FINANCIAL REVIEW

One Foot on the Gas, One Foot on the Brake

Sinclair Noe — January 30, 2015

 

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

DOW – 251 = 17,164
SPX – 26 = 1994
NAS – 48 = 4635
10 YR YLD – .08 = 1.67%
OIL + 3.25 = 47.78
GOLD + 25.00 = 1284.10
SILV + .31 = 17.33

GDP growth slows. The Commerce Department reports fourth quarter gross domestic product grew by 2.6%, down from a very strong 5% growth rate in the third quarter. The results were below consensus estimates of 3% growth. For all of 2014, the economy grew 2.4% compared to 2.2% in 2013.

Consumer spending advanced at a 4.3% pace in the fourth quarter – the fastest since the first quarter of 2006 and an acceleration from the third quarter’s 3.2% pace. The final read on the University of Michigan’s consumer sentiment index was 98.1, down a tick from the 98.2 in the preliminary estimate. That’s still above the 93.6 mark in December and the best reading in 11 years.

Just as consumers were stepping on the gas, businesses were tapping the brakes. Business spending on equipment fell at a 1.9% rate. It was the largest contraction since the second quarter of 2009. The fourth-quarter weakness could reflect cuts or delays to investment projects in the oil industry. But it could also be payback after two back-to-back quarters of robust gains.

A wider trade deficit, as slower global growth curbed exports and solid domestic demand sucked in imports, subtracted 1.02 percentage point from GDP growth in the fourth quarter.

That’s how it works when the rest of the world is moving to QE. Worldwide central bank stimulus now totals over $10 trillion dollars. The new buzz phrase is currency wars, or you could just call it competitive devaluation. Countries are competing against each other to achieve a relatively low exchange rate for their own currency. As the price to buy a currency declines, so too does the price of exports from the country and imports become more expensive. This allows domestic industry and employment to expand.

The downside of this is that price increases for imports can harm citizens’ purchasing power. A policy of competitive devaluation can also result in retaliatory action by other countries, which in turn, can lead to a general decline in international trade. For the US, the problem is that a stronger dollar is slowing GDP growth even as we see the benefits of lower oil prices to counter tougher export markets.

Inflation remains muted in the fourth quarter. In a separate report the Labor Department reports the personal consumption expenditures (PCE) price index fell at a 0.5% rate, the weakest reading since the first quarter of 2009. Excluding food and energy, prices rose at a 1.1% pace, the slowest since the second quarter of 2013. The strong pace of consumer spending in the fourth quarter was overshadowed by a drop in capital expenditure. The PCE is the inflation gauge used by the Federal Reserve, and it is telling the Fed not to rush into raising rates.

In Europe – Deflation. Eurostat today reported the largest decline in consumer prices in the eurozone since July 2009. Consumer prices were 0.6% lower than in January 2014, having fallen 0.2% on an annual basis in December.

European stocks slipped today on the deflation report, but the region’s equity benchmark was still on track for its best monthly performance in more than three years. The Stoxx Europe 600 is up 7.2% for the month of January, which would be its best since October 2011.

Russia’s central bank cut its key interest rate to 15% this morning, after announcing a surprise hike from 10.5% to 17% in December to shore up the weakening ruble.

European Union foreign ministers have extended existing sanctions against Russia, but held off on tighter economic measures for now. Last year’s travel bans and asset freezes will now continue until September. Any sanction require a unanimous vote by all the EU countries. There was some question about whether Greece would approve sanctions, but much of that was misreported. Greece did not oppose sanctions; the EU just never asked the Greeks, and the Greeks did not appreciate being neglected in that manner. It was really symptomatic of how the EU has dealt with Greece for several years now.

Meanwhile, Greece’s new, leftist government opened talks on its bailout with European partners today by flatly refusing to extend the program or to cooperate with the international inspectors overseeing it. Prime Minister Alexis Tsipras has repeatedly said he wants to keep Greece in the euro but he has also made clear he will not back away from election campaign pledges to roll back the terms of the bailout.

A funny thing happened today in the oil market, prices went up, and it was a fast move. There was a big drop in the number of US oil rigs. Baker Hughes reports petroleum producers took 94 oil-drilling rigs off the market in the United States this week as sub-$50 oil continued to wreak havoc on the oil industry. Prices jumped and then many traders probably decided to cover short positions on the last trading day of the month. This week’s drop left 1,223 oil units up, the lowest number in three years. It was the biggest one-week decline for oil rigs since 1987. That year, the oil industry had faced another oil bust that left hundreds of rigs idle or repossessed by banks, which sold them for scrap.

