FINANCIAL REVIEW

Too Much Pie

Sinclair Noe — December 1, 2014

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

DOW – 51 = 17,776
SPX – 14 = 2053
NAS -64 = 4727
10 YR YLD + .02 = 2.22%
OIL + 3.22 = 69.37
GOLD + 44.30 = 1213.80
SILV + .88 = 16.56

Last week I said that you can never eat too much pie. I would like to amend that statement.

That was a long weekend. While we were gone, the Dow hit another record hit on Friday, the 31st of the year. Dow stocks are still up about 7% for 2014; with all these record high closes, you might think it would be more, and you might think you could just throw a dart at any of the Dow 30 stocks and hit a winner. Unfortunately, not all Dow stocks were able to revel in the year’s rallies. In fact, nearly one-third of the market’s companies had negative returns this year. Big names that are down, including: Boeing – down about 7% despite fairly strong sales of airplanes, IBM – down 13% as they try to figure out what their business is, General Electric – is off about 6%, United Technologies – down about 3%, and Chevron – down about 6% for the year as oil prices have been sliding.

The oil companies are about the only ones not happy with lower oil prices. On Thursday, as we were enjoying turkey and way too much pie, OPEC was meeting in Vienna and they decided to leave oil production unchanged. That sent oil prices down big on Friday. Then early today, prices dipped all the way down to 63.72 a barrel before recovering to finish up 3.22 at 69.37. Earlier this year, most oil companies expected prices would remain above $90 a barrel; wham bam, next thing you know oil was under $80, and now there are more than a few oil related companies on the ropes and trying to figure out how low prices can go, and how they can survive.

Energy is a cyclical business, and adjusting production to lower prices and lower demand is not uncommon; companies did that in 2008 and 2009, when oil prices collapsed during the recession. Oil companies will have to adjust to lower prices. Right now we don’t know how low the bottom is, and it doesn’t make sense to try to catch a falling knife. Wait and let the market tell us.

The Federal Reserve is welcoming the sharp drop in global energy prices, with two influential policymakers saying today that it should provide a boost to American pocketbooks and shrugging off any pressure on already low inflation, with the thinking that any dis-inflationary problems will be temporary.

Someone’s income is someone else’s expense. Losers are those who were dependent on rising or steady oil prices. Winners are those who benefit from lower oil prices and lower prices for all the things whose cost is driven in part by the cost of oil. High-yield bonds dependent on higher energy prices are now at greater risk. You might consider separating energy-dependent flows supporting bonds from those that are not tied to the energy sector.

In the geopolitical arena, low oil prices have an enormous impact. Budgets of many foreign countries are coming under duress. Civil unrest is likely to increase in those countries due to their inability to fund subsidies that have acted to bribe the population. Look for more geopolitical turmoil worldwide and regime change in some countries. In others, dictators suppress the population with machine guns, so the unrest is below the surface until it explodes. Certainly lower prices tend to target oil producers such as Russia, and today Putin shot back by scrapping a major natural gas pipeline project scheduled to run through Bulgaria, in favor of a pipeline through Turkey. Putin said he was punishing Bulgaria for siding with the European Union. Meanwhile, the Ukrainian military accused Russian special forces of taking part in attacks on the strategically important Donetsk airport in eastern Ukraine, where fighting has intensified in recent days despite a September ceasefire deal.
The drop in oil prices is good news for most other businesses; great news for manufacturing firms and transportation companies; it might lift GDP by about 0.3 to 0.5 percentage points. And low prices are a real boon for most families. The cost of regular gas sank to a nationwide average of $2.82 a gallon from as high as $3.70 five months ago. In some areas gas prices have dropped to as low as $2.50 a gallon. By most estimates, lower oil prices put about $75 billion to more than $100 billion back in consumers’ pockets; it works out to more than a $1000 dollars for a typical household.

