Financial Review

The Rebalancing

Goldman Sachs says oil rebalancing has begun; how it plays out over time. Plus, M&A on Monday, Warren bites on Apple, Hawaii punches Takata, and Supreme no-decision.

Financial Review by Sinclair Noe for 05-16-2016

 

DOW + 175 = 17,710
SPZ + 20 = 2066
NAS + 57 =4775
10 Y + .05 = 1.75%
OIL + 1.66 = 47.87
GOLD + .70 = 1274.50
The National Association of Home Builders’ index of home builder sentiment was 58 for the fourth month in a row. Readings over 50 signal improvement.

 

A reading of New York-area manufacturing conditions fell sharply in May. The Empire State general business conditions index dropped to a reading of negative 9, from positive 9.6 in April.

 

This week’s economic calendar includes the April CPI tomorrow, a look at inflation on the retail level and minutes from the Fed’s FOMC meeting last month. And there is a connection between the two reports. In the March 16 FOMC meeting, the Fed stated, “Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.” In other words, when the dollar drops and oil prices go up, we should be at 2% inflation; well, we are pretty much there, or at least closer. The weaker dollar makes imports, including oil, more expensive, and the higher prices tend to spread through the broader economy. A sluggish April jobs report still leaves a June rate hike on the table.

 

Before we see an interest rate hike, the Fed needs to prepare the markets, and so far, the markets don’t think a hike will happen in June.  The CME’s Fed Watch tool, which uses fed fund futures trading levels to determine the likelihood of a hike at each meeting, indicates that a better than 50 percent chance of a move doesn’t happen until the December FOMC session. It is a bad idea to surprise market participants with a rate hike, so the Fed needs to start jawboning, otherwise we can expect a September or December hike.

 

Goldman Sachs says the crude oil supply glut is over and the market has moved from a state of oversupply to a deficit, and believes major supply disruptions in markets such as Nigeria, Venezuela and China will sharply lower production levels. Goldman raised its price forecast for crude to $50 a barrel for the second half of 2016, saying: “the physical rebalancing of the oil market has finally started.”

 

Goldman Sachs has quietly overtaken Chevron and Exxon Mobil to become one of the biggest natural gas merchants in North America, expanding in physical commodities trading even as other banks pull back. Last year, Goldman bought and sold 1.2 trillion cubic feet of physical gas in the U.S. – equal to a quarter of the country’s residential consumption and more than twice its volumes in 2013. According to Natural Gas Intelligence, Goldman is now the seventh-largest gas marketer in North America.

 

Back to the Goldman thesis that we’ll have $50 a barrel oil for the second half; it really isn’t much of a stretch because oil is just a couple of dollars shy of $50 right now. But can that level hold? In the past there has been a strong correlation between the dollar and oil: dollar down – oil up, dollar up – oil down. Now, if the Federal Reserve sees inflation hit its target of 2%, we might reasonably expect an interest rate hike, or even multiple hikes, which would make the dollar stronger and push the price of oil lower. If you think the Fed will hike rates two  or three times, you might think $30 a barrel oil is where we are headed. And that would certainly be the case if the US imported oil the way we did in the past, but over the past 8 years we have cut our imported oil by more than half, to about 5 million barrels a day; thanks to the production from the shale oil patch. So let’s look at the shale fields.

 

Energy bankruptcies continue to pile up. Breitburn Energy Partners and some of its units have filed for restructuring under Chapter 11. The oil & gas MLP said it secured a $75M debtor-in-possession financing to help fund its operations during the bankruptcy process. Also Sandridge Energy reached a pre-packaged bankruptcy pact with lenders. It has agreed on a reserve-based lending facility and a swap of about $3.7 billion of other funded debt for equity. Recent asset sales have been terrible and that’s why you’re seeing this wave of restructuring of debt rather than sales.

 

Few struggling energy companies have been able to find buyers, although there was a rare exception today. Range Resources agreed to buy Memorial Resource Development Corp. in a $3.3 billion all-stock deal to take advantage of growing demand from natural gas exports and chemical manufacturers. Despite this anomaly, we know that investment in the oil patch has slowed dramatically. C&I, or commercial and industrial loan activity continues to drop on a weekly basis. Still, mostly we are seeing Chapter 11, and that means higher oil prices will lead to all out pumping to get out from under reorganization.

