Addiction to Oil
Closing numbers and economic news, including: FOMC plus earnings on tap; Saudis try to end oil addiction; M&A news; free burritos and Area 120 startups.
Financial Review by Sinclair Noe for 04-25-2016
DOW – 26 = 17,977
SPX – 3 = 2087
NAS – 10 = 4895
10 Y + .02 = 1.90%
OIL + .26 = 42.90
GOLD + 5.70 = 1238.90
The Federal Reserve FOMC meets this week to determine monetary policy; they are not expected to raise interest rates this week, however they might set the stage for a rate hike in June. Earlier this month, Fed Chair Janet Yellen said the U.S. economy was on a solid course with some hints of inflation, so the Federal Reserve was on track for further interest rate hikes. First quarter GDP, to be released on Thursday, is expected to slump to a paltry 0.7% annual rate from a 1.4% rate in the last three months of 2015. It might be tough for the Fed to sound hawkish if it is followed by a weak GDP report.
Traders are also keeping an eye on the outcome of a Bank of Japan meeting on Thursday, with expectations that Japan could push deeper into negative interest rate territory.
Investors have been assessing first-quarter earnings, FactSet just released its latest update of earnings season stats for S&P 500 companies. And the numbers are pretty bad; 76% of companies have beaten analysts’ estimates, but the aggregate earnings decline is -8.9%. That’s actually worse than the -8.6% decline analysts expected on March 31. This will mark the fourth straight quarter of declining year-over-year earnings, which hasn’t happened since 2009. Throughout this bull market, companies have managed to squeak past very low expectations. Now, we can’t meet lousy expectations.
An avalanche of first-quarter earnings reports are on tap, with 186 companies in the S&P 500 slated to report results. The big news in earnings will be tomorrow, when Apple reports. Apple is expected to report a year-over-year decline in revenue for the first time since 2003. Along with the revenue decline, many are predicting that iPhone sales will fall year-over-year for the first time in the device’s history.
New U.S. single-family home sales fell in March, but the decline was concentrated in the West region. The Commerce Department said new home sales decreased 1.5 percent to a seasonally adjusted annual rate of 511,000 units. Sales were up in the Midwest and the South, and flat in the Northeast, but sales plunged 23.6 percent in the West, reversing February’s 21.7 percent jump; which leads me to believe we’re dealing with some statistical noise in the report. While the inventory of new homes on the market rose in March to the highest since September 2009, new housing stock remains less than half of what it was at the height of the housing bubble. At March’s sales pace it would take 5.8 months to clear the supply of houses on the market. That was the most since last September and was up from 5.6 months in February.
Saudi Arabia unveiled “Saudi Vision 2030,” a plan to overhaul the kingdom’s economy in order to reduce its massive reliance on oil revenues, which account for 80% of its income but are taking a battering amidst the plunge in crude prices. Prince Mohammed bin Salman said the kingdom will try to break its “addiction to oil” by creating the world’s largest sovereign-wealth fund with over $2 trillion in diversified assets and to sell under 5% in state oil monopoly Saudi Aramco in an IPO. The existing state-controlled Public Investment Fund will be transformed into a giant sovereign wealth fund to manage the kingdom’s petrodollars. Instead of direct subsidies, Saudis will receive payments as a form of benefit, while the government will attempt to cut unemployment to 7 percent from 11.6 percent by an unspecified date.
While volatility in the oil market may be pushing the Saudis to reform, low oil prices are also cutting the resources they can use to manage the change. And if the Saudis are willing to sell, who will step up to buy? Although the Saudi stock market opened up to direct foreign investment last June, total foreign ownership of the market remains tiny at less than 1 percent. With prices so low, it hardly seems like a good time for an oil IPO. Perhaps even more important than the price of oil is the political component. The Saudis are not known for openness and transparency; this plan will surely draw opposition both from within the kingdom and from outside investors who will likely demand to see change before investment. Oil was pretty strong last week in the face of a lot of bad news, including no agreement in Doha to freeze ouput, so don’t count out a repeat performance this week, especially since oil managed to crawl off the lows today. Crude oil has been the driving force behind equities since the February 11 low.
