Sunday, December 7, 2014

The Oil Conundrum, A Majorly-Stimulated Economy, Emerging Markets, and Your Weekly Update

A good week for U.S. economic indicators was capped off Friday by an employment report that exceeded the highest published expectations---with the November number coming in at 321,000 jobs, and September and October revisions adding another 44,000. Last week I shared with you my view of what we might expect from the stock market when the Fed begins tightening up on monetary policy. The fact that Friday's jobs report (which also had wages increasing at a rate twice the consensus estimate) did not inspire a massive rally in U.S. stocks (the Dow gained only .33% Friday, the S&P 500 gained .17%) I think speaks to that logic. The fact that Eurozone markets did rally big time (the German DAX gained 2.36% Friday, the French CAC 40 gained 2.21%) on the U.S. jobs number I think  speaks largely to the fact that the ECB is on the other side of the monetary policy fence (they'll be easing). 

Now, you shouldn't take my implying that good news may not be great news for U.S. stocks in the near-term as a suggestion that good news isn't indeed good news. Because it is. In fact, we'll take all we can get as we head into the year when the Fed at last gets the Fed funds rate off of what they call the zero lower bound. For the stock market to withstand the next Fed tightening cycle, we'll have to see profits continue to expand while P/E (price to earnings ratio)s contract (per last week's chart). And for profits to continue to expand from these levels, we'll have to see the economy continue to gain momentum going into next year.

The oil conundrum:

Inquiries are flowing in. Here are two from clients that essentially sum up the split of opinion among market participants:
1. "Should we be buying more energy stocks now that they're so cheap?"

2. "Wondering how badly we're getting hammered by oil prices still tanking (and apparently likely to continue for some time)? And "Are you nervous about energy in 2015?"

Now that (diverging thoughts [i.e., buyers and sellers]) is what makes a market!

T. Boone Pickens (famous oil man/expert) says oil will be back to $100 per barrel in 12 to 18 months. Others say it's heading to $40. Again, that's what makes a market.

Me, I don't know where the price of oil is heading in the near-term. But I do know this, plunging oil prices first result in reduced, if not halted, investment in new capacity. Low prices that remain low will result in cuts to current production. Cuts to current production will alter the supply/demand equation, particularly when we're talking about a commodity that, in one form or another, every human on the planet consumers. And one that when its price majorly declines becomes a major economic stimulus. And folks living in a majorly-stimulated economy feel good. And folks who feel good like to drive places and fly places and buy stuff with parts made from petroleum products. Yep, you get it, the price ultimately comes bounding back.

I've heard a number of pundits downplay the economic stimulus story of plunging oil prices. They cite the boom in states like North Dakota, and how the folks there will suffer if this keeps up: A good number of those jobs will go away and that'll reverberate throughout the rest of the economy. Well, they're right, and, well, they're wrong. Yes, some folks could lose their jobs, but if "reverberate" means that a cut in U.S. oil production will effectively nullify the economic gains of lower oil prices, they're wrong---on two fronts. One, the U.S. oil boom has been the result of newly adopted (i.e., it's been around awhile, but it's just now being used en masse) technology that doesn't rely on human capital like the old technology did. Meaning, the productivity of today's oil industry is way higher than yesterday's. I.e., it takes substantially fewer man hours to fill a barrel of oil than it used to. Plus, the U.S. remains a net importer of oil. Meaning, the boon to the U.S. consumer and industrial user of oil overcompensates for the hit to the oil producing states.

So, I say we enjoy it while it lasts. Because, alas, it won't last forever. And, yes, we're still a ways away from the point where the alternatives take over. And the price of oil will traverse many cycles in the meantime.

As for my answers to those two client questions:

1. Yeah, I suspect if one's patient one'll do okay buying oil stocks here. But if you're at 10% already, I think you're good for now.

