Been to the Mountaintop
Financial Review by Sinclair Noe for 01-15-2016
DOW – 390 = 15,988
SPX – 41 = 1880
NAS – 126 = 4488
10 Y – .07 = 2.03%
OIL – 1.52 = 29.68
GOLD + 10.30 = 1089.80
Let’s start with the good news: US stock and bond markets are closed Monday for the Martin Luther King Jr. holiday.
For the day the Dow dropped 2.4%, the S&P 500 dropped 2.1%, and the Nasdaq lost 2.75%. And even though it was a volatile week, almost all of the damage for the week came in today’s session. The Dow Industrials did take out the September lows but not the August lows of 15,370. The Nasdaq composite knocked out the closing low from August but not the intra-day August low. The S&P 500 hit an intra-day low of 1857, dropping below the August 24th low of 1867. So we should wait for confirmation of a close below 1867 – at which point we have wiped out any reasonable support. The Russell 2000 small-cap index dropped as much as 3.5 percent to its lowest level since July 2013. The major S&P sectors all ended sharply lower. The energy sector dropped 2.87 percent as oil prices fell but the tech sector was the big loser, down 3.1%, with Intel down 9% following a weak earnings report after the close yesterday.
It’s a sea of red all over the world. China is in a bear market. China’s Shanghai Composite tumbled 3.6% on Friday. The country’s “National Team” was reportedly active but unable to stem the slide, even after injecting over $15 billion of funds into the market. Selling since the December 22 peak has dropped the index 20%, to levels last seen in December 2014. The Euro Stoxx 600 tumbled 3 percent, and is now down 20% from its April high. The Euro Stoxx 50 Index of the region’s large caps also entered a bear market last week. The price of bearish contracts on the Euro Stoxx 50 Index rose to the highest since September versus that of options betting on a rebound. Stocks worldwide have lost more than $14 trillion, or 20 percent, in value from a record last June. $14 trillion is a mountain of money. It took 2 year to add $14 trillion in value and 7 months to lose it. A long time to climb the mountain, and just a few moments to fall.
Crude futures are in the $20s, with the prospect of additional Iranian supply on expectations that Western sanctions will be lifted within days. China’s Sinopec has also purchased its first ever batch of U.S. oil for export, a landmark transaction after the ending of a four-decade ban on domestic exports. West Texas Intermediate is down 1.52 at 29.68, (- 4.8%), after hitting an intra-day low of $29.28.
The risk premium on a gauge tied to US junk-rated companies surged to the highest level since November 2012. The spread between junk rated energy debt and treasuries is at 16%, the widest spread ever. That means that if prices stay at these levels or get worse, we are almost certain to see more defaults in the oil patch. High yield is selling off, emerging-market debt is selling off, and investment-grade bonds are selling off. Lipper reports investors pulled $2.1 billion from U.S. high-yield funds this past week after withdrawing $809 billion the week earlier. Yields on 10-year Treasury notes fell under 2 percent for the first time since October, while the dollar extended its longest rally since July. Gold surged with the yen on haven demand.
Now, consider that about 27% of the junk debt brought to market in 2014 came from oil companies, many of them riding the shale fracking boom. Then consider that Matthew Mish, global credit strategist at UBS, published a report Wednesday saying that most high-yield issuers’ business models “don’t work with oil in the $20-$40 range.” In this environment, even energy bonds that are trading at distressed levels, 20 cents to 30 cents on the dollar, could be worth “close to zero in reorganization.” For investors, another cause for worry is the relatively low levels of cash currently held by high-yield mutual funds to meet redemptions, on average less than 5% in cash reserves.
Wholesale prices in the US declined in December from the prior month, showing inflation is still well-contained as Federal Reserve officials weigh further increases in the benchmark interest rate. The producer-price index dropped 0.2 percent following a 0.3 percent gain in November. Over the past 12 months, wholesale prices fell 1 percent. The PPI excluding volatile food and fuel prices climbed 0.1 percent from the prior month. For astute listeners, you might wonder why the consumer price index, or prices at the retail level grew by 0.5% over the past 12 months, while the PPI declined by 1%. The biggest reason is housing costs are included in the CPI, not the PPI. Yep, the rent is too damn high.