Earlier today, the Commerce Department reported investment in drilling rigs and wells climbed at an 8.9% pace in the fourth quarter after an 8.3% increase from July through September. Prices were going down in the fourth quarter and domestic oil producers were shrugging and pumping more. At least until just recently.

By the way, if you were wondering what lower oil prices mean for renewables, the quick answer is not much. Oil is for cars; renewables are for electricity. The two don’t really compete. The biggest limit to solar installations is the availability of panels. And even as gas prices have dropped, the price for electricity continues to go up. And that is the advantage of solar; as time passes, the efficiency of solar power increases and prices fall. It’s a technology, not a fuel.

And it would be crazy to believe oil prices will stay this low forever. The history of oil prices follows a golden rule: What goes down must come up. Goldman Sachs identified almost $1 trillion in investments in future oil projects that are no longer profitable with oil under $70 a barrel. American drillers are idling rigs faster than they have since 1991. Eventually, supply will shrink and prices will rise again.
Shares of solar and wind companies have been pulled down with oil prices. Still, global investment in clean energy increased 16% last year, to $310 billion. Fossil-fuel subsidies outpace renewable-energy subsidies by a factor of 6 to 1, and this represents a strain on government budgets, and not just here in the US. Reducing the subsidy gap is one of the cheapest ways to increase fuel efficiency and speed up the switch to cleaner energy.

And then that pesky problem of climate change isn’t going away. The U.S. and China reached a historic deal in November to rein in greenhouse gases. Pope Francis is preparing a papal encyclical on climate change, a letter to the world’s bishops that will formalize the church’s moral position on the issue for 1.2 billion Catholics.

With today’s move, oil prices are up 5.8% for the week, but still down 9.4% for the month.

For the week, the Dow was down 2.8%, the S&P was down 2.8% and the Nasdaq down 2.6%. For the month, the Dow was down 3.6%, the S&P fell 3.1% and the Nasdaq was off 2.1%. January marked the worst monthly performance for both the Dow and S&P since January 2014.The Dow has now dropped under support at 17,200 and the S&P has dropped under 2000.

Do you want to know how stocks might perform this year? A widely followed market theory, the January barometer, claims that as January goes, so goes the year. It worked two years ago; January 2013 was a positive month for stock prices, up 7%, and the market went higher for the year by 30%. January 2014, saw stock prices drop by 4%, and it didn’t work – prices were up last year by a little over 11%.

Interestingly enough, while an up January is generally bullish for stocks, a down January is not a reliable predictor of a weak year overall. In ten out of twenty-four weak January years, the stock market actually ended higher, often by a very substantial amount. Indeed, this has happened four times in the last decade alone.

Visa announced an 11.5% increase in profit during the quarter, as a strengthening U.S. job market and cheaper gasoline prices encouraged people to spend. Beating both top and bottom line estimates, net income rose to $1.57B from $1.41B, a year earlier. Visa also announced a four-for-one stock split, cutting its weight in the Dow from 9% to 2.5%.
(Here’s a little quiz. Q: Now that the weighting for Visa is dropping, which Dow Industrial stock has the highest price weighting? A: Goldman Sachs.) (Goldman Sachs and Visa both entered the Dow in September 2013, when the average was last reshuffled. Visa rallied 25% since it joined the gauge on Sept. 20, 2013, while Goldman Sachs gained 3.7%, compared with Dow’s 13% advance. So, Goldman has the highest weighting, due largely to underperformance.)

Shake Shack’s initial public offering priced well above expectations at $21 apiece, and in its first day of trading, the burger chain more than doubled to $48. Underwriters had set an expected price range of $17-$19 per share, up from an initial $14-$16 due to strong demand. At the IPO price, Shake Shack boasted a valuation of about $746 million. Following today’s gain, the market value is more than $1.7 billion. Shake Shack’s debut comes two days after a CEO change at McDonald’s Corp., which is mired in its worst US sales slump in more than a decade.
Next week brings more earnings reports including a slew of energy companies. Monday, we’ll get a report from the Institute for Supply Management. Auto sales are coming out on Tuesday. Next Friday we have the monthly jobs report.