Financial Review by Sinclair Noe for 01-12-2016
DOW + 117 = 16,516
SPX + 15 = 4658
NAS + 47 = 4685
10 Y – .06 = 2.10%
OIL – .67 = 30.74
GOLD – 7.70 = 1087.50
The recent sell-off on Wall Street has some of the investment banks worried. For the past 7 years, JPMorgan Chase has seen every dip in the market as a buying opportunity. Now they are changing their tune and advising clients to sell any rally. A report from JPMorgan’s chief equity strategist cites several areas that are raising red flags, including: deteriorating technical indicators, expectations of anemic corporate earnings combined with the downward trajectory in U.S. manufacturing activity and a continued weakness in commodities, with oil dropping under $20 a barrel.
RBS, the Royal Bank of Scotland, says investors face a “cataclysmic year” where stock markets could fall by up to 20% and oil could slip as low as $10 a barrel. In a note to its clients the bank said: “Sell everything except high quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small.” It said the current situation was reminiscent of 2008, when the collapse of the Lehman Brothers investment bank led to the global financial crisis. This time China could be the crisis point.
Goldman Sachs is warning that global stock markets may get worse. They remain neutral on stocks for now, but any further drops would create opportunities to invest. They prefer Europe to the US stock market because the European Central Bank is supporting the economy, and that’s poised to help the region’s companies to possibly achieve single digit earnings growth.
Standard & Poor’s says the outlook for corporate borrowers worldwide is the worst since the global financial crisis. The proportion of issuers facing a potential downgrade at the ratings company surpasses possible upgrades by the most since 2009. The gap also widened the most since the financial crisis in the past six months, S&P said. The corporate-debt outlook has darkened because of slower growth in China and a commodity rout that’s cut prices to the lowest since 1999. The slump has also driven corporate defaults to the highest since 2009. S&P says there may be “significantly” more ratings downgrades than upgrades in 2016.
Lehmann, Livian, Fridson Advisors says the junk bond market is indicating a 44% chance of recession in the US within one year. They say, they aren’t making a forecast, just analysis of junk bond spreads over treasuries, now at 7.4%, which is not at recessionary levels of 10.19%, but indicates a 44% probability of recession. Jeffrey Gundlach, the co-founder of Doubleline Capital, sees a one-third chance of recession this year. Citigroup analysts say spread levels on the Markit CDX North America High Yield Index are pricing in an expected loss of 21.2 percent over a five-year period.
Now, that is a lot of negativity coming from the strategists and the big investment banks. You might expect at least some artificial optimism when the president of the Dallas Fed talks about oil. You’d expect some droplets of hope for that crucial industry in Texas. But when Dallas Fed President Robert Kaplan spoke on Monday, there was none, not for 2016, and most likely not for 2017 either, and maybe not even for 2018.
The wide-ranging speech included a blunt section on oil, the dismal future of the price of oil, the global and US causes for its continued collapse, and what it might mean for the Texas oil industry: “more bankruptcies, mergers and restructurings….”
But does all this negativity really mean the markets are collapsing, or is it a contrarian indicator? Is this a replay of last August, when we saw a nasty pullback, followed by a quick recovery, or is this the beginning of a recession that could drag down the markets and the economy? Of course we do not know, and the analysts do not know. What we do know is that there are risks in this market and those risks appear to be underpriced; on the flip side, these risks are now being identified. Another thing we know is that the Dow and the S&P are both trading below their 50 day and 200 day moving averages, so a downtrend is in place, at least for the moment.
We can also see what the analysts are seeing whenever we fill up the car. The price of oil is down 79% from the 20-year high hit in July 2008 at $145.29 which created record gasoline prices at the pump. Oil prices dropped under $30 a barrel today for the first time since 2003, dropping below a critical level of support: $30.28 a barrel, the financial crisis closing low on Tuesday, December 23, 2008.