2. When 10-15% of your equity exposure drops 10% on the year (30% the past few months), that's 1 to 1.5%  (3 to 4.5% over the past few months) less than you would've earned on equities without the energy exposure. Which, in a year when a portfolio's international exposure is weighing on the overall results as well, is a noticeable hit. Am I "nervous about energy in 2015?" Nope. I'm comfortable with 10% exposure.

The International Scene:

As you've noticed  (here, here and here), the Eurozone has been on my radar of late. Other than a passing remark regarding the Bank of China's easing stance, I haven't said much about the emerging markets the past few weeks. Of course you clients know, given the emerging markets speech you suffer through at virtually every review meeting, that I remain a huge long-term bull. I mean, emerging markets (think China, India, South Korea, Indonesia, South Africa, Brazil, Mexico and the like) are where 85% of the world's humans live. They're where young materially (as in materialism)-thirsty workers reside. They're where populations are growing (critical to a growing economy). They're where infrastructure has huge catching up to do. In short, they're where the world's greatest opportunities lie. They're also where volatility is defined. Therefore, we can't go hog-wild into the emerging markets. We can, however, as we have in many portfolios (of willing clients) add incrementally over time. Here's what I wrote in last December's "Our View Going Forward":
We see unusual long-term opportunity in non-US economies, particularly emerging markets. During the first quarter of 2012 we recommended a modest move out of developed non-US markets to index funds that track the stocks of companies domiciled in China, Brazil, India, South Korea, Indonesia, Taiwan, Thailand, Malaysia and other emerging nations. The global economic concerns of the past few years have, we believe, offered up an opportunity to buy into those potentially robust economies at extremely attractive valuations. 85% of the world’s population lives in emerging markets and, clearly, western ideals have taken root in the psyche of the citizens and leaders of many of these nations. That said, change can be painful, and we caution investors not to over-indulge in direct emerging markets exposure.

(Note: The opportunity for growth I continue to see in emerging market equities was not nearly realized (in fact share prices declined) in 2013. Here’s a recent blog post where I explain how quantitative easing in the U.S. has led to extreme volatility in the emerging markets.) 

 We believe, geo-politics notwithstanding, that long-term opportunities exist in developed-world equities as well. Particularly in companies with substantial reach into the emerging markets. The relatively young, forward-looking, populations in many of the emerging economies (the average age of an Indian worker is 26)—with their need/thirst for infrastructure—presents opportunities for multinational companies in the U.S. and other developed nations. Think industrials, materials, technology, agriculture, energy and finance.

China stocks have been on a tear of late... As you'll notice in the below snippet from a Bloomberg News article, one Wall Street firm credits easing monetary policy from the Bank of China. Which (central bank easing), again, speaks to one reason why I find the Eurozone interesting going into next year. As for my thoughts regarding the long-term importance of maintaining emerging markets exposure in your portfolios, I'm more committed than ever. But my commitment is  more about the longer-term trends referenced above than it is central bank policy: 
That bull-market feeling is back in China.

The Shanghai Composite Index (SHCOMP)’s advance to a three-year high today extended its gain over the past month to 14 percent, trouncing all 92 of the world’s other benchmark equity indexes by at least six percentage points. Mainland investors are opening stockaccounts at the fastest pace in three years, trading in Shanghaisurged above 500 billion yuan ($81.3 billion) today for the first time and initial public offerings have returned an average 180 percent in 2014.

Central bank efforts to bolster China’s economic growth are reviving optimism in the $4.6 trillion stock market after the Shanghai Composite lost more value than any other major benchmark index worldwide in the past five years. While exchange-traded fund investors are paring holdings on concern the gains won’t last, Morgan Stanley (MS) says there’s potential for an “ultra-bull” rally where share prices double in 18 months.

“New account openings are a sign that there is fundamental investor participation,” said Jonathan Garner, the Hong Kong-based head ofAsia and emerging-market strategy at Morgan Stanley who predicted in June that monetary stimulus would drive a second-half rally in Chinese shares. “Moves on high volumes should always be taken seriously.”

