Behind the Curtain
DOW – 24 = 16,117
SPX + 0.27 = 1862
NAS + 2 = 4217
10 YR YLD + .06 = 2.15%
OIL + 1.16 = 82.94
GOLD – 2.20 = 1239.90
SILV – .08 = 17.47
The Dow is down for a sixth consecutive session. We started the morning down almost 200 points, so there is that. Part of yesterday’s volatility is being blamed on mini-flash crashes; 179 to be precise. Basically the high frequency traders yank their bids, as their algorithms try to catch up with big moves. It isn’t really a flash crash so much as a lack of liquidity.
Take a deep breath. Think about how you are invested. Consider whether you are diversified across asset classes. The market has not collapsed. It has gone down in a fairly fast and furious manner, but it has not collapsed. What will happen next? Will the market bounce back? Will it go sideways? Will the pullback continue and become really painful? You don’t know; I don’t know; the market doesn’t know; nobody knows. Take a deep breath, consider where you are and where you want to be in the future. The stock market is always a gamble. Maybe you want to gamble with a part of your money, and that’s fine. Maybe you are tired of gambling and want to find something safer; that’s cool, too. Just understand what you’re doing. The volatility of the past couple of weeks is a reminder that the markets fluctuate; they are unreliable, and you have to have a plan in place.
It is earnings reporting season; here are a few of today’s highlights: Goldman Sachs posted earnings of $2.2 billion or $4.57 a share, up from $1.5 billion or $2.88 a share, a year ago. Goldman likes volatility, and the biggest increases in revenue and profit came from their bond trading.
Google posted a profit of $2.81 billion, or $4.09 a share, down from $2.97 billion, or $4.38 a share, in the same period a year earlier, even as revenue increased 20% to $16.5 billion.
Apple introduced a few new products today, an iPad Air and an iPad Mini, which are just a little bit bigger than an iPhone Plus, but they can’t make phone calls. They also upgraded the Mac, and the screen looks better. This follows one month after the debut of the new iPhone 6 which we learn today are the bestselling Apple phones yet. And the Apple Pay plan has been accepted by 500 banks, and will roll out on Monday. What we didn’t get was an Apple TV. I know, we’re all just waiting on pins and needles.
In economic news, the number of Americans filing new claims for jobless benefits fell to a 14-year low last week. Initial claims for state unemployment benefits dropped 23,000 to 264,000. The jobless claims report reinforced expectations that slack in the labor market was being reduced, very, very slowly; or it was just a statistical fluke tied to the Columbus Day holiday, which may have affected how the data was collected.
The National Association of Home Builders’ housing market index was at 54 in October, down from 59 in September. Any number above 50 indicates that more builders view sales conditions as good than poor, just not as good as the month before.
A report from the Federal Reserve showed production at the nation’s factories, mines and utilities advanced a larger-than-expected 1.0% last month, the biggest gain since November 2012. The Fed pinned part of the gain to unusual weather that boosted air conditioning use, but there was also a broad-based increase in factory output, which grew a solid 0.5%.
Another report from the Fed’s Philadelphia branch showed slowing growth in factory activity in the mid-Atlantic region.
St. Louis Federal Reserve Bank President James Bullard said in a television interview with Bloomberg that the Fed might want to keep its bond-buying program running for longer than anticipated given a drop in inflation expectations. The Fed has been winding down its bond buying program, or quantitative easing. At the last policy meeting in September the Fed FOMC reduced purchases to $15 billion a month and agreed to end the program after the October 29th meeting, if the economy continued to improve. Bullard thinks the economy has been improving, but his worry is inflation, which is low and doesn’t look like it will move higher soon. He may have a point; the strong dollar and lower oil prices are keeping a lid on inflation and actually pushing prices down. But Bullard is the only Fed official to voice the idea of continuing QE, and the idea might be misinterpreted as a sign of weakness in the economy.
And the drop in oil prices is actually helping the US economy, even as it clobbers other countries. Lower oil prices are probably a bigger concern for Russia than sanctions. This week, the Russian owned oil company Rosneft, accused Saudi Arabia of secretly manipulating prices; a conspiracy theory about American and Saudi collusion against the Soviet Union first voiced during the Cold War. If oil prices were to stay in the range they are in now, we’ll see the Russian budget fall into deficit next year; that’s on top of the economic challenges they are already facing from sanctions and the decline in the value of their currency.
