January 15, 2015

Stocks are mixed in early trading. The Dow and SPX are currently down 60 pts and -.48%, respectively. The dollar is a little weaker and that’s allowing commodities to run a bit. Importantly, oil is trading up around $48/barrel vs. its recent low of about $45/barrel. A bottom in oil is critical to stabilizing the stock market.

The US Government auctioned off $13bil in 30-year Treasury bonds yesterday. The yield, 2.43%, was the lowest ever in a new 30-year bond auction. And again today, yields are headed lower. The 5-year Treasury is trading down to 1.27% and the 10-year is down to 1.81%. Yesterday afternoon, Jim Cramer laid out all the reasons why lower interest rates are great for stocks. But on days like yesterday, trading action is dominated by those who are “convinced that rates are going lower because something is wrong…something is lurking…” He doesn’t believe that is the case. But I want to point out that falling yields and low inflation could potentially convince the Federal Reserve to delay interest rate hikes this year.

Once again yesterday, markets were unreasonably volatile. The VIX Index jumped up over 20 but that doesn’t even begin to explain the wild intra-day swings we’ve seen recently. The Dow’s move from high to low was 185 points yesterday and 344 points the day before. Of course, the financial news media took it a bit too far. Said one CNBC anchor, “This is apocalyptic!” No, it’s not.

The Swiss central bank announced a surprise move to end a self-imposed currency link between the Swiss franc and the euro currency. Until today, the franc’s exchange rate ceiling was 1.20 francs per euro. But obviously, without a cap the Swiss currency is much stronger than the euro and almost immediately the franc jumped to an exchange rate of .8 per euro. Now, understand that the Swiss central bank didn’t prepare anyone for this move, and it’s going to hurt large, multi-national Swiss companies in that their products for export will suddenly be much less competitive on price. Some global investors are wondering if this move was motivated by some panic that Europe’s economy is getting worse and perhaps Switzerland wants to distance itself from that.

We got Producer Price Index (PPI) data this morning. The Bloomberg headline is “wholesale prices fell the most in 3 years,” but that’s a bit misleading. Here’s what I see when I look at the report: US wholesale inflation rose 1.1% year-over-year in December, slightly ahead of forecasts. “Core” PPI—excluding food & energy—shot up 2.1% y/y vs. 1.8% in the prior month. So we can say that core wholesale inflation has been rising modestly since September, and in fact it hasn’t been this high since the middle of 2012. If you want to talk about disinflation or deflation, that has to be confined to commodities.

Citigroup and Bank of America both reported quarterly earnings this morning, and both stocks are lower on the day. Fixed income & currency trading, once an important source of profits for money-center banks, was very weak. And net interest margins also declined. Best Buy says its holiday sales were stronger than expected. Unfortunately, the company warned that sales will slump during the first half of this year and pricing pressure is growing in tech hardware.

January 16, 2014

Stocks opened lower this morning. At the moment, the Dow is off 57 pts and the SPX is down .2%. Financials are leading the market lower after having surged in the previous two sessions. In case you missed it, the SPX hit a fresh all-time high yesterday. Bonds are modestly higher on the day; the 10-year Treasury yield retreated a bit to 2.85%. The CEO of asset management firm Blackrock says he’s seeing a massive rotation away from long duration and Treasury debt, and into short duration and high yield bonds. Anticipating higher yields in 2014, investors who are committed to staying in fixed income are rebalancing to limit interest rate risk.  

After a tough couple of weeks, it’s really hard to ignore the rally of the past two days, and the fact that it correlated perfectly with earnings reports by Bank of America, JP Morgan and Wells Fargo. At the moment, traders and investors are taking that as a harbinger of good things to come for the economy.  This morning, Goldman Sachs and Blackrock piled on with better than expected fourth quarter earnings reports. Blackrock’s CEO: “The US is going to get stronger primarily because we more rapidly fixed our banking system.” 

