Goodbye Patience
DOW + 27 = 17,902
SPX + 5 = 2081
NAS + 40 = 4950
10 YR YLD un = 1.89%
OIL – 3.05 = 50.93
GOLD – 5.50 = 1203.20
SILV – .32 = 16.61
We start today with a big acquisition in the oil industry. Royal Dutch Shell agreed to buy BG Group for about $70 billion in cash and shares, the oil and gas industry’s biggest deal in at least a decade; since 2004 when Royal Dutch Shell was created. This is the biggest acquisition this year and the 10th biggest M&A deal overall, and the fourth biggest deal overall in the oil industry. The merged company will boast a market value twice the size of BP, and even larger than Chevron. ExxonMobil is still the 800 pound gorilla with market cap north of $350 billion.
To win over shareholders, Shell pledged cost savings of $2.5 billion, asset disposals of at least $30 billion within four years and a giant buyback of $25 billion from 2017 to 2020. Shell investors reacted coolly to the deal. Shell’s B shares, the class of stock being used to finance the deal, fell about 7% percent in London. For BG it represents a 50% premium.
BG Group is the exploration part of the former state owned British Gas that was privatized by Margaret Thatcher in the 1980s. British Gas was split into BG and Centrica. The new company will be the largest producer of liquefied natural gas, or LNG, among international oil companies. Shell pioneered the process of liquefying gas for shipment aboard tankers decades ago, and rivals such as Chevron are betting LNG will play an increasing role in emerging economies seeking alternatives to dirtier energy sources such as coal. The deal will still need antitrust approvals from regulatory agencies in Australia, China, Brazil and the EU.
This is a very interesting deal for many reasons, not the least is the downturn in oil prices over the past year, which has been devastating for smaller or less strategically positioned companies in the oil industry. Case in point: Noble Energy just announced it is cutting 220 jobs across the U.S., with around 100 losses at the oil company’s Houston headquarters and another 100 or so at its Colorado operations. The cuts represent 10% of Noble’s 2,200 U.S. employees. The news comes after the firm said earlier this year that it was planning to slash spending by 40%.
The roughly 50% premium paid for BG Group would make sense with oil priced at $90 a barrel, which is not the current price. Of course we could see oil prices skyrocket; the situation in Yemen is a stupid mess and that is right at a chokepoint to the Red Sea; and that is just one of many potential hotspots. Absent a geopolitical flare-up, the price of oil is not likely to zoom in the face of excess supply and moderate demand. Saudi Arabia is reporting it raised oil output to 10.3 million barrels a day in March, the highest in at least 12 years, and intends to keep producing 10 million barrels per day despite low crude prices. The Saudi oil minister says he believes oil prices will rise in the “near future”; maybe, but right now there is a glut.
America’s oil in storage just hit another record after rising by the most since March 2001. Stockpiles rose by almost 11 million barrels, or 2.3%. Analysts had expected an increase of 3.25 million barrels. The EIA report today showed the amount of oil the U.S. is cranking out also edged up slightly, to a rate of 9.4 million barrels a day. Investors have been closely watching the oil gather in storage tanks, which has been rising steadily since the oil-price crash started last year. U.S. crude production has been at the highest in decades even as drillers have made unprecedented reductions in the number of oil rigs out drilling new wells.
The last time we saw deals of this size was in 1999 when Exxon and Mobil merged at a cost of $83 billion and BP bought Amoco for $48 billion. Back in 1998, oil was priced closer to $12 a barrel, and the deal making marked a trough in prices. Shell CEO Ben van Beurden said the deal is “not a bet on the oil price.” You can believe that if you wish, but I doubt they would have made the deal if they thought oil was going to $30 a barrel for an extended period.
So oil prices are important but not the only thing. In the past 12 months, the oil majors have had to deal with the consequences of events in Ukraine and the Crimea as well as western government sanctions on Russia and the effects these sanctions have had on the profitability of their assets exposed to those sanctions. Shell was likely attracted by BG’s deepwater assets in Brazil and its LNG portfolio. BG Group is one of the world leaders in LNG and recently completed a $20 billion facility in Australia. The combination of Shell and BG will result in a portfolio that controls roughly 16% of the global LNG market. The LNG market is crucial for Europe; if Russia can’t or won’t meet Eurozone needs, this is an opportunity for Shell to seize market share. So, it looks like Shell is diversifying away from its core oil business, at a time when oil and gas exploration is becoming increasingly expensive in terms of profitability.