Industrial production fell 0.4% in December, the third straight monthly decline, led by cutbacks in utilities and mining (which includes the oilpatch). Power plants had more slack in December than any time on record, and the reason is simple, it was the warmest December on record, 6 degrees Fahrenheit above average.
Business inventories fell 0.2% in November, as department stores and companies that sell building materials cut down on their restocking. Business sales also fell 0.2% in November after a 0.3% drop in October. Manufacturers and wholesalers posted sales declines in both months.
Sales at US retailers declined 0.1% in December to wrap the weakest year since 2009, raising concern about the momentum in consumer spending heading into 2016. For all of 2015, purchases climbed 2.1 percent, the smallest advance of the current economic expansion.
Wal-Mart plans to close 269 stores, including its experimental small-format Express outlets, in a push to streamline the chain that will eliminate 16,000 jobs. The move affects 154 locations in the US, plus 60 stores in Brazil.
General Electric agreed to sell its home-appliances business to China’s Haier for $5.4 billion after cancelling a $3.3 billion a deal with Electrolux last month, due to objections from US antitrust regulators. Haier, one of several bidders in the latest round, paid 10 times the division’s earnings over the last year. Louisville will still remain the headquarters for GE Appliances.
BHP Billiton will write down the value of its U.S. shale assets by $7.2 billion, cementing expectations it will be forced to cut its dividend for the first time in over 25 years. The company has also seen prices for its most important product, iron ore, collapse in the last few months due to the economic slowdown in China. BHP, like many of its biggest competitors, has refused to rein in production. To make matters worse, the company is facing huge legal bills after a dam holding back waste water from a mine in Brazil that it jointly owns burst in December, causing a lethal flood and a trail of pollution hundreds of miles long. The Brazilian government has provisionally estimated the damage from that at $5.2 billion. BHP – 1.49 = 20.19
Citigroup is reporting fourth-quarter profit jumped as legal costs fell and revenue rose. Citi posted a profit of $3.3 billion, or $1.02 per share. That compares with the $344 million, or 6 cents per share, it reported in the same period of 2014. The 2014 numbers were hurt by legal problems at the Mexico subsidiary Banamex, a big mortgage-securities settlement with the Justice Department, and a failed stress test. Revenue edged up 3%, to $18.4 billion from $17.9 billion a year ago. Earnings were a penny better than estimates. Citigroup, once the largest US bank, has now slipped to the fourth largest, just behind number 3 Wells Fargo. C – 2.91 = 42.47
Wells Fargo’s fourth-quarter profit was flat compared with the year-ago period. Wells Fargo reported a profit of $5.7 billion, or $1.03 a share. That compares with $5.7 billion, or $1.02 a share, in the same period of 2014. Profit beat estimates, revenue missed. Last year, Wells Fargo acquired GE’s finance arm, including its commercial banking business; that also included commercial loans to energy companies. WFC – 1.82 = 48.82
Goldman Sachs has entered an agreement in principle to resolve investigations by a number of authorities relating to sales of faulty mortgages between 2005 and 2007, and deceiving investors about the quality of residential mortgage bonds they were peddling. Under the terms of the agreement, the bank will pay a total of $5.1 billion. The deal will also cut Goldman’s Q4 after-tax earnings by about $1.5 billion, which will pretty much wipe out Goldman’s earnings for the quarter. Now, let’s dig deeper: out of that $5.1 billion, about $1.8 billion will be in the form of consumer relief, meaning they don’t really pay it, they just adjust some accounts to stop the rip-off. Then Goldman will have $2.4 billion in penalties, and $875 million in cash. The bank has said that it securitized about $125 billion of home loans between 2005 and 2008, of which about $23 billion eventually soured. The penalty represents about 10 percent of investors’ losses. Goldman can deduct the rest of the settlement, about $2.7 billion, from its future tax bills. Goldman Sachs did not admit wrongdoing. GS – 5.78 = 155.61