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Friday, January 29, 2016

Cat Herders in the Oil Patch

Financial Review

Cat Herders in the Oil Patch

DOW + 125 = 16,069
SPX +10 = 1893
NAS + 38 = 4506
10 Y – .02 = 1.99%
OIL + 1.43 = 33.73
GOLD – 9.70 = 1116.00

The story of the day was oil, and it made for another ridiculous day of trading, dragging stocks up and down in its wake. Oil rose as much as 7.8% after Russia’s energy minister said that OPEC and other producers may meet to discuss output. Then, OPEC delegates said no talks were planned and oil prices floated back down to earth.

OPEC is comprised of countries that rely on oil to fund national budgets. So, low oil prices have resulted in national deficits and desperate times. Several countries would probably welcome production cuts that might lead to higher prices but then you have Iraq pumping like never before; and then add Iran to the mix.

Iran has put the finishing touches on a deal to buy over 100 Airbus passenger jets. Iranian President Hassan Rouhani is in Europe, trying to revive business ties. Rouhani visited Italy with a 120-member delegation of business leaders and cabinet ministers, signing a raft of deals. The shopping trip then moved to France to buy planes. Peugeot is also scheduled to meet with the group.

All those planes and cars cost money. Iran will be adding to production, not cutting.  And that means that if Saudi Arabia cuts production, the void will simply be filled by Iran. The Saudis would lose market share with no commensurate increase in prices.  And the whole idea of coordinated production cuts is as realistic as herding cats.

So there is plenty of supply, but still no signs of demand. The world’s biggest oil companies are asking tanker operators to slow down delivery of crude. Tankers hauling 2 million-barrel cargoes are delivering them at speeds of about 13 knots, compared with a maximum of 15. The slower speeds might result in a voyage that would normally take 40 days, instead lasting 48. On-shore storage tanks are full and the oil tankers are serving as off-shore storage facilities.

Global economic growth is the driver for oil demand, but growth has slowed even faster than the oil tankers. It is difficult to determine the exact extent of the slowdown; the numbers from China might be less than accurate but there are other ways to measure. Whether you look at the Baltic Dry Index, the Shanghai Shipping index, or the US or European Air Freight statistics, or even the freight reports by US railroads the data all points to one conclusion: there is a big slowdown in the delivery of raw materials and finished products.

Demand for long-lasting “durable” goods sank in December, reflecting a downturn in business investment. Orders for durable goods fell a seasonally adjusted 5.1% last month, marking the biggest decline in a year and a half. The larger-than-expected decline could result in fourth-quarter growth turning negative. Orders for so-called core capital-goods, which strip out aircraft and defense, dropped 4.3% in December. For the full year they decreased 7.5%, erasing a 5.8% gain in 2015. It was the first annual decline in three years.

The Federal Reserve FOMC wrapped up its two-day policy meeting yesterday afternoon. The Fed left interest rates unchanged. In a written statement, policymakers said “economic growth slowed late last year,” and the risks are no longer balanced between an economy picking up steam and one slowing further.

We talked about that yesterday; you know that. Now here is the part of the Fed statement you did not hear about but it is probably the most important part. The Fed wrote: “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way.”

Here is why that sentence is so important. Wall Street tracks the Federal Reserve’s balance sheet.  If you have been paying attention over the past 7 years, you know this.  Overlay a chart of the balance sheet on the S&P 500 and it is clear that you are looking at mirror images. And right now, the Fed’s balance sheet is flat lining with a hint of downward movement.

Initial jobless claims fell last week after touching a seven-month high earlier in January. Initial jobless claims declined by a seasonally adjusted 16,000 to 278,000 in the week ending January 23. The four-week average of initial claims also tacked lower, down 2,250 to 283,000. New claims remain at very low levels. The number of people applying each week for benefits has dropped more than 50% after hitting a 27-year high of 665,000 during the tail end of the Great Recession.

So, why is the job market looking strong in the face of all this negative news? The simple answer is that US companies are still making money.  According to FactSet Research, the trailing 12-month net margin of S&P 500 companies is 9.8%, which is above the 8.8% average over the last decade. Part of the problem for stocks is that, while we are still seeing earnings, the growth of earnings has slowed.