 

Then consider what is happening with Saudi Arabia, which suffered another cut to its credit rating on Saturday as Moody’s Investors Service downgraded the country along with Bahrain and Oman because of the past slump in oil prices.  The credit rating agency said: “A combination of lower growth, higher debt levels and smaller domestic and external buffers leave the Kingdom less well positioned to weather future shocks.” As a side bar, the US Treasury today said the Saudis hold about $116 billion in US government debt, far less than the $750 billion the Saudis threatened to cash in if Congress enacts a bill allowing the monarchy to be held responsible in American courts for any role in the Sept. 11, 2001, terror attacks. It also shows the Saudis have been burning through their foreign exchange reserves. How can the Saudis improve their financial situation? Easy – they pump more oil. Goldman might be right that the supply glut is over for the time being, but the higher the price, the more supply comes to market. And that brings us to…

 

Royal Dutch Shell is eyeing a possible $40 billion spinoff of non-core assets around the globe as it grapples with $70 billion in debt following its takeover of BG Group earlier this year. Shell is establishing a separate division, New Energies, to invest in renewable and low-carbon power. Even if we see more supply in the oil market, we still have to consider demand; and there we are seeing a definitive shift away from oil to renewables, which should put a permanent ceiling on demand.

 

Pfizer announced it would buy Anacor Pharmaceuticals in an all-cash deal worth about $4.5 billion, as it turns to smaller deals after walking away from its scuttled acquisition of Allergan. The deal values Anacor at $99.25 per share or a premium of 55% over Friday’s close. Anacor has no products on the market, but it does have a treatment for eczema under review at the Food and Drug Administration.

 

Gannett said it raised its all-cash offer for Tribune Publishing to about $475 million, just two weeks after Tribune’s board rejected a lower bid. The revised offer represents a 22% increase over its prior bid and a nearly 100% premium over Tribune Publishing’s share price on April 22.

 

Warren Buffett’s Berkshire Hathaway revealed a new stake in Apple. Berkshire now holds 9.81 million Apple shares worth just over $1 billion. For the record, Warren has never been a big fan of tech, so the Apple bet probably came from one of his portfolio managers, Todd Combs and Ted Weschler.

 

European antitrust authorities will impose a record fine on Google in the coming weeks for abusing its dominance of the online search market in the region, according to the U.K.’s Telegraph newspaper. The European Commission is planning to fine the tech giant about €3-billion-euro, surpassing the toughest antitrust punishment to date. Google will also be banned from continuing to manipulate search results to favor itself and harm rivals.

 

Following a meeting with the U.S. Labor Secretary Thomas Perez, Verizon management and the unions representing the company’s 39,000 East Coast workers on strike have agreed to resume negotiations tomorrow. The employees walked out on April 13, after having failed to reach an agreement on a new labor contract over issues including healthcare, moving positions offshore and temporary job relocations.

 

Amazon is getting ready to roll out new lines of private-label brands; the strategy is aimed at boosting margins as well as gaining insights into what goods consumers purchase. The new brands will include items such as nuts, spices, tea, coffee, baby food, vitamins, diapers and laundry detergents. Amazon will only offer these labels to its Prime subscribers, and the first of the brands could start appearing at the end of May or early June.

 

Philips is seeking to raise as much as $1.1 billion from the initial public offering of its lighting unit as it pushes ahead with a plan to list on Amsterdam’s stock exchange after a private sale didn’t result in a buyer. Final pricing is set for May 26, with the listing commencing the following day.

 

Hawaii has become the first state in the nation to sue Takata over its air bags, seeking $10K per violation for more than 70,000 cars sold across its islands. According to the Hawaii Office of Consumer Protection, Takata switched to ammonium nitrate – a cheaper inflator component – despite the fact that it was widely known to be an unstable and dangerous chemical. The lawsuit also names Honda, the automaker most affected by the continuing mass recalls of Takata airbags.

 

The world’s largest sovereign wealth fund is going to sue Volkswagen. Norway’s sovereign wealth fund is set to sue Volkswagen over the huge losses it suffered as a result of Volkswagen’s emissions scandal. VW shares are down over 23% since the scandal erupted in October 2015.

 

The Supreme Court handed down a decision on Zubik v. Burwell, the religious challenge to the contraception mandate Obamacare. The Affordable Care Act requires most employers to offer health insurance to their employees, including contraceptive coverage. Religious nonprofits were offered a work-around that allows them to file a one-page form with the federal government, so that the insurance company can step in and provide the coverage directly to their employees. But the plaintiffs claimed that infringed on their religious freedom.  The Supremes decision today was a no-decision; they kicked it back to the lower court and said, essentially, work it out.

 

 

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