You may recall a few years back, the US tried to break its addiction to oil; the result was the shale oil revolution, which helped to ease our dependence on foreign oil, even if it didn’t break our addiction. Imagine what could happen if the US actually tried to break the addiction by starting a renewable energy revolution. Today’s announcement from the Saudis tells us that they are imagining that scenario.
China’s debt load is at a record high. The Financial Times reports China’s debt total climbed to 237% of GDP in the first quarter, an all-time high. Data from the Bank of International Settlements shows China’s debt load is far greater than emerging markets as a whole, which carry debt at an average of 175% of GDP. According to the FT, China’s debt has exploded since 2007, when it was 148% of GDP.
Gannett, the publisher of USA Today, said it offered to buy Tribune Publishing Co but the owner of the Los Angeles Times refused to begin “constructive” talks. Gannett said it made an offer to buy Tribune Publishing on April 12 for $815 million, including the assumption of $390 million of debt. Tribune Publishing said in a statement that it had told Gannett it would engage financial and legal advisers to review the proposal and its “numerous contingencies.”
The Justice Department gave antitrust approval to Charter Communications’ proposed purchase of Time Warner Cable and Bright House networks, which would create the second-largest U.S. broadband provider and third-largest video provider. The DOJ says online video will provide competition, and one condition to the deal is that Charter must agree to refrain from telling its content providers that they cannot also sell shows online. The Federal Communications Commission must also approve the deal, and the agency’s chairman said he, too, is looking to protect competition. It was not immediately clear when the FCC would decide. Charter has valued the deal at $56 billion for Time Warner Cable, excluding debt, and $10 billion for Bright House Networks.
Ball is selling its beverage-can assets. Ball will sell 17 can factories and other facilities to European-based packaging company Ardagh for $3.42 billion. Ardagh will sell $2.85 billion of bonds to help fund the deal. Apollo Global Management, Blackstone Group LP and Madison Dearborn Partners were said to be other interested bidders.
Goldman Sachs has entered online banking. The investment bank is now allowing ordinary citizens to open a bank account. Goldman’s digital savings account offers a rate of 1.05%, and can be opened for as little as $1. The bank accounts are available after Goldman acquired about 150,000 retail customers through its GE Capital deal that closed last week.
Xerox reported a 4.2 percent fall in quarterly revenue, hurt by a strong dollar and lower sales of printers and copiers. Net income attributable to the company fell to $34 million, or 3 cents per share, in the first quarter ended March 31, from $225 million, or 19 cents per share, a year earlier. Revenue fell to $4.2 billion from $4.4 billion.
Halliburton is delaying earnings. The oil services provider announced it’s taking a $2.1 billion charge for the first quarter after cutting more than 600,000 jobs and taking a write off. Additionally, Halliburton’s earnings will be delayed from April 25 to May 3 in order to account for the Baker Hughes deal which is expected to close before the end of the month.
It looks like Chipotle’s free burrito strategy might be working: a survey shows that 41% of respondents who received a free burrito coupon visited Chipotle 3.8-times over the prior 30 days, compared to 1.4-visits for the 59% who didn’t receive a coupon. Brand perception was also higher in the couponed group. Meanwhile, analysts at Credit Suisse found that Google searches for food-safety issues related to Chipotle have dropped sharply since the beginning of the year. We’ll see how the free food strategy is working when Chipotle reports earnings tomorrow after the bell.
Philips is leaning towards holding an IPO of its lighting unit – its original line of business – rather than selling the operations. The divestment of the lighting operations will leave the company to focus on healthcare technology. Philips’ also reported better-than-expected earnings; adjusted earnings before interest, taxes and amortization climbed 14% to $420 million.
Carlyle has joined up with former Barclays CEO Bob Diamond to bid for the U.K. bank’s 62% holding in its African operations. Barclays Africa Group is listed in Johannesburg with a market capitalization of $8.5 billion, putting the value of the stake at $5.27 billion. Barclays is selling the unit due to increasing regulatory pressures.
Google is building a startup incubator called Area 120 in which teams of employees will be able to submit business plans to join the initiative. Those accepted will work on their projects full-time for a few months, after which they’ll be able to pitch Google on creating a new company that the parent firm would take a stake in. Area 120 is an attempt to prevent entrepreneurial employees from leaving Google entirely to found their own businesses.