Financial Review

Headwinds and Tailwinds

Sinclair Noe — January 14, 2016

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DOW + 227 = 16,379
SPX + 31 = 1921
NAS + 88 = 4615
10 Y + .03 = 2.10
OIL + .66 = 31.14
GOLD – 15.00 = 1079.50

Global stocks have lost almost $3.2-trillion in market value since the start of 2016, pushing all major US indexes into correction or bear market territory. Asian markets (except for China) and European exchanges were mostly lower. Even with a bounce, we’re trending lower, short-term.

The Bank of England this morning kept its key interest rate at a record low of 0.5% and made no changes to its $540 billion asset purchase program. Both decisions were widely expected.

The Hong Kong dollar sank by the most in more than a decade overnight and speculation mounted in the options market that the city’s 32-year-old currency peg will soon come to an end, as investors lost confidence in Chinese assets. Other currencies also took a hit. The loonie fell to its lowest level since April 2003, fueling speculation the Bank of Canada could cut interest rates as early as next week.

The average number of people who applied for jobless benefits in the past month climbed in early 2016 to the highest level since last July. Initial jobless claims for the first full week of January, meanwhile, rose by 7,000 to a seasonally adjusted 284,000; the four-week average rose to 278,750.

The prices the U.S. paid for imported goods fell 1.2% in December, and dropped 8.2% for all of 2015. Even if oil prices are set aside, import prices have been falling. The cost of all imports excluding fuel slid 3.4% in 2015, marking the only decline since the government began keeping track in 2001. At the same time, export prices sank 1.1% in December. For the full year, export prices sank 6.5%, the biggest decline since the government first began keeping records in 1983.

JPMorgan Chase said fourth-quarter profit rose 10 percent. Net income rose to $5.4 billion, or $1.32 a share, from $4.9 billion, or $1.19, a year earlier. Revenue rose 1 percent to $22.9 billion in the fourth quarter. Earnings rose as the bank cut expenses from litigation and employee compensation shrank. Now there’s a business model for you.

We didn’t see much in the way of positive surprises in the earnings report, unless you consider not paying the lawyers and the regulators more to be a surprise. Still, they beat estimates. JPMorgan was up .86 at 58.20 today. Flat is the new up in investment bank land.

JPMorgan kicks off a parade of bank earnings reports. Wells Fargo and Citigroup report on Friday. A few analysts think the big banks have already taken their licks and are so far into oversold territory that there might not be much downside left. The KBW Nasdaq bank index shows bank shares down 17% from their July 2015 highs, down 15% since December, and down almost 10% so far in 2016.

If the big banks are going to climb out of their hole, they’ll need a lot better news than JPMorgan delivered today. One of the bright spots was from advisory fees on M&A. Mergers and Acquisitions in the fourth quarter reached near record levels, capping a record year. Globally, M&A activity topped $4.9 trillion in 2015, outpacing the previous record of $4.6 trillion set back in 2007. In a rising interest rate environment, it is hard to imagine 2016 will be a better year for M&A.

JPMorgan’s advisory revenue was up 43% to $622 million. Not bad but not outrageously great; and it was about the only strong area and not a surprise. Meanwhile trading revenue fell 3%, equity trading fell 7%, and credit underwriting disappeared.

And the headwinds are more problematic than the tailwinds are helpful. There’s no question debt and credit trading was difficult in fourth quarter. High-yield debt in general hit the skids hard, and nowhere was that more prevalent than in the energy sector. The Federal Reserve’s most recent Shared National Credits exam noted that 74% of the increase in classified loans were oil and gas loans, “where near default loans increased four times.”

JPMorgan nearly doubled its loss provisions in the fourth quarter, mostly due to bad energy loans. Asked on the earnings call if the bank is setting aside too little, Dimon says he’d put up more if he could, but accounting rules dictate what can be done.

I’m not sure which rules Dimon was referencing but we do know that every 10 basis points of expense increases for loan loss provisions will knock about 4% off banks’ earnings. Bottom line: a decent report from JPMorgan but it doesn’t look like enough to lift the banking sector.