On the other side of the coin, Best Buy reported an awful quarter, missing on both the top line (revenue) and bottom line (earnings). Same-store-sales fell .9% during the holiday shopping season. The retailer suffered from weak store traffic, price competition by rivals, and product supply constraints. The stock is down something like 30% this morning. Citigroup also missed badly, partly because it is more dependent on fixed income trading than the other major banks. Fixed income trading revenue fell 15%. The stock is down 3% in early trading.

The Consumer Price Index (CPI) rose .3% m/m in December, in line with expectations. On a year-over-year basis, retail inflation is rising at a 1.5% clip. While inflation remains very tame, it has accelerated modestly in recent months. As a rule of thumb, the Federal Reserve’s target for CPI is somewhere in the neighborhood of 2-2.5%.  

The Philly Fed Survey, which measures regional business activity, posted better than expected results in January. Manufacturing activity continued to accelerate this month, and improvement was broad-based in the major components (employment, new orders, shipments). Index readings are significantly better than year-ago levels. I note the corresponding New York index also posted strong results recently.  

Barron’s picked up some research on why REITs get hammered when interest rates rise. REITs clearly aren’t bonds, and yet during the second half of last year they performed like bonds. REITs have outperformed the S&P 500 Index in 16 of the last 24 years. But, as the founder of investment research firm Green Street points out, “They are a hybrid between fixed income and equities. History shows that when rates spike, REITs fare poorly.” In addition, REITs tend to borrow heavily, and rising rates mean rising cost of capital. 

October 19, 2013

Stocks opened lower but quickly recovered. The Dow and SPX are currently up 8 pts & flat, respectively. Financials and energy (and housing related stocks) are leading the way. Asia was mostly lower overnight and Europe is also down. Commodities are broadly lower (WTI crude is now under $93/barrel; copper is off .4%). Bonds are modestly lower as rates creep higher. The 10-year Treasury yield edged up to 2.69%.

So the SPX now trades at a forward P/E ratio of 17. That’s 17 times expected earnings over the next four quarters. Remember, the index started the year trading around 14 times. So this year’s rally has been more about P/E expansion than it has been about earnings growth. In that sense, we’ve entered a new phase of the stock recovery. Some say it’s all to do with the Fed’s quantitative easing, which is keeping interest rates very low and encouraging investors to buy stocks. If that’s true, modest tapering of QE isn’t likely to end the rally. Investors will continue to ride the momentum. Of course, somewhere off in the future there will be a price to pay for QE. Bloomberg quotes the CEO of Marketfield Asset Management: “higher inflation, higher interest rates, much more difficult business conditions.” But he says that’s a long way off. “I would be very surprised if this bull market ended sooner than 18 months, and maybe it’s 36 months.”

The Organization for Economic Cooperation and Development (OECD) cut its global economic forecast. Global GDP is now expected to grow 2.7% this year and 3.6% next year. The prior forecast was 3.1% and 4%, respectively. The primary reason for the move was to account for some slowing in key emerging markets like India and Brazil. OECD says the US will grow about 1.7% this year and 2.9% next year. Stocks immediately shrugged off this report.

Bloomberg ran an article highlighting the fallout from a multi-year credit binge in China. The government (mostly through state-owned banks) encouraged a $6.6 trillion lending spree as stimulus to counter the effects of the global economic crisis. A lot of that went to building out infrastructure and helping state-sponsored enterprises stay afloat. But now it looks like a good portion of those loans may not be repaid. Bloomberg calls this “over-investment gone bust.” Big Chinese banks have been busy writing off loans, and Wall Street suspects they are preparing for another wave of write-offs. The country’s leaders seem to understand overcapacity throughout the industrial sector is a problem and this is why we got yesterday’s speech by Xi Jinping promising less government intervention in the financial system.    

Best Buy issued a profit warning for the fourth quarter, saying it needs to compete on price to keep up with competitors during the holiday shopping season. The electronics retailer is losing market share to Amazon and Wal-Mart, and has responded by shedding employees and cutting costs. The stock is down about 6% in early trading. Of course, Wall Street analysts are trying to figure out whether the holiday shopping season will be strong enough to extend the stock rally. And it’s looking like a key theme will be aggressive promotional activity.