Financial Review by Sinclair Noe for 01-06-2016
DOW – 252 = 16,906
SPX – 26 = 1990
NAS – 55 = 4835
10 Y – .07 = 2.18%
OIL – 1.98 = 33.99
GOLD + 16.30 = 1094.80
Sometimes the world can be a messy place. Global markets get discombobulated. That has been the case in the first few trading days of the year. Saudi Arabia and Iran are about as friendly as cats and dogs, China’s economic growth is grinding slower, and then, in left field, North Korea drops a bomb, or at least tests a bomb, maybe.
North Korea announced that scientists had successfully detonated a hydrogen bomb. The U.S. Geological Survey reported that a magnitude 5.1 earthquake was triggered near North Korea’s nuclear test site in the northeast of the country, but could not confirm that it was related to an H-bomb test.
China’s central bank set the yuan’s reference rate at an unexpectedly weak level, a reminder of the shock depreciation in August that sparked a wave of financial-market turmoil. Chinese media said that last summer’s selling ban on major shareholders would remain in place until the government publishes new rules on such sales. The Shanghai Composite Index jumped 2.3 percent. Emerging-market stocks dropped to a six-year low and developing-nation currencies declined versus the dollar, while shares in Europe resumed losses after closing higher on Tuesday. Investors are continuing to replace risky assets with safe havens such as Japanese yen, U.S. Treasuries, German Bunds and gold.
Surely this was not what the Federal Reserve was expecting in December when they raised interest rates above zero for the first time in nearly a decade. Today, we found out more about what the Fed was thinking with the publication of the FOMC meeting minutes. The official account emphasized the expectation of Fed officials that “economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate” over the next year. And that is the plan if everything goes well. The minutes indicate that some officials are worried the Fed is once again overestimating the health of the economy. And even though the vote to hike rates was unanimous, there were some nervous and reticent voters. The Fed is expected to raise interest rates by about one percentage point over the next year, an expectation based on the predictions of Fed officials in their December economic forecasts, and confirmed today by Federal Reserve Vice Chairman Stanley Fischer. In an interview on CNBC, Fischer said that four rate hikes by the U.S. central bank this year is close to his expectations, but added that global uncertainty could still veer this path off course.
Fed officials generally expect the strength of the domestic economy, propelled by increased consumer spending, to outweigh the weakness of the global economy. We had confirmation of this line of reasoning today in the ISM non-manufacturing survey. The Institute for Supply Management’s non-manufacturing index, which covers almost 90 percent of the economy, came in at 55.3 last month. While the level is down from November’s 55.9 and the weakest since April 2014, readings greater than 50 signal growth. In other words, the domestic economy is still chugging along, but the rest of the world is weighing on things.
And the Fed minutes included economic forecasts that sound good. The medium-term projection for real GDP growth was revised up slightly, on balance, from the previous forecast, primarily because of the recently passed Bipartisan Budget. The forecast for inflation was revised down slightly in the near term in response to recent data for consumer prices and the further decline in the price of crude oil but they feel confident they will hit their 2% inflation target by next year. Even after stripping out volatile food and energy components, prices rose just 1.3 percent in the 12 months through November, according to the Fed’s preferred measure for core inflation. The thinking is that oil prices will start to move higher later this year. Also, the longstanding pattern is that inflation rises as unemployment declines.
Most of the news on the labor market has been good. Private-sector employment gains ramped up last month. ADP reports employers added 257,000 jobs in December. This is the strongest gain since December 2014. The ADP report is used as an early indicator of the Labor Department’s employment report, which will be released Friday and covers government jobs in addition to those in the private sector. The past two years have shown some of the best job growth since the 1990s.
The good news on employment has not translated into higher wages and that means there has been no inflationary pressures from all the job gains. Under normal circumstances, the Fed’s forecast of higher inflation might pan out, but the global economy is weak and that is having a deflationary impact.
