Laissez les Bons Temps Rouler
Financial Review by Sinclair Noe for 01-26-2016
DOW + 282 = 16,167
SPX + 26 = 1903
NAS + 49 = 4567
10 Y – .03 = 1.99%
OIL + .11 = 30.45
GOLD + 11.80 = 1120.70
The Federal Reserve had always planned to pause after raising interest rates in December, but the question now is how long that break will last. Initial expectations were that the FOMC would raise rates again this March, but a downturn in the equity markets, a stronger dollar and weak inflation have led some to predict that another move may be months away. Investors may get some more insight as Fed officials gather today for a two-day session, their first policy-making meeting of 2016. For now, the Fed can simply say that they are data dependent and the 25 basis point increase in December has not had an effect on the economy. They might say that everything is basically good in the economy and the markets, if they get any mention at all, are just not looking at the right data.
In a recent speech, Federal Reserve Bank of New York President William Dudley summed up the situation:
“In terms of the economic outlook, the situation does not appear to have changed much since the last [Federal Open Market Committee] meeting. Some recent activity indicators have been on the softer side, pointing to a relatively weak fourth quarter for real GDP growth. But this needs to be weighed against the strength evident in the U.S. labor market. I continue to expect that the economy will expand at a pace slightly above its long-term trend in 2016. In other words, I anticipate sufficient economic strength to push the unemployment rate down a bit further and to more fully utilize the nation’s labor resources.”
But the Fed is not unanimous in its confidence. St. Louis Fed President James Bullard, a noted hawk of late, was more cautious given five-year forward-inflation expectations. Bullard told reporters after his speech that strong U.S. employment would argue that the FOMC’S median projection of rate increases totaling 1 percentage point this year is “about right,” while inflation and price expectations concerns “would tend to push off rate increases.” Bullard said he would put more weight on expectations if they continue to decline.
The bottom line is that the Fed does not know if the economy will slip into recession, or if the economy will stabilize and the markets continue to act crazy, or if both the markets and the economy stabilize. And so tomorrow the Fed will try to act like things are basically on track and their eyes are wide open.
Once again oil prices were leading equity markets on news that Kuwait and Saudi Arabia want to stabilize oil prices, which means they want to cut production; more specifically they want non-OPEC producers to cut output, which probably won’t happen. Anyway, that’s today’s justification for a more than 6% jump in oil intraday, which follows yesterday’s 7% decline, which follows last week’s three-day 21% rally in oil. And some people think there is no money to be made in $30 oil. Wrong. No money for the producers working in the field, but for the speculators, “laissez les bons temps rouler”, let the good times roll. Is there any reason behind these wild swings? Did the rules of supply and demand expire? Have the fundamentals changed from last Tuesday to today? Nope.
So, this raises the question of whether low oil prices can push the economy into recession. Well, there is no history of that. A drop in oil prices means less money in the hands of oil producers but more money in the hands of oil consumers. Currently the U.S. is importing about 5.1 million barrels a day more than we’re exporting of crude oil and petroleum products. At $100 a barrel, that had been a net drain on the U.S. economy of $190 billion each year. That drain that will now be cut by more than half by falling oil prices.
We usually see consumers spend their extra income right away, whereas it takes more time for producers to alter their spending plans. As a result, even if the U.S. was not a net importer of oil, we might still expect to see a short-run positive stimulus from dropping oil prices. The actual change in overall consumption spending in response to the oil price decline through March of last year was about 0.4% smaller than would have been predicted on the basis of the historical correlations. But we see something different when we look at the behavior of individual consumers. A study by the JP Morgan Chase Institute compared the response to lower gasoline prices of people who had previously been buying a lot of gasoline with the responses of people who had been buying relatively little. They found that the first group increased spending relative to the second, with the magnitude of the difference in spending between the two groups consistent with the claim that consumers spent almost all of their windfall. In any case, we’ve now had plenty of time for cuts in spending by U.S. oil producers to start to have an economic effect of their own. If there’s an increase in spending by consumers of $1 and a decrease in spending by producers of $1, it’s really a net wash for the economy, just spread out in different places.
