its latest update of earnings season stats for S&P 500 companies. And the numbers are pretty bad; 76% of companies have beaten analysts’ estimates, but the aggregate earnings decline is -8.9%. That’s actually worse than the -8.6% decline analysts expected on March 31.

This will mark the fourth straight quarter of declining year-over-year earnings, which hasn’t happened since 2009. Throughout this bull market, companies have managed to squeak past very low expectations. Now, we can’t meet lousy expectations.

An avalanche of first-quarter earnings reports is on tap, with 186 companies in the S&P 500 slated to report results. The big news in earnings will be tomorrow, when Apple reports. Apple is expected to report a year-over-year decline in revenue for the first time since 2003. Along with the revenue decline, many are predicting that iPhone sales will fall year-over-year for the first time in the device’s history.

New U.S. single-family home sales fell in March, but the decline was concentrated in the West region. The Commerce Department said new home sales decreased 1.5 percent to a seasonally adjusted annual rate of 511,000 units. Sales were up in the Midwest and the South, and flat in the Northeast, but sales plunged 23.6 percent in the West, reversing February’s 21.7 percent jump; which leads me to believe we’re dealing with some statistical noise in the report.

While the inventory of new homes on the market rose in March to the highest since September 2009, new housing stock remains less than half of what it was at the height of the housing bubble. At March’s sales pace it would take 5.8 months to clear the supply of houses on the market. That was the most since last September and was up from 5.6 months in February.

Saudi Arabia unveiled “Saudi Vision 2030,” a plan to overhaul the kingdom’s economy in order to reduce its massive reliance on oil revenues, which account for 80% of its income but are taking a battering amidst the plunge in crude prices. Prince Mohammed bin Salman said the kingdom will try to break its “addiction to oil” by creating the world’s largest sovereign-wealth fund with over $2 trillion in diversified assets and to sell under 5% in state oil monopoly Saudi Aramco in an IPO.

The existing state-controlled Public Investment Fund will be transformed into a giant sovereign wealth fund to manage the kingdom’s petrodollars. Instead of direct subsidies, Saudis will receive payments as a form of benefit, while the government will attempt to cut unemployment to 7 percent from 11.6 percent by an unspecified date.

While volatility in the oil market may be pushing the Saudis to reform, low oil prices are also cutting the resources they can use to manage the change. And if the Saudis are willing to sell, who will step up to buy? Although the Saudi stock market opened up to direct foreign investment last June, total foreign ownership of the market remains tiny at less than 1 percent.

With prices so low, it hardly seems like a good time for an oil IPO. Perhaps even more important than the price of oil is the political component. The Saudis are not known for openness and transparency; this plan will surely draw opposition both from within the kingdom and from outside investors who will likely demand to see change before investment.

Oil was pretty strong last week in the face of a lot of bad news, including no agreement in Doha to freeze output, so don’t count out a repeat performance this week, especially since oil managed to crawl off the lows today. Crude oil has been the driving force behind equities since the February 11 low.

You may recall a few years back, the US tried to break its addiction to oil; the result was the shale oil revolution, which helped to ease our dependence on foreign oil, even if it didn’t break our addiction. Imagine what could happen if the US actually tried to break the addiction by starting a renewable energy revolution. Today’s announcement from the Saudis tells us that they are imagining that scenario.

China’s debt load is at a record high. The Financial Times reports China’s debt total climbed to 237% of GDP in the first quarter, an all-time high. Data from the Bank of International Settlements shows China’s debt load is far greater than emerging markets as a whole, which carry debt at an average of 175% of GDP. According to the FT, China’s debt has exploded since 2007, when it was 148% of GDP.

Gannett, the publisher of USA Today, said it offered to buy Tribune Publishing Co but the owner of the Los Angeles Times refused to begin “constructive” talks. Gannett said it made an offer to buy Tribune Publishing on April 12 for $815 million, including the assumption of $390 million of debt. Tribune Publishing said in a statement that it had told Gannett it would engage financial and legal advisers to review the proposal and its “numerous contingencies.”

The Justice Department gave antitrust approval to Charter Communications’ proposed purchase of Time Warner Cable and Bright House networks, which would create the second-largest U.S. broadband provider and third-largest video provider. The DOJ says online video will provide competition, and one condition to the deal is that Charter must agree to refrain from telling its content providers that they cannot also sell shows online.

The Federal Communications Commission must also approve the deal, and the agency’s chairman said he, too, is looking to protect competition. It was not immediately clear when the FCC would decide. Charter has valued the deal at $56 billion for Time Warner Cable, excluding debt, and $10 billion for Bright House Networks.

