Friday, December 19, 2014

The Fed Is Patient (excerpt)

Thank you, Janet Yellen! You didn’t disappoint me. You are still the “Fairy Godmother of the Bull Market!” As I’ve noted many times before, the S&P 500 tends to rise after Yellen speaks about the economy and monetary policy. The S&P 500 soared 4.5% on Wednesday and Thursday in response to the dovish FOMC statement and Yellen’s bullish press conference.

On Wednesday, I wrote:
However, the plunge in oil prices and the turmoil in the junk bond market might increase the likelihood that the Fed will delay the so-called "lift-off" of interest rates beyond mid-2015. "None and done" in 2015 is a distinct possibility for Fed policy. Let’s see what Fed Chair Janet Yellen has to say later today. I’m counting on her to continue to be the "Fairy Godmother of the Bull Market.”
On Tuesday, I wrote, “The FOMC might surprise us and keep ‘considerable time’ in the statement.” I noted that inflationary expectations are falling. I also wrote:
The distress in the junk bond market might also dissuade the FOMC from changing the "considerable time" language. In any case, Fed Chair Janet Yellen’s press conference on Wednesday afternoon could have a big impact on the markets. I’m still betting that she is the "Fairy Godmother of the Bull Market.”
On Monday, I noted that FRB-Chicago President Charles Evans, one of the Fed’s uber-doves, has called on his colleagues to be patient and to delay raising interest rates.

Wednesday’s FOMC statement confirmed my analysis:
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
The FOMC remains dovish and patient. It will be even more dovish and patient next year when Evans will be a voter. Two of the three dissenters (Richard Fisher and Charles Plosser) were hawks, who are retiring. The FOMC has to be concerned about the financial stresses caused by the plunge in oil prices and the strength of the dollar, as evidenced by the spike in junk bond yields and the selloffs in the bonds, stocks, and currencies of emerging economies. That’s why they are willing to be patient for a considerable time longer.

Yesterday's Morning Briefing: Grand Central 24/7. (1) Fairy Godmother. (2) The FOMC will be even more dovish and patient next year. (3) Evans will get a vote next year, and two hawks are retiring. (4) FOMC clearly concerned about financial instability related to dropping oil prices, soaring dollar, and and rising junk yields. (5) Central banks succeeding in inflating wealth. (6) Their transmission mechanisms to their economies aren’t working so well. (7) Weak data stimulate PBOC to ease and Chinese stocks to soar. (8) ECB’s Coeuré pushing for QE. (9) November crude oil demand drowned in sea of oil. (10) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Thursday, December 18, 2014

Crude Oil: Anatomy of a Glut (excerpt)


We now have November data compiled by Oil Market Intelligence on global oil demand and supply. The data show that world crude oil revenues and outlays, at an annual rate, plunged by $1.1 trillion from June through November, down to $2.7 trillion. OPEC’s revenues are down at an annualized $409 billion over this period.

Global oil demand growth continued to slow. While the 12-month average rose to a record high of 92.8mbd during November, it was up just 0.7% y/y, the lowest since April 2012. The weakness is mostly attributable to the advanced economies of the OECD, where oil demand is down 0.8% y/y, while emerging economies’ demand is up 2.2%.

The big story, of course, is the surge in non-OPEC production in recent months. It jumped 2.8mbd over the past six months through November. It is up 4.4% y/y. That’s forced OPEC to reduce output slightly last month. US and Canadian output rose 1.1mbd over the past six months through November.

I expect that the plunge in oil prices will reduce global production quickly within the next few months, especially in countries with relatively high production costs. We predict that the price of a barrel of Brent will stabilize between $60 and $70 next year.

Today's Morning Briefing: Grand Central 24/7. (1) Fairy Godmother. (2) The FOMC will be even more dovish and patient next year. (3) Evans will get a vote next year, and two hawks are retiring. (4) FOMC clearly concerned about financial instability related to dropping oil prices, soaring dollar, and and rising junk yields. (5) Central banks succeeding in inflating wealth. (6) Their transmission mechanisms to their economies aren’t working so well. (7) Weak data stimulate PBOC to ease and Chinese stocks to soar. (8) ECB’s Coeuré pushing for QE. (9) November crude oil demand drowned in sea of oil. (10) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Wednesday, December 17, 2014

The Next Financial Crisis? (excerpt)

Of course, debt defaults are likely to occur among oil producers. But I doubt they will trigger a financial crisis comparable to what happened in 2008 and 2009. Most of their junk bonds are in bond funds. There could be a liquidity crisis in those funds, but the pain will be limited to very few investors, in my opinion.