Below are the highlights from last week's U.S. entries to my economic journal. As I suggested in the opening line above, last week was overall good on the economic indicator front. The "What Respondents Are Saying" sections from the Institute of Supply Management (ISM)s purchasing managers surveys (which I feature below), and the results of the consumer sentiment surveys, speak volumes about why the hard data is pointing to an acceleration in the U.S. economy:

(Oh, and lastly, if you're our client, and haven't yet listened to last Friday's audio titled "Important Message to Clients", please do. Your reply is requested with regard to two items therein.) 


 DECEMBER 1, 2014

MARKIT PMI MANUFACTURING INDEX shows slowing growth in the sector.. a 10 month low of 54.8 vs an estimate of 55 and 55.9 prior. New orders and output slowed... The employment component is still strong however... The manufacturing surveys of late have clearly flattened out... Still growing (above 50) but at a slower pace of late...

THE ISM MANUFACTURING INDEX did not at all concur with Markit's survey. The ISM came in at a very strong 58.7. Which is near recovery highs. New orders came in extremely strong at 66 with backlog orders up as well. Jobs growth remained strong, as did production growth. Slowing delivery times indicates strength as well. Input prices are dropping, reflecting declining oil prices. Here's what's the survey's respondents are saying (taken straight from the release):

"The Holiday Season continues to exceed expectations. Customers are generally optimistic for future sales growth." (Food, Beverage & Tobacco Products)

"Continued strong demand. Deliveries through the West Coast are delayed due to a number of factors." (Fabricated Metal Products)

"We have seen continued growth in transportation equipment. Slowdowns and threats of strike of West Coast longshoreman weigh heavily on U.S. operations." (Transportation Equipment)

"Business continues to be stronger than last year." (Furniture & Related Products)

"Improvement in defense spending and manufacturing." (Computer & Electronic Products)

"West Coast port longshoreman slowdown is affecting business with longer lead times." (Chemical Products)

"We continue to hire people. People are also leaving to take other jobs indicating the job market is starting to improve for manufacturing." (Electrical Equipment, Appliances & Components)

"Market has remained strong going into year-end." (Wood Products)

"Order intake has been substantial, resulting in a very healthy backlog. The packaging automation requirements in the food and beverage market are robust." (Machinery)

"Demand remains strong for new orders." (Miscellaneous Manufacturing)

THE GALLUP US CONSUMER SPENDING MEASURE showed consumers spending $95 per day in November, vs $89 in October. Also up year-on-year ($91 last November)... This is well above the recovery average...

DECEMBER 2, 2014

AUTO SALES spiked above the highest estimates... 17.2 million, vs 16.5 million prior... North America-made cars were especially strong at 14.0 million... This is the second straight gain and speaks volumes about consumer optimism of late...

THE ICSC RETAIL REPORT came in surprisingly down 1.8% last week. The year on year rate, however, rose 1.1% to 2.8%... The report was  upbeat in saying that consumers are behind in their Xmas shopping, pointing to a potentially big December pickup.

THE JOHNSON REDBOOK RETAIL REPORT showed strength last week, growing to 4.8% (above 3.5% is typical during economic expansions) year on year, vs 4.2% the prior week...

THE GALLUP US ECONOMIC CONFIDENCE INDEX FOR NOVEMBER rose to -8 in November vs -14 prior. That's the highest monthly reading in the past 18 months. The post recession high was -7 in May 2013... This is the 4th consecutive increase after a year of flat readings... The following is from Econoday's summary:
Though the index remains in negative territory, November is the closest it has come to breaking into positive territory in quite some time. The current reading is the second-highest monthly reading since Gallup began tracking the index daily in January 2008. November saw higher weekly scores than at any point in the past year and a half, with a weekly high of minus 6 for the week ending November 16. The month ended with a score of minus 8 for the week ending November 30. Meanwhile, 43 percent of Americans said the economy is "getting better," while 52 percent said it is "getting worse." This resulted in an economic outlook score of minus 9 -- the best outlook score since July 2013.