Ball is selling its beverage-can assets. Ball will sell 17 can factories and other facilities to European-based packaging company Ardagh for $3.42 billion. Ardagh will sell $2.85 billion of bonds to help fund the deal. Apollo Global Management, Blackstone Group LP and Madison Dearborn Partners were said to be other interested bidders.

Goldman Sachs has entered online banking. The investment bank is now allowing ordinary citizens to open a bank account. Goldman’s digital savings account offers a rate of 1.05%, and can be opened for as little as $1. The bank accounts are available after Goldman acquired about 150,000 retail customers through its GE Capital deal that closed last week.

Xerox reported a 4.2 percent fall in quarterly revenue, hurt by a strong dollar and lower sales of printers and copiers. Net income attributable to the company fell to $34 million, or 3 cents per share, in the first quarter ended March 31, from $225 million, or 19 cents per share, a year earlier. Revenue fell to $4.2 billion from $4.4 billion.

Halliburton is delaying earnings. The oil services provider announced it’s taking a $2.1 billion charge for the first quarter after cutting more than 600,000 jobs and taking a write off. Additionally, Halliburton’s earnings will be delayed from April 25 to May 3 in order to account for the Baker Hughes deal which is expected to close before the end of the month.

It looks like Chipotle’s free burrito strategy might be working: a survey shows that 41% of respondents who received a free burrito coupon visited Chipotle 3.8-times over the prior 30 days, compared to 1.4-visits for the 59% who didn’t receive a coupon. Brand perception was also higher in the coupon group. Meanwhile, analysts at Credit Suisse found that Google searches for food-safety issues related to Chipotle have dropped sharply since the beginning of the year. We’ll see how the free food strategy is working when Chipotle reports earnings tomorrow after the bell.

Philips is leaning towards holding an IPO of its lighting unit – its original line of business – rather than selling the operations. The divestment of the lighting operations will leave the company to focus on healthcare technology. Philips’ also reported better-than-expected earnings; adjusted earnings before interest, taxes and amortization climbed 14% to $420 million.

Carlyle has joined up with former Barclays CEO Bob Diamond to bid for the U.K. bank’s 62% holding in its African operations. Barclays Africa Group is listed in Johannesburg with a market capitalization of $8.5 billion, putting the value of the stake at $5.27 billion. Barclays is selling the unit due to increasing regulatory pressures.

Google is building a startup incubator called Area 120 in which teams of employees will be able to submit business plans to join the initiative. Those accepted will work on their projects full-time for a few months, after which they’ll be able to pitch Google on creating a new company that the parent firm would take a stake in. Area 120 is an attempt to prevent entrepreneurial employees from leaving Google entirely to found their own businesses.

Glum Start to the Week

Charles Schwab: On the Market
Posted: 4/25/2016 4:15 PM ET

Glum Start to the Week

U.S. stocks began the new trading week lower, with crude oil prices seeing pressure and caution prevailing ahead of an active earnings season, as well as monetary policy decisions from the Fed and Bank of Japan later this week. On the equity front, Xerox fell short of expectations and Valeant Pharmaceuticals named a new leader. Treasuries were modestly lower as domestic new home sales and regional manufacturing activity both unexpectedly fell, while gold was higher, and the U.S. dollar lost ground.

The Dow Jones Industrial Average (DJIA) fell 27 points (0.2%) to 17,977, the S&P 500 Index declined 4 points (0.2%) to 2,088, and the Nasdaq Composite decreased 10 points (0.2%) to 4,896. In moderate volume, 863 million shares were traded on the NYSE and 1.6 billion shares changed hands on the Nasdaq. WTI crude oil lost $1.09 to $42.64 per barrel, wholesale gasoline was $0.02 lower at $1.53 per gallon, while the Bloomberg gold spot price rose $4.67 to $1,237.70 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was 0.3% lower at 94.85.

Xerox Corp. (XRX $10) reported 1Q earnings-per-share (EPS) ex-items of $0.22, one penny south of the FactSet estimate, as revenues declined 4.0% year-over-year (y/y) to $4.3 billion, above the expected $4.2 billion. The company said revenue declines in document technology remained in line with last quarter and continue to be pressured by weak developing markets economies. XRX added that is has accelerated its cost reduction efforts and expects to begin realizing the benefits in 2Q. The company issued 2Q EPS guidance with a midpoint below forecasts, while reaffirming its full-year profit outlook. Additionally, XRX said it remains on track to complete its planned separation into two independent, publically-traded companies by the end of the year. Shares were sharply lower.

For our latest analysis on earnings season, read Schwab's Chief Global Investment Strategist, Jeffrey Kleintop's, CFA, article, Earnings Season for Investors: It's a Marathon, Not a Sprint, at www.schwab.com/marketinsight, and follow Jeff on Twitter: @jeffreykleintop.