In a separate report today, the nation’s trade deficit dropped 5% in November to the smallest amount in a year, but not because the economy is much improved: U.S. exports fell slightly, hitting the lowest level since the start of 2012, and imports dropped even faster. The trade gap declined to a seasonally adjusted $42.4 billion from $44.6 billion in October. U.S. exports slipped 0.9% to $182 billion in November. Imports fell a sharper 1.7% to $224 billion. The lower deficit in November was largely the result of falling imports of electronic goods as well as lower prices for crude oil and other commodities.
Still, the Fed was willing to hike rates despite tangible evidence. The question is how long they will continue to raise rates absent some signs of inflation. Financial markets expect only two quarter-point increases this year, according to pricing in federal funds futures. Fed vice chair Stanley Fischer said today, “We make our own analysis and our analysis says that the market is under-estimating where we’re going to be.” Maybe. Or perhaps the Fed is over-estimating where the economy is going to be.
Brent crude slipped to a fresh 11-year low overnight, while WTI dropped below $34 per barrel. Oil prices came under pressure as the World Bank predicted China’s troubles will spill over to emerging markets, which will face the decline in commodity prices. In addition to the economic concerns and geopolitical issues, the market remains overwhelmed with a global glut of oil. Saudi Arabia, the largest producer in OPEC, has refused to cut production. And many US producers have kept oil wells flowing despite the crushing financial blow of low prices. Taken together, it’s a formula for a prolonged period of low prices. Today, the Energy Information Agency reported gasoline inventories last week surged the most since 1993. Gasoline stocks rose 10.6 million barrels in the week ending Jan. 1 compared with expectations for a 2.3 million-barrel gain. That sent futures to the lowest since 2009.
As fuel prices fall, three of the largest U.S. airlines said they will charge customers more. Delta Air Lines increased prices on flights by up to $4 one-way and Southwest Airlines followed suit. American Airlines also raised domestic fares to match its rivals. While U.S. airlines regularly adjust their fares, hiking prices for nearly all domestic flights is less common and an industry-wide match even less so, and then to do a rate hike with fuel prices dropping – well, thank you, thank you very much.
U.S. regulators have grown so concerned that traders are using high-speed computers to manipulate markets that they’re planning a new tactic to clamp down on the practice. The Financial Industry Regulatory Authority said it plans to issue report cards this year that will grade firms on how much spoofing flows through their order books, and expects brokers to use the assessments to root out misconduct.
Shares of Apple slid 2.5% on Tuesday following a report that suggested the tech giant may significantly slash its iPhone 6S and 6S Plus output. Japanese news outlet Nikkei reported Apple is expected to reduce production on its flagship device by about 30% between January and March. Apple suppliers Cirrus Logic, Skyworks, Qorvo, Avago, and InvenSense also tumbled on the news.
Puerto Rico’s latest default means a $10.3 million hit for Ambac Financial, which insures some of the debt the island’s infrastructure authority PRIFA failed to disburse on Monday. The payment on its own is small for Ambac, but with more than $2 billion total par exposure to Puerto Rican debt, the company could be in trouble if defaults continue.
Chipotle Mexican Grill has been served with a grand jury subpoena as part of a criminal investigation related to a norovirus outbreak at a California restaurant. The disclosure came as the chain projected a double-digit decline in sales after several outbreaks linked to food-borne illnesses. The company will formally report its financial results on Feb. 2, but today Chipotle warned investors that it expected a drop of 14.6 percent in same-store sales for its fourth quarter. For the full month of December, same-store restaurant sales were down 30 percent. The norovirus outbreak happened in Simi Valley, California in August followed by another outbreak near Boston College in December, and that is in addition to E. Coli outbreaks in several states. All told, more than 500 people were sickened after eating in a Chipotle restaurant in the last half of 2015. Bon appetit.
Twitter is building a feature that will allow for posts much longer than its standard 140 characters, and is currently considering a 10,000 character limit. An end-of-first quarter launch is targeted. Apparently the idea that brevity would engender a respect for eloquence just hasn’t panned out.