Financial Review

Worst Ever

Sinclair Noe — January 7, 2016

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DOW – 392 = 16,514
SPX – 47 = 1943
NAS – 146 = 4689
10 Y – .02 = 2.15
OIL – .74 = 33.23
GOLD + 15.40 = 1110.20

The Chinese stock market was open for about 15 minutes; stocks dropped 5%, triggering circuit breakers, or rules that suspended trading. When trading resumed, it was all downhill and that triggered another level of circuit breakers, shutting down trading for the day; 29 minutes in total, the shortest session in Chinese market history.

Circuit breakers are a new idea for Chinese markets; they have only been used since Monday, the start of the New Year. Trading was halted on Monday for 30 minutes. We have circuit breakers in place on Wall Street, and the idea is to allow a cooling off period when stocks are in freefall. In the US, trading is halted temporarily after declines of 7% and 13% in the Standard & Poor’s 500 Index, and only suspended for the rest of the day if losses reach 20%.

In China, it only seems to make investors more nervous and they scramble to sell before getting locked out. After the trading halt, Chinese regulators decided to scrap the circuit breaker rule for the foreseeable future.

The Shanghai Composite Index finished down 7% at 3,125, bringing its losses over just four trading days to 11.7%. It is on track for the largest weekly loss since the week ended Aug. 21. Stock markets fell across the region: Hong Kong’s Hang Seng Index was down 3.1%, the Nikkei Stock Average lost 2.3%, Australia’s S&P/ASX 200 dropped 2.2% and South Korea’s Kospi was down 1.1%.

What’s triggering the panic selling?   The selloff was sparked after the central bank cuts its yuan reference rate by the most since August. China’s foreign reserves dropped by a record $108 billion in December as its defense of the yuan becomes costlier. The economy is decelerating to its slowest annual pace since 1990, but that’s been known for some time.

Analysts are predicting a 6.5% economic expansion this year, but the continued slide in the yuan is weighing heavily on investor sentiment, as it suggests all the government’s stimulus efforts aren’t working. A currency devaluation is seen as a last-ditch effort to boost exports, and the fear is China won’t be able to maintain its growth targets. Global equities have lost $2.5 trillion in value in the first three trading days of the year. It’s the worst start of a New Year for stocks since 2008, and we all remember that year.

Actually, with today’s losses, this is the worst start ever for the S&P 500 – ever.  Earlier today, George Soros compared the current market to 2008, and said the market is now “facing a crisis and investors need to be very cautious.” And then he went on to describe all the things we’ve been telling you about for some time here on the Review.

Of course the big question is where stocks go from here. Stocks are in a downtrend. The S&P 500 is down over 8% from its May high, but the average stock in the larger S&P 1500 was down 24% from its high as of yesterday’s close, according to new research from Bespoke Investment Group.

A bear market is defined as a decline of 20% or more, meaning the average stock has already reached. The S&P 600 Small Cap Index is down 27.6% from its 52-week high. In the midcap S&P 400, the average decline is 23.6%. The S&P 500, the benchmark for US stocks, hit a record high close of 2130 on May 21^st, or about 8%. But the stocks in the S&P 500 have seen an average decline of just over 20%.

Now the reason for the discrepancy between the index and the average stock in the index, is that the indexes are weighted to give greater importance to the larger stocks, and a few of the larger stocks have performed very well; specifically, the FANG stocks: Facebook, Amazon, Netflix, and Google/Alphabet.

The S&P 500 is trading below its 200 day moving average and the 50 day moving average. The next significant levels of support at 1867, the lows set back in August. Likewise, the Dow Industrials are below the 50 and 200 day moving averages. And we are heading into earnings reporting season with expectations for a 4.7% decline in fourth quarter earnings, which would be the third consecutive quarter of declining earnings.

And while any single day of trading isn’t likely to tell you where stocks are headed, trading in the month of January can give you a pretty good clue about the rest of the year. The idea is called the January Barometer, devised by Yale Hirsch, the founder of the Stock Trader’s Almanac, in 1972.

