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Friday, January 22, 2016

Might Sound Crazy

Financial Review

Might Sound Crazy

DOW + 210 = 16,093
SPX + 37 = 1906
NAS + 119 = 4591
10 Y + .03 =  2.05%
OIL + 2.57 = 32.10
GOLD – 3.60 = 1098.80

Stock markets all over the world are in rally mode. European shares enjoyed the biggest two-day rally since 2011, while the euro approached a two-week low on the European Central Bank’s signal that it may bolster economic support as soon as March.

Asian stocks climbed the most since September on speculation Japan and China may also take steps to calm markets.  Japan’s Nikkei (+5.9%) paced the gains in Asia as it posted its biggest gain in 4 1/2 months. The Hang Seng in Hong Kong gained 3.5%, and the Shanghai in China was up 1.25%.

In Europe, France’s CAC (+3.1%) leads the charge. The Stoxx Europe 600 Index rose 3.1 percent, rallying 5.1 percent in two days.

The Dow posted its first weekly gain in a month; not much, just 105 points, or 0.6%. After dropping earlier this week to 2014 lows, the S&P 500 has recovered in the past two sessions to end the week 1.4-percent higher. But the index is still down 7 percent in 2016 and remains at levels touched last August.

The 2016 Treasuries rally slowed this week on concern yields that fell to within about half a percentage point from a record low made the market too expensive. Treasuries posted their first decline in three weeks. The likelihood of more Fed rate hikes took a hit yesterday after the European Central Bank indicated it may provide more economic stimulation at its next policy meeting in March.

The probability the Fed will increase its benchmark by its April meeting has dropped to about 32 percent, down from 56 percent at the end of last year. The central bank’s Open Market Committee is set to announce its next rate decision on Jan. 27.

Oil’s in a bull market. I know that sounds crazy, but check the numbers. West Texas Intermediate crude oil is back above $32 a barrel after today’s gain of more than 8%. Oil has staged a tremendous rally off Wednesday’s low of $26.19 climbing to $32.10 a barrel today; that’s a 21% gain, and the definition of a bull market is a 20% gain.

It certainly doesn’t feel like a bull market, and typically it takes more than 3 sessions to establish a bull market. And while it is possible that Wednesday marked the low price for oil, the rally feels more like speculators have jumped in, trying to time a low or covering short positions.

The rally has been too fast for the oil companies to catch up with the commodity. Over 99% of 559 oil and gas companies are in a bear market. Furthermore, one-third of those companies have fallen over 90% from their highs, which is an indicator of potential bankruptcy issues.

Earlier this week the American Petroleum Institute and the Energy Information Administration both reported inventories of crude oil increased by more than 4 million barrels over the past week. It seems counter-intuitive; more supply, no increase in demand, and the price moved higher this past week. The problem is that many of the US oil producers are adding supply even though they aren’t making money.

Oil drilling is a capital-intensive business. Many of the newer producers issued debt to fund operations, and now they are forced to keep pumping, even at a loss, in order to service the debt. Standard & Poor’s estimates that 50% of energy junk bonds are “distressed,” meaning they are at risk of default. Unless prices change soon, many are just postponing the inevitable.

Since the beginning of 2015, 42 oil companies have gone bankrupt and the ones that haven’t are feeling enough financial stress to slash spending and cut tens of thousands of jobs. And if we start seeing even more defaults, that will impact the banks.

In the past week, we saw the earnings reports from the big banks. Wells Fargo lost $90 million from its portfolio of oil and gas. JPMorgan nearly doubled its loss provisions in the fourth quarter, an extra $124 million, mostly due to bad energy loans, with a warning that reserves might need to be increased to $750 million. Citigroup set aside reserves of $300 million for bad energy loans, and they are bracing for losses up to $600 million in the first half of 2016; if prices hold around $25 a barrel, they reckon they will need to set aside $1.2 billion.

It doesn’t seem far-fetched that banks might want to prop up oil prices. Or, as JPMorgan CEO Jamie Dimon recently said, “To the extent we can responsibly support clients, we’re going to. And if we lose a little bit more money because of it, so be it.”

