FINANCIAL REVIEW

Up, Down – Take Your Pick

Sinclair Noe — February 4, 2015

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

DOW + 6 = 17,673
SPX – 8 = 2041
NAS – 11 = 4716
10 YR YLD + .02 = 1.80%
OIL – 4.49 = 48.56
GOLD + 8.80 = 1269.90
SILV + .06 = 17.43

ADP reports private-sector employment gains slowed in January as employers added 213,000 jobs. ADP revised December’s gain to 253,000 from a prior estimate of 241,000. The non-farm payroll report (that’s the government’s big monthly jobs report) comes out Friday morning; it is expected the economy added about 245,000 jobs in January, down from 252,000 in December.

The Institute for Supply Management said its nonmanufacturing index edged up to 56.7% in January from 56.5% in December. Readings over 50% signal that more businesses are expanding instead of contracting. The good news is that new orders remained very healthy. The index measuring fresh demand rose a few ticks to 59.5% and remained close to a post-recession high. On the downside, the employment gauge fell 4.1 points to 51.6%, marking the lowest level in 11 months. It was also the second worst reading in 20 months. So, on the jobs front, we should still see gains, just not as strong as the past few months.

Gallup’s Job Creation Index came in at plus 28 for the month of January. This is nearly identical to the plus 27 found in December, and just below the seven-year high of plus 30 reached in September. The index has experienced six years of incremental progress after bottoming out at minus 5 in February and April 2009. Gallup says workers’ perceptions of hiring at their places of employment are the most positive Gallup has recorded in any January since Gallup began tracking this in 2008. Americans’ confidence in the economy has improved significantly since early December, and over the same period, Americans have become much more optimistic when asked if it is a good time to find a quality job. Whether these sentiments prove to be advance indicators of hiring that is more visible across U.S. workplaces may partly depend on whether they help fuel more consumer spending.

Oil prices were down today following a rally that pushed up prices by about 22% over the past four sessions (which would technically qualify as a bull market). Drilling activity plunged in the US and oil companies deepened spending cuts to more than $40 billion since Nov. 1. US crude stockpiles increased last week from the highest level in three decades, adding an extra 6 million barrels to inventory. And prices dropped 8% today. So, the question is where are prices headed? I’ve been reading stories all day about the direction of oil prices. Some say the past few days are nothing more than a dead cat bounce or a short squeeze; others claim this is the start of a “V” shaped recovery and prices are going back to triple digits. Up, down – take your pick. I don’t know, the people writing the stories don’t know.

One reason oil prices have dropped is because the dollar has been getting stronger and oil is purchased in dollars; a strong dollar means it requires fewer dollars to purchase the same amount of oil. The Dollar Index is up about 20% since last summer. Oil prices are down about 50% over the same time. It doesn’t quite match. Another thing that doesn’t quite match is all the other stuff we buy that is imported. We’re buying imports with strong dollars.  Why isn’t all that stuff, not made in America, lower in price?

The thing is, the dollar index is measured against a basket of six currencies including the euro and the Japanese yen. If you look at the stuff Americans buy, they’re from countries that aren’t represented in the dollar index; such as: China, Mexico, India, Vietnam and Israel. Almost 80% of U.S. consumer-goods imports, excluding autos, come from countries that aren’t in the dollar index. Comparing against those countries, the dollar is up about 7% and import prices are down about 5.5% So, a strong dollar is just a small part of the reason for lower oil prices.

Even if prices went up from here it might not be enough to save some of the producers and their creditors. And if prices go lower, it might not affect production as you might imagine. Two weeks ago, Baker Hughes announced it was cutting 12% of its workforce and 15% of its output, but previous downturns have resulted in 40% to 60% cuts. At the same time BHP Billiton announced it was cutting the number of rigs it operates in US shale oilfields from 26 to 16, but it would take a few months to cut back, and even after the cutbacks “the company does not expect the slowdown to have an immediate effect on its oil and gas production, which it still expects to average about 700,000 barrels of oil equivalent per day.”

Yes, over time, lower prices will affect production, but over the intermediate term, creditors will demand payments and that means the pumps keep pumping, even at little to no profit. Revenues will have to cover obligations. Debt must be serviced.