Confidence among lower- and middle-income Americans climbed three points from October, to a current score of minus 11, and among higher-income Americans, it rose four points to plus 6. Upper-income Americans, those who make $90,000 a year or more, also had positive index scores of plus 5 in May and June of 2013.

November's economic confidence reading brings more promising news for those watching the index's movement. The consecutive monthly increases in economic confidence come as gas prices continue to drop and are slated to fall below $2 a gallon in some parts of the country. Additionally, the Dow rose 2.5 percent in November.

CONSTRUCTION SPENDING rebounded big time in October.. 1.1% month over month, vs -.4% prior... The noted positive components were public outlays and private residential.

DECEMBER 3, 2014

MBA WEEKLY MORTGAGE INDEX showed growth in new purchase apps +3%, but continued weakness in refinances. Econoday sums it up nicely:
The purchase index snapped back in the holiday shortened November 28 week, rising 3.0 percent after falling 10.0 percent in the prior week. The gain helped the year-on-year reading which improved to minus 4.0 percent from minus 10.0 percent. The refinance index, however, continues its long run in negative trend, down a steep 13.0 percent for a sixth straight decline. Rates were mostly lower in the week with the average 30-year mortgage for conforming loans ($417,000 or less) down 7 basis points in the week to 4.08 percent.

THE ADP EMPLOYMENT REPORT showed 208k new jobs in November. Off the 225k estimate but respectable nonetheless...

US PRODUCTIVITY rose 2.3% in Q3 vs 2.0% prior... the consensus estimate was for a 2.4% gain... The report speaks positively about corporate profits and modestly about consumer income. I do expect to see wage inflation as next year unfolds against an expectation of a tightening labor market...

MARKIT'S SERVICES PMI INDEX came in slower for the 5th straight month, at 56.2 vs 57.1... although it remains solidly in expansion territory (above 50). The employment component remains strong. Here's Econoday's summary:
Markit's sample of US service providers reports a 5th straight month of slowing growth from June's recovery peak, at a composite index of 56.2 vs 56.3 at mid-month and a final 57.1 in October. Readings on new business and output have now moderated for 7 straight months. A positive is a 5-month high in hiring and a 5-month high in the business outlook. Of note is continued moderation in inflation pressures with the increase in input costs the lowest since April last year and the increase in prices charged the lowest since July this year.

Despite slowing in the report, levels are still very healthy and sustainable. Coming up at 10:00 a.m. ET this morning is the non-manufacturing report from the ISM which, aside from services, also covers the construction and mining sectors.

THE ISM NON-MANUF (SERVICES) PMI, unlike Markit's, shows a growing trend in the services sector. At 59.3, it came within a hair of the recovery high of 59.6... You have to go back 9 years to find another reading (other than August's 59.6) this high. While the majority of the components read strong, the employment component softened a bit. While it still shows employment growth, the pace contracted in November. That's an unusual reading these days, but given the strength of the other components I'd expect to see the jobs component remain strong going forward. Other areas of note are the commentaries regarding strain on capacity (can lead to capex and/or inflation), and the increase in the prices index... Here's what's the survey's respondents are saying (taken straight from the release):

"Business is good with new technology and products." (Information)

"General uptick in demand/spending." (Finance & Insurance)

"We are experiencing downward pricing pressures on the price of natural gas as a result of the lower energy prices being driven by OPEC’s lower oil prices." (Mining)

"Food cost continues to be a challenge due to cost of goods increases. Beef, produce and turkey markets remain high. Chicken, pork and eggs, although year-over-year are higher; prices have fallen from one month ago." (Accommodation & Food Services)

"Business is strong. Many new accounts want to be implemented before year-end so cost reductions can be included." (Professional, Scientific & Technical Services)

"We are looking forward to a strong holiday season." (Retail Trade)

"We are still seeing continued momentum month-over-month with the strongest area being government accounts." (Wholesale Trade)

CRUDE OIL INVENTORIES declined 3.7 million barrels last week due to a rise in refinery demand. Running at 93.4% of capacity last week, refineries have added to product inventories: gasoline inventories up 2.1 million barrels and distillates up 3 million.

