Lighthouse Market Update
Stocks opened higher this morning but fell flat. The Dow and SPX are currently down 18 pts & flat, respectively. The most beaten-down sectors are leading—materials, financials, energy. Transports and biotechs are doing a little better than the overall market. By the way, the Dow Jones Transportation Average (TRAN) has far outpaced the SPX over the last month (9% vs. 3%), and so we may be looking at a real trend reversal. There’s a lot of catch-up to be had. WTI crude oil is trading up around $32.40/barrel. The dollar is up on the day and the Bloomberg Commodities Index is flat. Bonds are selling off a bit today. The 5- and 10-year Treasury yields are trading up to 1.25% and 1.77%, respectively. Looks like yields wants to move higher.
Oil prices have now fallen more than 70% from the 2014 peak, and investors fear bond defaults and bankruptcies among energy companies. Energy XXI and SandRidge Energy apparently defaulted on some bond interest payments last week. The two companies are saddled with a lot of debt, but few prospects for growing revenue. Bloomberg reports they have until the middle of next month to “either pay the interest, work out a deal with their creditors or face a default that could tip them into bankruptcy.” The two companies are high-yield issuers, meaning they issue junk bonds. Junk bond funds have had a tough time, down roughly 12% (total return) over the past year.
Economist Joe LaVorgna of Deutsche Bank has gone bearish. He sees “serious odds of recession” in the US (35-40% chance). Although recession is not his “base case” outlook, he is increasingly concerned about what he sees as deteriorating economic data. The problem, he says, is that the economy isn’t growing very quickly, and the manufacturing sector is clear in recession. At the same time, the services sector looks to be losing some momentum. In addition, He’s also concerned about a potentially “nasty election.” All this makes the US economy less able to absorb a shock (like falling economic growth in China).
The CEO of TD Bank (TD) was interviewed yesterday on CNBC after the company reported fourth quarter earnings results. He sees falling oil prices as a big problem for the stock market, but not for his bank. Loans to energy companies represent only 1% of TD Bank’s total loans. Further, he doesn’t see a need to increase loan loss reserves at this time. Keep in mind, now, TD is a Canadian bank and Canada’s economy is fairly dependent on oil production. So it seems he’s either overly optimistic or investors are wrong about the perceived contagion effect of oil on the banking system.
Aries Capital (ARCC), a middle-market lender, had some interesting things to say on their earnings conference call. The CEO said, “I think that the problems that the oil and gas markets…are going to present…for the high yield markets is misunderstood…maybe not being currently…considered in the right way by many folks that aren’t invested in high yield and in some of the larger cap credit markets the way that we are. We expect defaults will go up this year, they’re already going up.” So he does expect oil prices to remain lower for longer, and does expect some bankruptcies for small, lower-quality energy companies. “So, I think with more distress in portfolios and less capital in the market, we just see a real lasting change here rather than a blip where you kind of buy on the declines and wait for a rally, we’re really not expecting that.”
This morning, we got the first revision for US gross domestic product (GDP) for the fourth quarter of 2015. Economic growth was revised up to 1.0% (quarter-over-quarter, annualized) vs. the initial estimate of 0.7%. Economists on average expected a downward revision to just 0.4% growth. So that’s a big swing-and-a-miss for them. The revision was driven by a bigger than expected business inventory build. Unfortunately, consumer spending growth was revised down to 2.0% y/y growth vs. the initial estimate of 2.2%. The other major components were mostly unchanged. Exports fell 2.7%, non-residential business investment was down 1.9%, and residential investment soared 8%. The report’s inflation gauge (1.3%) is still nowhere near the Federal Reserve’s target (2.0%) to begin normalizing interest rates. Barron’s says US economic growth “fumbled” into year-end, but the “early outlook for the first quarter calls for a turn higher to trend growth, perhaps as much as 3%.”
A separate report from the Dept. of Commerce showed US personal incomes rose a better-than-expected .5% m/m in January. Personal spending also accelerated at a .5% rate for the month. That’s the highest rate in 8 months. On a year-over-year basis, personal incomes are rising at a 4.3% clip and consumer spending is up 2.9%. The consumer savings rate remained at a very healthy 5.2%. This report is clearly very positive and points to some improvement in the economy. Finally, I’d point out that the report’s inflation gauge jumped from 1.4% y/y to 1.7% y/y—edging closer to the Federal Reserve’s target.
*This blog is intended to be informational only, and does not include recommendations to buy or sell specific securities. Topics discussed may include Mike’s personal opinions, which may not coincide with the opinions of his employer. Finally, please understand that–as with other social media–if you leave a comment, it will be made public.