Over the last five years, oil and gas companies have issued bonds and taken out loans that are together worth $1.2 trillion, according to data from Dealogic. Back in the 1980s oil crash about 700 banks failed, mainly smaller, regional banks in Texas. Now, there are some smaller Canadian banks and a few Texas-based regional banks with concentrated exposure to the oil patch, but losses are not expected to approach the 80s, and the other creditors are the mega banks that can withstand a few billion in losses.

Still, the sharks are already smelling blood. Several private equity firms such as Carlyle, Blackstone, and KKR are taking on large positions in indebted oil companies. There are already examples of these firms providing emergency loans at very high rates plus an ownership stake. At the recent Davos World Economic Forum, David Rubenstein, co-founder of the Carlyle Group said “The single best opportunity to invest is distressed debt in energy.”

But the energy companies are not going to give up easily. The squeeze is tightest when companies face a deadline to pay back money they have borrowed. And they may be forced to maintain or increase production.

And moving beyond the supply demand equation, yesterday, the New York Times reported that Saudi Arabia has been trying to pressure Russian President Putin to abandon his support for Syrian President Bashar al-Assad, using its dominance of the global oil markets at a time when the Russian government is reeling from the effects of plummeting oil prices. A Saudi diplomat was quoted saying, “If oil can serve to bring peace in Syria, I don’t see how Saudi Arabia would back away from trying to reach a deal.” None of this is a revelation; we talked about oil as a financial weapon back when Russia was first posturing in Ukraine. Any weakening of Russian support for Assad could be one of the first signs that the recent tumult in the oil market is having an impact on global statecraft.

Here’s the point: if anyone says they know what oil prices are going to be, they are wrong.

A funny thing happened today with Greece. The Athens General Stock Index closed up today by about 7%. Then this afternoon in New York, right before the close, the ETF that is based on Greece, the GREK, suddenly plunged about 11%. The European Central Bank announced that it will no longer accept Greek government debt as collateral starting next week. The ECB said it is presently impossible to assume a successful conclusion of the current Greek program. In other words, the ECB doesn’t see Greece complying with existing bailout rules.

But the governing council also approved the Greek central bank issuing Emergency Liquidity Assistance to the Greek banking system to cover any liquidity shortfall caused by today’s move. This means Greece could still get money, but they will pay more for it, and it is just a temporary Band-Aid. This also means that the money spigot could be turned off if Greece’s new government doesn’t behave the way the ECB wants. Unless the 15 billion-euro limit on short-term borrowing set by Greece’s troika of official creditors is raised, the government may run out of cash on Feb. 25. With Greeks yanking their cash from banks and withholding tax payments, it is thought the new Greek government would only be able to survive for a few more weeks by tapping social-security funds and withholding payments to vendors.

The Greeks may be able to survive this, provided there is not a run on their banks. It basically boils down to political hardball. The Greeks were hoping to rewrite their debt. The Troika has now slapped down that plan.

General Motors reported a 91% jump in its fourth-quarter profit, beating analyst expectations. GM said it plans to boost its dividend starting in the second quarter. Later this month, GM will pay about 48,000 U.S. hourly workers profit sharing checks of $9,000 based on its 2014 financial performance. Fourth-quarter profit earnings before dividends rose to $1.99 billion compared with $1.04 billion a year earlier. Excluding some charges, the company earned $1.19 a share, handily beating analyst estimates of 83 cents a share.

Ford is adding 1,500 workers across four plants to build the new F-150 pickup truck and plans on shifting hundreds of union-represented workers from entry-level wages to the pay veteran plant workers make, in the coming weeks.

Staples has agreed to buy Office Depot for $6.3 billion. The deal values Office Depot at $11 a share, a premium of 44% over the closing price of Office Depot shares as of Monday. Together, the two companies have roughly 4,000 stores and annual sales of more than $35 billion. A merger would almost certainly reduce competition, result in some store closings, and mean higher prices for consumers. A combination of the two likely would get a close look from antitrust regulators, who in 1997 sued successfully to block the same proposed merger.