Following the collapse of the Third Avenue Focused Credit Fund last month, the SEC has launched a review of the entire junk-bond fund complex. Reuters reports the agency “sent detailed requests” to mutual fund and ETF managers following the Third Avenue liquidation plan in which investors could wait a year or more to get their money. Regulators are “seeking information about how they price less liquid securities, and whether certain parties have ever challenged those prices.”

Intel reported a small increase in quarterly revenue, reversing two quarters of declines, as growth in its data center business more than offset weak sales to PC makers. Net income fell to $3.61 billion for the fourth quarter, from $3.66 billion, a year earlier. Net revenue rose to $14.91 billion from $14.72 billion. On a per share basis, earnings were flat at 74 cents. The fourth quarter of 2015 marked the fifth consecutive quarter of worldwide PC shipment decline. Intel was up .83 at 32.74, but they are down over $1 in after-hours trade.

GoPro shares were clobbered, down 26%. The wearable camera maker said on Wednesday it expected revenue of about $435 million for the fourth quarter, well below the average analyst estimate of $512 million.

Renault shares dropped more than 20% after a union said French fraud investigators seized computers from the automaker, apparently as part of a probe into emissions testing. The French government said tests on nearly two dozen Renault models and other automakers found several that exceeded the country’s air quality standards but so far found no evidence of technology designed to cheat on emissions tests, except a couple of VW models.

Volkswagen and EPA officials remain at an impasse following yesterday’s talks between VW CEO Matthias Müller and EPA chief Gina McCarthy, casting doubt over a quick resolution of the automaker’s emissions cheating scandal. The two sides gave no indication of any progress during a meeting at EPA offices in Washington, D.C.

Trading in Fiat Chrysler was halted several times today in Milan Italy, as prices dropped by 10% or more on a report from Automotive News, saying that two Chicago car dealerships have filed a lawsuit alleging the company offered dealers large amounts of money to report US unsold vehicles as sold. A spokesman for Fiat Chrysler in the U.S. said the auto maker “has not been served with this lawsuit and cannot comment.”

West Texas Intermediate crude oil fell to $29.73 in overnight trade, its lowest level since February 2004; prices bounced from that low. Prices have already tanked 20% this year.  Not a big surprise that there was some support at $30. The question is whether support can hold in the face of a potential new source of supply. The United Nations’ nuclear watchdog is likely to confirm on Friday that Iran has curtailed its nuclear program as agreed with world powers, paving the way for sanctions to be lifted.

The past 18 months have been rough for the oil industry. The low price has caused layoffs in what had been a robust and growing shale oil extraction business. A new report shows the number of jobs in the United States in the solar industry outpaced those in the oil and gas industries for the first time ever. As of November 2015 there were almost 209,000 people who worked in the solar industry, 90 percent of whom only work on solar-related projects. There were only about 185,000 people working in oil and gas in the United States in December 2015, according to the Bureau of Labor Statistics.

The solar industry has seen prices drop, not quite as much as oil, but as the technology becomes cheaper, sales have remained solid. One other key difference for the economy, jobs in solar pay about half what jobs in the oil industry pay, on average.

Meanwhile, renewables just finished another record-breaking year, with more money invested ($329 billion) and more capacity added than ever before (121 gigawatts), according to new data released by Bloomberg New Energy Finance. Spending on clean power declined in Europe, but increased 17% in China, 7.5% in the US, and for the first time, more than half of the world’s annual investment in clean energy came from emerging markets.

And since clean energy is also getting cheaper, the world got more bang for each buck. Investment dollars rose 4 percent last year, while the new capacity added for wind and solar jumped 30 percent. Looking out still further, the International Energy Agency said last year that between now and 2020, renewable energy will be the largest area for growth, and predicts 700 gigawatts of added generating capacity.

Oscar nominations were announced this morning.  “The Revenant” led the nominations with 12 nods, including best picture, and best actor for Leonardo DiCaprio; while the action movie “Mad Max: Fury Road” landed 10 nominations.

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.