Now, here’s where it gets interesting for you. Since the beginning of December, the price of oil has mirrored the S&P 500. When oil goes down, the S&P 500 index drops; when oil goes up, stocks move higher in lockstep. This is not the norm. Typically, there is an inverse relationship; when oil goes higher, stocks tend to fall because businesses face higher energy costs which cut into the bottom line; when oil drops, businesses get a break on margins.

In the past, higher oil has acted as a drag on the economy. Look at any recession over the past 60 years and it was preceded by, or coincided with higher oil prices. So, what we are seeing now, with oil and stocks moving in lockstep, is an anomaly. Now, here is a further disconnect; demand for oil is still growing; yes, it has slowed, but it is still growing. One of the things the market is really good at is reversion to the mean.

The National Association of Realtors reports purchases of previously owned U.S. homes rose more than projected in December, helped in part by warmer weather and wrapping up the best year since 2006. Contract closings jumped 14.7 percent, the most on record, to a 5.46 million annualized rate, and for all of 2015, sales climbed to 5.26 million from 4.94 million.

The median price of an existing home rose 7.6 percent from December 2014 to reach $224,100. The number of previously owned homes on the market dropped to 1.79 million last month. At the current sales pace, it would take 3.9 months to sell those houses, the lowest since January 2005 and down from 5.1 months at the end of the prior month. Less than a five months’ supply is considered a tight market.

Now, the big question to start the year is whether low oil prices will drag the stock market down or subsequently if a falling stock market will drag the economy into recession. As I said earlier, low oil prices are an aftermath of recession, not a predictor. And when we look at existing home sales, this is another indicator of a strong economy.

Any discussion of the business cycle should pay close attention to consumer spending, and not just how many people are going to the local mall, but rather the big ticket items, such as automobiles, which just finished a record year for sales, and even more important, private investment in residential real estate.

Residential investment tends to lead the economy, equipment and software is generally coincident, and nonresidential structure investment lags the business cycle. Usually residential investment would turn down before a recession, and that isn’t happening right now. Instead residential investment is starting to increase.

A massive winter storm is barreling toward Washington D.C., with the system poised to drop near-record snowfall on the U.S. capital before walloping other cities with blizzard conditions. The National Weather Service described the storm as “potentially crippling” for a swath of the Northeast, with snowfall exceeding two feet in many metro areas.

We are already seeing snow and ice in North Carolina, and power outages in Charlotte. Airlines preemptively canceled more than 4,500 flights before the first snowflakes had even fallen, and now it looks like 6,000 cancelled flights for the weekend.

General Electric reported fourth-quarter before the opening bell. GE posted net earnings per share of $0.64 on revenues of $33.9 billion. In the same period a year ago, GE reported EPS of $0.56 on revenues of $42.0 billion.  A big beat on both earnings and revenue.

Apple is no longer the world’s largest public company, when defined by enterprise value, which includes debt and subtracts cash to give a more complete picture of a firm’s worth. Alphabet overtook Apple in December and is now valued at $420 billion compared with Apple’s $393 billion. Measured by market cap, Apple still remains bigger, at $560 billion versus Alphabet’s $498 billion. Meanwhile, Tim Cook made a surprise visit to Brussels yesterday, as EU regulators close in on a final decision about the company’s Irish tax deals.

Amazon is stepping up its investment plans across Europe this year, seeking to develop its digital media, grocery delivery and cloud businesses. Amazon hired a record 10,000 people across Europe in 2015 – taking its workforce above 41,000.

Regulators have temporarily banned health insurer Cigna from offering certain Medicare plans to new patients after a probe uncovered issues with current offerings. The insurer disclosed late Thursday in a public filing that the Centers for Medicare and Medicaid Services (CMS), had suspended the company from enrolling new customers or marketing plans for Cigna Medicare Advantage and Standalone Prescription Drug Plan Contracts. The sanctions, which took effect at the end of the day Thursday, do not affect patients who are already enrolled.

Automakers recalled a record 51.26 million vehicles in the United States last year. According to the NHTSA, that figure topped the 50.99 million vehicles called back in 2014, meaning that the recalls in each of the past two years surpassed any annual total logged by federal regulators in nearly five decades.

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