Simply put, if the Standard & Poor’s 500 index ends January with a gain, the odds favor a rising stock market for the year. But if stocks end January in the red for the month, there is a very strong probability the year will finish negative. According to Jeffrey Hirsch, the son of Yale and the current editor of the Almanac, “The January barometer has registered eight major errors since 1950 for an 87.7% accuracy ratio.”

The January Barometer is not a guarantee of performance for the year, just a look at probabilities. And it is still too early to say whether January will be positive or negative. And even if January shows losses, it doesn’t mean you should sell everything; it would just be an alert telling you to be cautious, make sure you have an exit strategy, and make certain you know just how much risk you’re willing to take.

Oil futures in New York slid to the lowest in 12 years with West Texas Intermediate dropping as much as 5.5 percent in overnight trading. Volatility in the oil market may increase today as tensions in the Middle East rise following Iran’s accusation that Saudi Arabia was responsible for a missile attack on its embassy in Yemen. Oil closed down 2.2% at $33.23. By the way, I paid $1.80 a gallon the other day to fill up the tank. When oil was trading at $100 a barrel, (in other words 3 times more than today) the price for a gallon was not $5.40. The oil companies are still ripping us off at the pump.

According to the World Bank, the global economy will sputter along this year as China’s slowdown prolongs a commodity slump and contractions endure in Brazil and Russia. As a result, the international institution cut its forecasts for the third straight year, predicting 2016 growth to fall by 0.4 percentage point to 2.9%. With regards to the U.S., the World Bank decreased its 2016 prospects to 2.7%, down from 2.8 percent from June, citing the dampening effect on exports from the surging dollar.

Late yesterday, the Federal Reserve released the minutes from the last FOMC meeting. Today, Richmond Federal Reserve President Jeffrey Lacker today said the Federal Reserve might need to raise interest rates more than four times this year if oil prices stabilize, the dollar stops appreciating and inflation surges toward the U.S. central bank’s 2 percent target. Lacker’s comments are in-line with Fed vice-chair Stanley Fischer, which would indicate fed funds rates at just over 1% by the end of the year.

So, on one hand we have markets in China dragging down markets around the globe, even though the economy in the US is decent. Nobody thinks the U.S. or European economies are in high gear, and bears point to weakening corporate profits and tighter monetary policy by the Federal Reserve, but this doesn’t look like 2008 in the broader economy.

The number of Americans who applied for new unemployment benefits in 2015 fell to the lowest level in 42 years. This week’s figures show 277,000 people filed initial jobless claims in the seven days running from Dec. 27 to Jan 2. That is down 10,000 from an unrevised 287,000 in the prior week.

In a separate report, global outplacement consultancy Challenger, Gray & Christmas said U.S.-based employers announced plans to cut 23,622 jobs in December, the fewest since June 2000. That was down 24% from November and the lowest December job-cut total on record.

The Department of Labor will report on December payrolls tomorrow morning; the consensus estimate is for somewhere around 205,000 to 215,000. This should be a major tell on whether the Federal Reserve is on the right track or whether their forecasts are nothing more than hooey.

Yahoo is working on a plan to cut its workforce by at least 10% and it could start the process as early as this month. The layoffs, which would result in more than 1,000 people leaving the tech giant, are set to affect the company’s media business, European operations, and platforms-technology group. The move also follows Starboard Value’s letter to Yahoo yesterday, which took aim at CEO Marissa Mayer, her leadership team, and raised the prospect that a proxy battle may be on the way.

Macy’s had a tough Christmas. The department store chain says it will eliminate about 4,500 jobs, or about 3 percent of its work force, in a major restructuring drive designed to save about $400 million.  Macy’s said sales at its Macy’s and Bloomingdale’s stores fell 4.7% in November and December.

Here’s the latest Consumer Electronics Show news: BlackBerry has unveiled plans for building autonomous car software to capture a piece of the ballooning industry. The company wants to extend its QNX software (already used by automakers to build in-car entertainment systems) to self-driving technology, and plans to launch the product in the second quarter of 2016.

CES attendees also saw General Motors show off its Chevrolet Bolt, the automaker’s newest electric vehicle that has a range of 200 miles. The Bolt is likely to be priced at $38,000 and cost around $30,000 after the federal $7,500 income-tax rebate for electric car purchases.