Valeant Pharmaceuticals International Inc. (VRX $35) announced that Joseph Papa has been named its Chairman and Chief Executive Officer (CEO). Papa announced his resignation from Perrigo Co. PLC. (PRGO $101) today as the company issued softer-than-expected preliminary 1Q guidance. VRX was slightly lower, while PRGO fell over 15%.

New home sales surprisingly dip

New home sales (chart) declined 1.5% month-over-month (m/m) in March to an annual rate of 511,000 from February's upwardly revised 519,000 pace, and compared to the Bloomberg forecast of 520,000. The median home price decreased 1.8% y/y to $288,000. The supply of new home inventory rose to 5.8 months at the current sales pace as m/m gains in the Midwest and South were more than offset by flat sales in the Northeast and a tumble out of the West. New home sales are based on contract signings instead of closings.

The Dallas Fed Manufacturing Index declined to -13.9 for April from March's unrevised -13.6 level with economists forecasting an improvement to -10.0. A reading below zero denotes contraction.

Treasuries were lower, as the yields on the 2-year and 10-year notes, along with the 30-year bond, ticked 1 basis point higher at 0.83%, 1.90% and 2.72%, respectively. For our latest analysis on the bond markets see Schwab's Chief Fixed Income Strategist, Kathy Jones' article, Mixed Signals From the Bond Market: Something's Got to Give, at www.schwab.com/marketinsight and follow Kathy on Twitter: @kathyjones. For our latest analysis on the recent stock market rally see our video by Schwab's Chief Investment Strategist, Liz Ann Sonders and Schwab Center for Financial Research Senior Vice President, Mark Riepe, CFA, Is This Recovery for Real?, by clicking on the "Insights & Ideas" tab at www.schwab.com/marketinsight and continuing to the "Market Commentary" section. Follow Liz Ann and Schwab on Twitter: @lizannsonders and @schwabresearch.

Tomorrow's economic calendar will give investors a look at preliminary durable goods orders, forecasted to rise 1.9% m/m for March following the 3.0% decline in February. Excluding transportation, orders are projected to increase 0.5%, following the prior month's 1.3% fall. Demand for nondefense capital goods excluding aircraft is forecasted to increase 0.6%, after February's 2.5% decline. As well, Markit's preliminary Services PMI Index is expected to show activity ticked higher during April to a level of 52.0 from the 51.3 registered in March, while the S&P/CaseShiller Home Price Index and Richmond Fed Manufacturing Index are also scheduled for release.

Europe and Asia lower ahead policy meetings

European equities finished lower, with oil & gas and basic materials issues coming under pressure, while the global markets appeared to be treading cautiously ahead of this week's monetary policy meetings out of the U.S. and Japan. The euro traded higher versus the U.S. dollar, while bond yields in the region moved to the upside. The economic mood in the region was likely being dampened by a report showing German business confidence unexpectedly dipped in April. Also, automakers in the region were hamstrung by continued headlines regarding emission manipulations.

Stocks in Asia also finished mostly to the downside in cautious trading ahead of this week's monetary policy decisions out of the U.S. and Japan, while markets in Australia were closed for a holiday. Japanese equities declined, with the yen recovering from late last-week's weakness that came amid ramped up expectations that the Bank of Japan may deliver further stimulus measures following this week's monetary policy meeting. For our analysis of the global monetary policy front, see Schwab's Chief Global Investment Strategist, Jeffrey Kleintop's, CFA, discusses article, why Negative Interest Rate Policy Adds Up To Less than Zero for Investors and Schwab's Director of International Research, Michelle Gibley's, CFA, commentary, Are Central Banks Out of Options?. Read more at www.schwab.com/oninternational, and be sure to follow Schwab and Jeff on Twitter: @schwabresearch and @jeffreykleintop. Mainland Chinese stocks, as well as those traded in Hong Kong fell amid waning expectations of accelerated stimulus measures from the country's central bank in the wake of the recent string of upbeat economic data, while resource-related issues found pressure as commodity exchanges announced measures to cool trading in raw materials, per Bloomberg. Elsewhere, South Korean securities and markets in India both traded lower.

The international economic calendar for tomorrow will be light, with 1Q GDP from South Korea and Hong Kong's trade balance slated for release.

Schwab Center for Financial Research ("SCFR") is a division of Charles Schwab & Co., Inc. The information contained herein is obtained from third-party sources and believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation, or a recommendation that any particular investor should purchase or sell any particular security. The investment information mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinions are subject to change without notice in reaction to shifting market conditions.