Central Banks, Oil and the Economy

  • A lot has happened since the last update, as central banks around the globe are once again providing additional stimulus to power-up stock markets. Here are the highlights since my last update on what you may have missed:
  • A surprise move by the Japanese Central bank to cut rates to -0.1% on January 29th caused a massive rally in U.S. stock markets. The move to negative rates was a surprise since the bank testified before the Japanese Parliament just one week earlier that they would not consider moving rates into negative territory. What changed in the Japanese economy in these 7 days? Nothing… except the Japanese stock market got clobbered. In other words, the move to negative rates was to manipulate reassure the NIKKEI stock market and keep it from crashing.
  • At the end of January, the head of Europe’s central bank, Mario Draghi, hinted at more stimulus, leaving the United States as the only major economy raising interest rates. The Eurozone’s key rate is currently -0.3%, but they’re not alone: Sweden’s key rate is -0.35%, Denmark’s key rate is -0.75% and Switzerland’s key rate is -1.1%.
  • The Financial Times recently reported that $5.5 trillion in government bonds worldwide now have negative rates. That’s about one-quarter of the world’s government bonds. Not a good statistic.
  • Oil is bouncing higher because of a potential meeting among OPEC members to cut oil production. Rumors among OPEC members are common, so I don’t ascribe much value in oil making a bottom anytime soon. Meanwhile, oil inventories (released every Wednesday) have reached levels that have not been seen in decades.
  • Chinese economic data is weakening as their GDP numbers are showing decelerating growth. I also just learned that China has poured more concrete in the last five years than the United States has poured in the last 100! If you didn’t know, China uses its construction activity as its jobs program and has a stockpile of small cities with empty buildings as they attempt to move their population into city centers. I think history will show this as a misallocation of resources resulting in unproductive assets for years to come.
  • U.S. GDP was recently released, and it confirmed weak growth of 0.7% for Q4. This number will be revised twice in the coming months, so it could very well be revised to a negative number, which would show a possible start to a recession.
  • U.S. Durable Goods orders looked horrible, coming in at -5.1%. That is the type of number you see in a recession. S&P is downgrading the credit of the major oil companies, as their credit strength has been weakened by the drop in oil prices. I expect to see poor earnings from these companies for the foreseeable future. Large oil companies are already reducing their capital spending for 2016 and laying off large swaths of their workforce. Chevron plans to cut spending by 24% this year and laid off 10% of its employees in October. Exxon plans to cut spending by 25% in 2016. And BP plans to eliminate 9% of its jobs over the next two years. At some point, these companies will rationalize their capital structure and reduce the amount of money they pay out as dividends.

We’re almost half way through earnings season (215 of 500 companies in the S&P500 have reported) and here’s the score (from HedgeEYE):

  1. Total S&P 500 SALES -2.4% y/y and EPS -3.7% y/y
  2. Energy (13 of 40 reported) SALES -34.8%, EPS -70.6%
  3. Materials (13 of 27 reported) SALES -14.2%, EPS -32.7%
  4. Industrials (36 of 65 reported) SALES -7.7%, EPS -4.8%
  5. Financials (45 of 90 reported) SALES +1.2%, EPS -3.4%
  6. Information Technology (36 of 65 reported) SALES -1.2%, EPS -2.5%

Now, onto some charts below…..

Charts

I like to use the S&P 500 since it is the best representation of all stocks (the DOW has only 30 stocks). The first chart is from my last Market Update (Jan. 24th). It shows the S&P 500 selling off and reaching a potential bottom with some technical resistance points I included in the chart.

The following chart is the same chart updated through today’s price action. As you can see, the market rallied and bounced off the 50% retracement level. DING!

So what happens next? As you can see from the above charts, the daily price action is becoming increasingly volatile, which leaves the market vulnerable to large drawdowns. It is possible that the market will re-test into higher resistance zones on the chart, but it would either need oil to rally higher or for the Fed to reverse policy (which isn’t going to happen—not soon, anyway). As I mentioned in the last update, we can perhaps look to 2008 and compare the price action in this next chart from northmantrader.com:

This chart illustrates the value of technical analysis, since chart patterns tend to repeat over and over.

That’s it for now as we head into the end of the week for durable-goods orders and the payrolls report.

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.