The companies in the Standard & Poor’s 500 energy sector are expected to lose a collective $28.8 billion this calendar year, down from $95.4 billion in net income earned during 2008. The analysis includes only the 36 S&P 500 energy companies that reported net income in 2008.
Take the situation at the S&P’s 500 biggest energy company, Exxon Mobil. The company is expected to report net income of $16.3 billion in calendar 2015, that’s down 64% from the $45.2 billion the company reported as net income in 2008. Still, it is a profit. Shares of Chesapeake Energy, an oil explorer, has seen its shares drop 94% from the day oil peaked back in 2008. The company is expected to post a loss of $13.1 billion for 2015, down from the $604 million profit it made in 2008. Or BP, which today announced it was cutting 4,000 jobs. An estimated 250,000 oil industry jobs have been lost worldwide since the price decline began.
Of course, you could just sell or avoid the energy sector, but the problem there is that some of these oil companies will default; not Exxon, but some of the smaller players. The defaults could be a big problem for the junk bond market; the junk bond market could be a big problem for the banks; the banks are always a problem; not just because they probably have a few bad bets on the oil patch, but because they leverage those bets with trillions of dollars of derivatives.
But just avoiding the oilpatch might not be enough; according to Bank of America’s High Yield credit strategist “on an unadjusted basis non-commodity earnings growth has been negative 2 of the last 4 quarters, representing the worst 4 quarter average earnings growth in a non-recessionary period since late 2000.”
The fourth quarter earnings reporting season is underway. Yesterday Alcoa kicked off earnings season, posting better than expected earnings and worse than expected revenue. Today Alcoa dropped just over 9%, to a 7 year low. Alcoa is down 28% over the past 9 sessions.
CSX reported after the closing bell today; the number 3 US ralroad reported a lower quarterly net profit citing a drop in freight volumes, especially a 32 percent decline in the amount of coal hauled. Fourth-quarter net income was $466 million or 48 cents per share, 2 cents better than estimates, but down from $491 million or 49 cents per share a year earlier.
Still to come this week are Intel, JPMorgan, Wells Fargo, and Citigroup, among others.
The Labor Department’s Job Openings and Labor Turnover Survey, also known as the JOLT survey, showed 5.43 million job openings, up from 5.34 million in October. That’s still shy of the all-time high notched earlier in the year, but moving in the right direction. Even better, hires rose to 5.2 million from 5.17 million, and more people, 2.83 million, quit. That’s a sign of worker confidence in their job prospects.
The National Federation of Independent Business reported that its small-business optimism index edged up 0.4 points to a reading of 95.2. The readings have ranged between 94.1 and 98 in 2015. The percentage of small-business owners who expect real sales to improve rose by 9%, while those who expect better business conditions in the next six months slumped by 7%, which seems to be a contradiction.
The International Monetary Fund’s managing director Christine Lagarde says the Federal Reserve should wait to hike rates again until they see “clear evidence of firmer wage or price pressures.” Well, that didn’t stop the Fed in December… so. The Fed’s official inflation target, the PCE price index, rose at just 0.4% 12-month rate in November, well below the 2% official target.
Private-equity firm Apollo Global Management is said to be in advanced talks to buy Apollo Education (no relation) for about $1 billion. Apollo Education, operator of the for-profit University of Phoenix, had been in talks with a number of firms over a control-changing purchase.
McDonald’s could face pressure from the European Union after consumer groups in Italy filed fresh complaints. The company is accused of charging franchisees rents at excessive levels above market rates. McDonald’s is already one of the targets of an EU investigation into its tax arrangement with Luxembourg.
Last call for Internet Explorer. Effective today, Microsoft has officially stopped supporting older versions of the web browser to encourage users to migrate to its new browser, Edge, instead. That could cause security and other issues for some companies.
The Powerball jackpot is now up to $1.5 billion, maybe more by tomorrow night’s drawing. If you take the lump sum and pay taxes, you would only get about one-third that amount, but don’t worry because you are not going to win. Probably. Your six numbers will not match, and your finances will stay put, minus $2. Most likely. Sorry. And good luck.