Iraq has increased output, but oil revenues are being eaten up by the conflict with ISIS, which could last a very long time. And a side note; while the fight against ISIS has not resulted in any quick victories, one small victory is that the sustained campaign of airstrikes has dismantled their network of oil rigs and refineries, cutting off the terrorist group’s ability to make gasoline for their tanks and trucks, and cutting off sales of black market oil that had been raising about $2 million a day.
Venezuela called for an emergency meeting of OPEC to address the steep decline in prices. For now OPEC is not going to call an emergency meeting. The next scheduled meeting of OPEC is in November, and there will be calls for cutting production to push prices higher. Saudi Arabia might allow lower prices because it squeezes Russia and Iran, and it might even squeeze shale oil producers in the US, who have been taking some of the market share from the Saudis. Oil from shale formations costs $50 to $100 a barrel to produce, compared with $10 to $25 a barrel for conventional supplies from the Middle East and North Africa. Saudi Arabia has very low production costs and its domestic spending program allow for a balanced budget at a price of roughly $95 a barrel, compared with $100 or more for Russia and even more for Iran. Saudi Arabia also has huge cash reserves to prop up its budget while prices remain low. They can afford to squeeze the competition.
When you go to the gas station and save a few bucks, enjoy it while you can. Gasoline now averages $3.18 a gallon nationwide; you might have seen prices drop under $3. Citigroup issued a report today saying that lower oil prices will provide a stimulus of as much as $1.1 trillion to global economies by lowering the costs of fuel and other commodities. We will all have more money to spend on other stuff and that will lead to more growth. Citi says all commodities are energy intensive to one degree or another, and cheaper energy is an advantage to both consumers as well as industrial and manufacturing operations. Which may be one of the greatest endorsements for renewable energy, but that wasn’t the point of their research report.
A slump in the prices of agricultural commodities like corn, soybeans and wheat should, over time, make trips to the grocery store cheaper. Prices of many other industrial commodities have also declined over the last year, silver and iron ore more than oil. One factor has been weakness in Europe and Japan, which means lower demand for commodities as well as a strengthening dollar. The downside of lower commodity prices is that it signals a slower economy, the upside is that you can put food on you plate and drive where you want to drive and still have money in your pocket, which you will likely spend; even though we had a report yesterday showing retail sales in September dropped 0.3%.
But most of the economic data has been fairly positive lately; not outstanding but decent. And still, the bond market has pushed yield on the 10-year Treasury down to 2.15% today, and briefly under 2% yesterday. Treasuries are consider the “safe haven” play. And that has been the move as the stock markets bob up and down on the waves of volatility. Maybe the stock market is trying to tell us something. Maybe the stock market knows something. Nope. The stock market does not have a crystal ball. Many market players thought the market was being guided by a powerful force, but it turns out the all-powerful, all-seeing, all-knowing wizard is really just some guy behind the curtain, or in this case the Fed officials behind the curtain.
For the past couple of years the markets have had excessive confidence in the Fed’s ability to pour money into the markets, and an untested faith that the Fed could calmly turn off the easy money spigot without causing a ripple on the calm waters of the markets. And so investors pushed market valuations higher than what was warranted by the sluggish fundamentals. It seemed as if the economy could move forward, just enough to get some air under the wings without actually taking flight. And that seemed good enough because we avoided recession and also inflation, and volatility was squeezed out of the market. In turn, we confused consistency with performance, and that in turn encouraged risk taking without examination of fundamental valuations, liquidity realities, and the relentless siphoning of profits without the required reinvestment into productive capacity.
The markets go through cycles of fear and greed, and the past couple of years have been the latter, and now we are staring down the former. It hasn’t been any one thing that has shaken investor confidence; it has been a confluence of many things from war to pestilence, from slower growth to unrealistically high valuations, from a lack of fiscal policy to no more tools in the monetary policy tool belt. We always suspected that the exit from QE would be a bit rocky, and a bit unnerving. It is.