Earnings season is back. Alcoa unofficially kicks of quarterly earnings; a traditional thing; the aluminum company used to be one of the Dow 30 stocks; ticker symbol AA; they go first. Alcoa beat earnings estimates by a couple of cents per share but posted a slight missed on revenue projections. Overall, S&P 500 earnings for the first quarter are forecast to have dropped 2.8% from the year ago quarter, which would be the worst performance since the third quarter of 2009.
The Federal Reserve has released minutes from the FOMC policy meeting in March. That was the meeting where the Fed dropped the term ”patient” from the language surrounding policymakers’ approach to future interest rate hikes. At the time, Janet Yellen said that axing patient “does not mean we are going to be impatient.” Today’s minutes reveal that some policymakers are indeed impatient, ready to raise rates in June; others are very patient indeed, and a couple don’t like the idea of rate hikes at all. So, not much new in the minutes. As we suspected the Fed has not made up its collective mind about rate hikes even as they take a very small step closer to a hike. Uncertainty at the Fed is a recipe for volatility in the markets.
In other words, we could see markets moving in multiple directions, and some of the moves might even seem contrarian. While higher target rates from the Fed would likely slow economic activity by making borrowing costs higher, it would also signal that the economy is stronger and it would push the dollar higher. That would signal the world to bring their money to America – the safe haven play.
Switzerland today became the first country ever to issue 10-year debt that gives investors a yield under 0%. Several European countries inside and outside the Eurozone have sold government debt with up to five years of maturity at negative yields, which means investors effectively pay for the privilege of buying it. But no other country has previously stretched this out as long as 10 years. For Eurozone investors they have the option of paying Switzerland to park their cash, or coming to the US, letting the Treasury pay, plus arbitrage on a strengthening dollar.
So, it is possible that rates could move lower, even as the Fed moves closer to hiking rates. And some people argue that the Fed doesn’t really set interest rates, the bond market does. There is another old saying: “don’t fight the Fed.”
What does that mean for you? Well, if or when rates go up, investors will be able to buy newly issued bonds generating higher streams of income in the not so distant future. That means bonds go down in price, and bond funds go down.
It also means that personal debt becomes more expensive. Take a look at the makeup of your debt, too. Is your mortgage a floating rate loan? Do you have any other floating rate debt? If so, this might be the right time to lock it in place at a low rate. Mortgage rates are the lowest that many lenders have witnessed in their lifetimes; given the Fed’s clear signals, do you really want to delay acting on this? If you’ve been contemplating taking out a loan to make some home improvements, to buy a second home, or for some other purpose; and assuming that you’re in a financial position to handle the payments of course; this is probably a good time to think about the timing of your plans.
It might already be happening. The Federal Reserve reports consumer credit grew at a seasonally adjusted annual rate of 5.6%, for a gain of $15.5 billion in February. This is the fastest pace of growth since October. All of the increase came from non-revolving debt, like car and student loans, which grew at a 9.4% rate up – from a 5.8% rate in January. This is the fastest pace since February 2013. Revolving, or credit-card, debt declined at a 5% rate in February, after a 1.4% decline in the prior month. This is the biggest decline in credit card loans since April 2011. So, in a strange twist, the threat of higher rates is starting to cause increased credit activity; but that is likely temporary.
Over the longer term, higher rates mean less affordable homes and cars. Higher rates mean anything financed costs more. Higher rates mean a higher dollar and that means less profit for multinationals. The direction is clear, and most of us can see it. A CNBC All America Economic Survey shows 27% of Americans judge the economy as excellent or good, the highest level in eight years, up from 16% at this time last year. Looking forward, only 28% of Americans believe the economy will get better in the next year, well below the post-recession high of 36% in March 2012. Things are pretty good now but the road ahead is not so certain. Goodbye patience, hello uncertainty and volatility.
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