It is now estimated that fourth quarter earnings for the S&P 500 will decline 6.1% from the year earlier quarter. About a third of S&P 500 companies have now reported and the index is on track for a median 3.5% decline in sales, according to FactSet data. Companies are still making money, just not as fast as a year ago.

Today is the busiest day of the earnings reporting season.’s holiday quarter profit missed Wall Street’s estimates by a wide margin. Fourth-quarter net profit rose to $482 million, or $1.00 per share, in the quarter ended Dec. 31 – marking its largest quarterly profit on record – up from $214 million, or 45 cents per share, a year earlier. It was the first time Amazon has reported three consecutive profitable quarters since 2012. Profit was well below estimates of $1.56 a share. Net sales rose 21% to $35.7 billion, but missed analysts’ expectations of $35.9 billion. Amazon shares were smacked 12% in after-hours trade.

Microsoft reported quarterly revenue and profit that beat analysts’ expectations. Total revenue, however, fell 10% to $23.8 billion, squeezed by a strong dollar as well as a weak personal computer market that has reduced demand for Microsoft’s Windows operating system. On an adjusted basis, revenue fell to $25.69 billion. Net income fell to $5 billion; excluding items, the company earned 78 cents per share, 7-cents better than estimates.

Ford Motor reported fourth-quarter net income of $1.9 billion, or 47 cents a share, swinging from a loss in the prior-year period and beating estimates. Ford’s North America operations posted record sales, as lower oil prices helped drive demand for Ford pickup trucks.

Harley-Davidson reported net income of $42.2 million, or 22 cents a share, in the fourth quarter, down from $74.5 million, or 35 cents a share, in the year-earlier period. Revenue also dipped slightly, but the results were good enough to top analysts’ estimates.

Caterpillar reported better-than-expected adjusted earnings for its fourth quarter, though its revenue missed expectations. Caterpillar said it now expects its revenue to fall by about 10% to a range of $40 billion to $44 billion. In October, the company had forecast a 5% sales decline for 2016, with lower sales of mining equipment accounting for two-thirds of the damage. The decline would mark its fourth straight year of lower sales, a record for the company. Still, Caterpillar forecast better than expected earnings of $4 a share for 2016.

Under Armour posted double-digit revenue and profit gains in its latest quarter on strong footwear and apparel sales; they also raised their 2016 revenue guidance. Apparel sales climbed 22% to $864 million, led by growth in training, running, golf and basketball. While more than 90% of the company’s revenue is North America-based, foreign revenue increased 70%.

Samsung Electronics’ fourth-quarter earnings displayed a sharp slowdown in profit growth from chips, signaling challenges ahead as the tech giant continues to grapple with weak smartphone sales. Net profit in the December quarter fell 40% to $2.7 billion, short of market expectations. Samsung also warned of a “difficult business environment” and “weaker IT demand,” joining Apple in foretelling a downbeat 2016 for the technology sector.

On Tuesday, Freeport McMoRan reported a net loss for the fourth quarter of just over $4 billion. The company already suspended its dividend and made deep cuts in capital spending and copper production; with the release of Q4 results they also said they were looking to sell interests in certain mining assets to help reduce debt, which stand at about $20 billion, nearly 4 times its market value of $5 billion.

Yesterday, Moody’s cut more than $9 billion of Freeport McMoRan’s debt to a senior unsecured rating of B1, from Baa3, and a resulting negative outlook; that’s a move from investment grade to junk. Moody’s wrote: “At this time no meaningful catalyst is seen that will improve the overall market dynamics given weak global growth rates and slowing demand in China.”

Salt on the wound: reports today that the company’s export license in Indonesian has expired without extension. The Indonesian government is waiting for Freeport-McMoRan to respond to its request for a $530 million deposit toward building a new smelter.

American Airlines has expanded its refunds for pregnant customers visiting areas impacted by the Zika virus to include Puerto Rico, Martinique and nine countries in the Americas and Caribbean. There is no vaccine or treatment for Zika, and an estimated 80 percent of people infected have no symptoms, but the problem is birth defects.

More than 4,000 cases of microcephaly have already been reported in Brazil. The World Health Organization is warning that the virus is “spreading explosively” and could infect as many as 4 million people in the Americas.

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