The S&P/Case-Shiller 20-City Composite Index rose 0.1% in the three months ending in November, for a 5.8% yearly increase. That was up from a 5.5% yearly gain in the period ending in October, and marked the strongest reading since July 2014. Phoenix home prices were up 0.3% for November, and up 5.9% for the 12 months ending in November. At the peak, prices in Phoenix were 127% above the January 2000 level. Then prices in Phoenix fell slightly below the January 2000 level, and are now up 55% above January 2000 (55% nominal gain in almost 16 years).
The Conference Board reported that consumer confidence rose to 98.1 in January from a reading of 96.3 in December, and the best reading since October.
China’s stock market crashed to a 13-month low. China’s Shanghai Composite plunged 6.4% to its lowest level since December 2014. The telecom and IT sectors were hit the hardest during Wednesday’s rout, tumbling 9.6% and 8.7%, respectively.
The big news in earnings came after the closing bell; Apple posted $18.4 billion in net income on sales of $75.9 billion in the December quarter. Earnings per share were $3.28, or 5-cents better than estimates. Holiday sales of iPhones rose to 74.8 million, which was below estimates, and the best guess is that everyone who wants an iPhone has one. Revenue in the first three months of the year will be $50 billion to $53 billion, the first quarterly drop since 2003 and below estimates. Apple said the strength of the U.S. dollar against foreign currencies is trimming revenue. What would have been $100 in sales in the fourth quarter of 2014 is today worth only $85 because of the shift in currency-exchange rates. The smartphone industry is transforming. The entire planet is becoming connected one sensor at a time. So, it is less important how many individual products Apple sold, and more important to understand how they are or are not transitioning. Apple up slightly in after hours.
Freeport-McMoRan posted a loss of $4.1 billion, or $3.47 a share, in the quarter, after a loss of $12.2 billion, or $11.31 a share, in the year-earlier period. On an adjusted basis, results topped estimates. Revenue fell to $3.8 billion from $5.2 billion, matching estimates.
Lockheed Martin will separate its government information technology business and combine it with national security firm Leidos Holdings in a $5 billion transaction, a move to shift the contractor’s focus to its core aerospace and defense units. The news came as the company lifted its sales guidance for the year after easily topping fourth-quarter expectations, thanks in part to a recent acquisition and F-35 jet fighter production contracts.
In other earnings news: D.R. Horton dropped after reporting slowing price gains. Halliburton was down following a big drop in Q4 revenues. Kimberly-Clark lost more than 3% after guidance fell short. 3M, Johnson & Johnson, and Procter and Gamble all reported better than expected profits. Coach reported its first increase in sales in 10 quarters.
American International Group, AIG, said it would spin off its mortgage insurance unit, cut jobs and sell its broker-dealer network as part of an overhaul promised to shareholders to fend off activist investor Carl Icahn. The insurer said in a statement that it plans to cut $1.6 billion of costs and return at least $25 billion to shareholders over the next two years. In a separate filing, AIG said it had frozen its pension plan and let about 300 of its “top 1,400 employees” leave. Further job cuts are planned this year.
JPMorgan has agreed to pay the remnants of Lehman Brothers $1.42 billion in cash to settle most of the failed investment bank’s $8.6 billion lawsuit over claims that it illegally siphoned billions of dollars from Lehman before its collapse. The payment doesn’t settle every claim, but resolves the bulk of the suit, and allows post-bankruptcy Lehman to make another $1.5 billion distribution to its creditors. The settlement is not expected to have a material impact on JPMorgan’s upcoming results.
Huntington Bancshares has agreed to acquire smaller rival FirstMerit for $3.4 billion in a tie-up of two Ohio-based lenders. Regional banks have seen a steady consolidation since the global financial crisis.
Tax inversions are still on the loose. Johnson Controls is set to become the latest American company to move abroad in search of savings upon merging with Tyco and taking on its Irish tax address. The deal is at least the 12th inversion since the U.S. Department of the Treasury moved to curb the tax-reducing deals in September 2014 – roughly the same number in the 16 months before the legislation.