What are we doing with all that extra money? Well, we are not driving to the mall. Sales, both in stores and online, from Thanksgiving through the weekend were estimated to have dropped 11 percent, to $50.9 billion, from $57.4 billion last year, according to preliminary survey results released yesterday by the National Retail Federation. Sales fell despite many stores’ opening earlier than ever on Thanksgiving Day, or maybe sales fell because so many stores were opening earlier; it might have been backlash for trying to intrude on our holiday, and in support of retail workers who most likely wanted to spend a little time away from the store; or maybe it just smacked of desperation. American shoppers have keen instincts, and if we suspect retailers will buckle, we have the patience to wait them out; maybe shoppers smelled blood.

Whatever the case, sales were down big. Overall, 133 million people shopped or planned to shop at stores or online over the four-day weekend, 5.2 percent fewer than last year. And shoppers spent an average of $380.95 over the four days, 6.4 percent less than the $407.02 they spent last year.

And though many retailers offered the same aggressive discounts online as they did in their stores, the web failed to attract more shoppers or spending over the four-day holiday weekend than it did last year. The average person who shopped over the weekend spent $159.55 at online retailers, down 10.2% from last year. At least that’s the best guess. The survey of shoppers is subject to revision, and has not always been the most reliable indicator. Still it doesn’t look good.

And now, Cyber Monday, well, we’ll just wait and see. One of the twists this year is that more people will make Cyber Monday online sales with their smartphones. On Cyber Monday in 2013, 38% of shoppers said they used smartphones to shop, up from 23% in 2012.

If you really want to find a deal, try a mortgage. New guidelines go into effect today aimed at making mortgage lending easier. The new standards stem from an agreement in October put in place to clarify when banks would be penalized for making mistakes on mortgages they sell to Fannie Mae and Freddie Mac. Banks became more risk averse after the mortgage meltdown, and very conscious of exactly what they are allowed to do and how they are supposed to treat loans. They apparently had very unclear guidance from Freddie and Fannie about the rules of the road, in terms of which types of mortgages were going to be acceptable for Fannie and Freddie to buy. Lenders have said this lack of clarity is why credit is tight and many consumers aren’t qualifying for loans. Demand for loans and the credit worthiness of borrowers have also forced banks to pull back on lending.

Banks are expected now to relax some of their credit requirements and give prospective borrowers more consideration, particularly those whose credit score took a hit because of one-off events, like loss of a job or a single large medical bill. Fannie Mae and Freddie Mac will soon give guidance to banks requiring only a 3% to 5% down payment from borrowers.

By now, we’ve all heard stories about how hackers have infiltrated major retailers and banks, and they are ready to steal your credit card numbers, and account numbers, and anything digital. Now comes word that hackers are trying to game the stock market. Security researchers say they have uncovered a cyber-espionage ring focused on stealing corporate secrets for the purpose of gaming the stock market, in an operation that has compromised sensitive data about dozens of publicly held companies. Cybersecurity firm FireEye says that since the middle of last year the hackers have attacked email accounts at more than 100 firms, most of them pharmaceutical and healthcare companies. Victims also include firms in other sectors, as well as corporate advisors including investment bankers, attorneys and investor relations firms.

The hackers only targeted people with access to highly insider data that could be used to profit on trades before that data was made public. They sought data that included drafts of Securities and Exchange Commission filings, documents on merger activity, discussions of legal cases, board planning documents and medical research results. The victims ranged from small to large cap corporations. Most are in the United States and trade on the New York Stock Exchange or Nasdaq. The cyber-security firm declined to identify the victims. It said it did not know whether any trades were actually made based on the stolen data.

Looking forward, lawmakers returned to Capitol Hill today; they have less than 2 weeks to figure out how to keep the government funded. With government funding set to expire Dec. 11, top Democrats and Republicans had hoped to pass a so-called omnibus measure that would tie together tailored spending bills to fund the government through September 2015, the end of the fiscal year. So, they will try to cram 2 years of business into the next 2 weeks. Just a reminder that they had some temporary extensions on tax cuts that are scheduled to expire at the end of the month, assuming that the government is still open for business.

Friday brings the monthly jobs report. The economy has settled nicely into a hiring groove since the early spring, adding more than 238,000 jobs a month and putting the US on a path to produce the strongest employment gains in 15 years. Friday’s report is expected to show another 230,000 jobs added to the economy in November.