DECEMBER 4, 2014

CHAIN STORE SALES rose 4.9% over the past year... a healthy pace...

CHALLENGER JOBS CUTS totaled 35, 940 in November, down from 51,183 in October and 45, 314 last November. Makes sense given what we're seeing in the jobs-related data.

THE BLOOMBERG CONSUMER COMFORT INDEX continues to show sentiment near a 7 year high. The following from Bloomberg's release speaks to my optimism for retail this shopping season:
Dec. 4 (Bloomberg) -- Consumer sentiment last week held close to an almost seven-year high as falling gasoline prices kept Americans upbeat about the buying climate.

The Bloomberg Consumer Comfort Index eased to 39.8 in the period ended Nov. 30 from 40.7, which was the highest since December 2007. A gauge of attitudes about whether it’s a good time to spend stayed at the best reading since November 2007.

From Bloomberg:

Households making their holiday gift purchases have become more optimistic as they pay the lowest prices for gas since 2010 and employment opportunities expand. Faster growth in wages and further improvement in the job market that reduces the number of long-term unemployed would help set the stage for bigger consumer spending gains into next year.

Confidence had the “strongest start to a holiday shopping season since 2007,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. This “should brighten the season for retailers.”

WEEKLY JOBLESS CLAIMS dipped back below 300k last week, to 297k....

NAT GAS INVENTORIES declined by 22 bcf last week...

M2 MONEY SUPPLY grew by $3.5 billion last week... after rising $12.1 billion the week before...

DECEMBER 5, 2014

THE BLS NONFARM PAYROLLS REPORT came in way above the consensus estimate, at 321k vs the 225k forecast. This essentially confirms, and some, the signals I've been reporting on for weeks. Plus, the month on month hourly earnings increase came in at a surprisingly strong .4% (estimate was .2%). This speaks volumes about the present momentum of the U.S. economy... This report, the wage number in particular, no doubt has the Fed's attention. It's virtually a given, barring a surprise pullback in the U.S. economy, that the Fed will begin the tightening process during the course of next year. However, given their obvious concerns over roiling the financial markets while raising interest rates, etc., and the present lack of inflationary pressures (the wage number notwithstanding), I expect they'll start the process in as gingerly a fashion as possible.

The U.S. imported $43.4 billion worth of goods and services than it exported last month. This is billed as a negative, given that the consensus estimate was for a $41 billion gap, by those who are paid to comment on such things. Personally, I view the negativity as utter hogwash. THE TRADE DEFICIT speaks to the relative health of the U.S. consumer, our freedom to shop the world for the things we desire, and the rest of the world's desire to acquire U.S. goods, services and assets... The deficit relates to goods and services, the remainder flows back as foreign direct investment in U.S. assets.... A very good thing by the way...

On the surface OCTOBER FACTORY ORDERS surprised on the downside. Under the surface, however, the bulk of the weakness came from nondurables, which is essentially the result of lower oil prices. Durable goods rose .3%, versus a drop of .7% in September...

CONSUMER CREDIT rose $13.2 billion in October. However, the gain was not in the area that would be meaningful to retailers (revolving credit). It was concentrated in non-revolving credit. Which would be auto loans and the government's acquisition of student loans from private lenders. If November's wage growth becomes the new trend, we'll likely see a pickup in revolving credit going forward...

1 comment:

  1. […] Now—to understand where the naysayers are coming from—given that such a thing is presented as a “net” positive, there has to be a calculation where positives are netted against negatives. So then, what are the negatives? Well, I’ve already touched on the obvious.  […]