 Meanwhile, Volkswagen assumes it will have to buy back about 115,000, cars in the United States as a result of its emissions crisis. The rest of VW’s 500,000 U.S. vehicles will need major refits, incurring significant costs for parts and a long stay at the garage as sections of the exhaust must be reconstructed and approved.

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.

FINANCIAL REVIEW

Admit It

Sinclair Noe — January 8, 2015

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

DOW + 323 = 17,907
SPX + 36 = 2062
NAS + 85 = 4736
10 YR YLD + .06 = 2.01%
OIL + .08 = 48.73
GOLD – 2.20 = 1209.90
SILV – .16 = 16.48

Since 1928, the Standard & Poor’s 500 has started the year with 3 straight losing days eight times. And only once has the S&P 500 finished one of those years in the red. During the 8 years since 1928 that the S&P started with 3-day losing streaks, the index has returned 8.3% on average. For all years since 1928, the S&P has returned 7.5% on average. Maybe it’s a good thing to start the year with 3 straight losing sessions.

Then there is the idea that the first 5 trading sessions of the year can be used to extrapolate the direction of the market for the year. If that is the case, then we might expect some rough sledding for the markets in the early part of the year followed by a strong second half of the year. This is a variation on the idea of the January barometer, which says (basically) that if January is positive, the year will be positive, and vice versa; that didn’t work last year, but it is accurate about 89% of the time. Of course, that’s just probabilities and tendencies. We don’t know where the market will go in the first half or the second half. Nobody knows. What we know is that the stock market goes up more than it goes down.

There is concern that the Federal Reserve will raise interest rates, essentially taking away the punch bowl from the party. The FOMC minutes released yesterday indicated the Fed will be patient about raising rates. Wall Street will likely throw a little tantrum when they do hike rates; and if they don’t raise rates, Wall Street will likely throw a tantrum because the concern would be that something is wrong with the economy that would prevent a rate increase.

Raising rates should not mean the end of the bull market. The economy probably is strong enough to handle tightening by the Fed. If that was all we had to consider, then this should be a good year for the markets. The reality is that the economy is much stronger than most people are willing to admit; it isn’t perfect; I’ve never seen a perfect economy, but it is decent and it’s getting better all the time.

Think about it, and try to be objective. Interest rates are low; the yield on the 10-year Treasury note is right around 2% and that means mortgage rates for a 30-year fixed mortgage are under 4%; you might even get a 15 year mortgage for under 3%. That’s fantastic.

Oil is under $50 a barrel and that means you’re paying less than $2 a gallon at the pump. One year ago, we were paying $3.25 a gallon. That’s a good thing on so many different levels. You save a few dollars on every trip to the filling station; it costs less to ship your food to the market; we have more money to spend on other things, or to save for a rainy day.

The lower prices for fuel helped put a cap on the trade deficit, now at an 11-month low. The trade gap narrowed even though the dollar is the strongest currency on the planet. GDP grew at a 5% clip in the third quarter. Growth estimates for the fourth quarter are currently between a 2.5% and 3.0% rate. We have a resurging economy. Detroit is building cars you would actually want to own and drive. In Las Vegas this week, the Consumer Electronics Show features exhibitions taking up 40 football fields’ worth of high tech stuff; and it’s not just gadgets and gee-gaws; we’re talking about things that are revolutionizing the way we live, increasing efficiency and productivity, and improving our quality of life.

Yes, you can still be dazzled by a zillion inch high def TV, but you can also find the latest in technology to provide practical healthcare solutions; fitness bands to monitor your heartbeat; hearing aids that use Bluetooth to connect to a smartphone or tablet. There is a scanner that allows you to scan food or medicine to determine the nutritional value and chemical components. The CES show has technology and new apps to teach kids math, science, and even computer programming concepts. There is also a resurgence of practical clean energy and green technology because we all know cheap oil prices won’t last forever. There’s a pocket sized solar charger that can grab a full day’s charge for your phone after just 90 minutes in the sun; devices to connect your house to the internet and make your home more efficient and smart, and of course electric vehicles, and even driver-less cars. And if you need something, a 3-D printer can make it while you wait.

And here’s the kicker: many of the vendors at CES this year were crowdfunded. While not all crowdfunded products are useful, the fact that the community has voted on them with their money makes the process more democratic and proves that the products have real demand. There is a whole pavilion dedicated to startups and crowdfunded companies and it features 375 of them this year, compared to 200 last year.

Now, tomorrow morning we’ll get the jobs report for December. Remember that last month’s report showed the economy gained 321,000 net new jobs in November and the unemployment rate is down to 5.8%. November marked the tenth consecutive month of job gains greater than 200,000, and an all-time record 50th consecutive month of job gains. Total employment is now 1.7 million above the previous peak. Total employment is up 10.4 million from the employment recession low. So far this year, the United States has added some 2.65 million jobs, putting the country on track for its best year of job growth since a 3.2 million gain in 1999.

That’s pretty good. We still need to see improvement. There are still 2.8 million long-term unemployed. And more than 6.8 million people are working part-time, even though they would like a good full-time job. And wage growth remains essentially flat, after adjusting for inflation. There is still slack in the labor market but compare our situation to the 11.6% unemployment rate for the Eurozone, or 25% unemployment in Greece.

And if you have had the good fortune to have a good job and you managed to save a few dollars, don’t forget what has happened in the stock market. Even though many Americans haven’t felt the surge in stock prices, the positive run on Wall Street is already the fourth-longest since 1928. To put another it way, a baby born at the start of the bull market would be entering kindergarten now. The bull market started in March 2009, as the S&P cratered to a low of 666. Today, we closed at 2062. That’s more than 300% gain in less than 6 years. Now, I know you didn’t catch the absolute bottom and ride it, but if you just caught a part of those gains you’re doing pretty good.

All of this has led some on Wall Street to fear the string of good luck could be nearing an end. Some even believe stocks are in the midst of a bubble that could pop in an ugly way soon. The odds are stacked against the current bull market dethroning the all-time record of 4,494 days, or just over 12 years. That remarkable run occurred between December 1987 and March 2000, impressively spanning parts of five presidential terms.

There is always a potential for shocks and with assets ranging from fully valued to expensive, investors may be vulnerable to potential setbacks. There are a few possible bumps in the road for 2015:
Geopolitical tensions could flare; pick your poison, Russia and Ukraine, Iraq and Syria, India and Pakistan. Yesterday’s terror attack in Paris reminds us that no place is entirely secure. Geopolitical tensions could intensify and rattle global demand, slowing down growth everywhere including the United States.

Europe is vulnerable. The EU is drifting into deflation. The ECB says they will do whatever it takes to stimulate the economy, including large scale purchases of sovereign debt. Meanwhile, Greece is getting ready to vote for a political party that promises to repudiate sovereign debt. It’s a sticky wicket. And there is even a possibility the Euro union could unravel; not the most likely outcome but a possibility nonetheless. Outright deflation remains a palpable risk. Even if the ECB can engineer a big stimulus package, the jury is out on whether QE measures will be enough to restart the currency union’s economy. And if the Eurozone can’t pull itself out of its economic malaise, that will hurt profits for many US companies that do business overseas.

And even though the US economy is on the upswing, it is one of the few major economies expected to accelerate in 2015. If wages remain stagnant in the US, that could undermine consumption and there is a chance that growth could disappoint. This has happened before and the most likely result is increased volatility, especially with stocks already on the pricey side.

And then there is the Fed, patiently waiting to tighten policy and raise rates. If their patience wears thin, if they hike rates too fast or too high, the markets would likely get a burst of intense volatility. But the reality is that the Fed has been very patient so far; they have done a decent job of telegraphing their intentions; they have floated trial balloons, and they will most likely move slowly and incrementally. And if that is the case, the bull market should survive. Bull markets end when the fundamentals get skewed and/or with a shock to the system. The bull market has been one of the longest in history and bull markets don’t just die from old age alone.

The economy is stronger than most people dare to admit. Fear sells and some people are just trying to sell fear. Sure, there is plenty of room for improvement and it will take a lot of hard work and maybe even a bit of luck and there are no guarantees, but the US economy is the strongest in the world. If anybody tells you different, don’t buy it.