The cost to insure Russia's five-year bonds has surged to the highest levels since 2009, reflecting fears related to the fact that the Russian government gets half of its revenue from oil and gas exports. Moscow has significant foreign exchange reserves to service its debt. So far, the ratings agencies aren't downgrading Russian government debt. Standard & Poor's reaffirmed Russia's credit rating in October, though it warned of a downgrade over the next 18 months if the government's finances deteriorate.

Venezuela, on the other hand, is in dire straits. Oil makes up 96% of the country’s export earnings, and it stands to get squeezed more because its oil production costs are relatively high. Venezuelan credit default swaps cost five times more than they did in June.

The Bank of America Merrill Lynch high-yield corporate bond composite rose to yield 7.13% on Monday, up 197bps from the year’s low of 5.16% on June 23. The spread over 10-year Treasuries rose to 501bps on Monday, up from the year’s low of 253bps on June 23. That’s the widest since November 20, 2012. This spread is highly correlated with the S&P 500 VIX, which rose to 23.6 yesterday, still well below levels during the current bull market’s previous panic attacks.

Yesterday’s FT featured a story titled, “Oil plunge sparks US credit market fears.” It focused on collateralized loan obligations (CLOs). These “are a type of bond that bundles together cash flows from loans made to highly indebted companies and then slices them according to risk. … Oil and gas loans make up 4.5 per cent of the S&P LCD Loan index by amount outstanding-a proxy for exposure that may be embedded in CLOs. Energy loans make up 4.1 per cent of JPMorgan Chase’s loan index.”

Today's Morning Briefing: Two Shades of Grey. (1) Frackers: America’s patriots. (2) “Drill, baby, drill!” (3) Hurting our natural-born adversaries. (4) Assessing the odds of a new financial crisis. (5) Some German exports hit by sanctions on Russia. (6) Russia has reserves to service its debt. (7) Venezuela is an accident waiting to happen. (8) Stressed-out high-yield bond funds and CLOs. (9) Fed to the rescue again? (10) Flash PMIs mostly muddling around 50.0. (11) Focus on market-weight-rated S&P 500 housing-related industries. (More for subscribers.)

Tuesday, December 16, 2014

Energy Depressing S&P 500 Revenues & Earnings (excerpt)

Falling oil prices along with the slow pace of global economic growth are weighing on analysts’ estimates for S&P 500 revenues and earnings. They’ve lowered their revenue growth rates for 2014 and 2015 to 3.4% and 3.0% as of the week of December 4. At the beginning of October, when the price of oil was just starting to crash, they were predicting 3.9% and 4.2%.

Their estimates for earnings growth were 7.9% and 12.4% for this year and next year at the start of October. Now they are estimating 7.0% and 9.3%. They’ve slashed their estimate for Q4-2014 by 6.5% since then down to $29.91, slightly below Q3’s $30.06. That’s the S&P 500’s biggest decline since Q1-2009. Most of these downward revisions are attributable to the slashing of revenues and earnings estimates by energy industry analysts.

Today's Morning Briefing: Slipping in the Oil Patch? (1) The global growth question. (2) A new financial crisis? (3) Financial jitters could delay dropping “considerable time.” (4) Is Yellen still the “Fairy Godmother of the Bull Market?” (5) CRB raw industrials spot price index still consistent with muddling global economy. (6) US still stands out. (7) Eurozone stagnating, especially in Italy and France. (8) Japanese live in small places. (9) Chinese bank loans producing less bang per yuan. (10) India and Brazil production numbers are weak. (11) Energy analysts depressing S&P 500 estimates for revenues and earnings. (More for subscribers.)

Monday, December 15, 2014

The Energy Bubble (excerpt)

With the benefit of hindsight, it now appears that the energy boom of the past few years might have been a bubble, not just in the US, but worldwide. Booms have a tendency to turn into bubbles when they attract too much equity and debt capital, which leads to excess capacity. When the bubbles inflate, so do the prices that attract all the capital. When the resulting excess capacity leads to falling prices, the bubble bursts as capital dries up. The key characteristic of tulip and other bubbles is expectations that tulip prices will continue to rise even as more tulips are produced.

During the second half of the 1800s, we had the railroad boom in the US. During the early 1900s, the booms were in autos and appliances. The Great Depression ended with the defense spending boom of World War II. During the 1950s and 1960s, the expansion of the highway system stimulated the growth of suburbs. The resulting housing boom ended in a big bust at the end of the previous decade. The IT revolution stimulated the US economy during the 1990s. The energy industry was energized by the technological revolution, resulting in the fracking boom.

Again, with the benefit of hindsight, it now seems that the fracking boom was a bubble financed by investors desperately seeking better returns available from high-yield bonds issued by energy companies and countries. The chart of US plus Canadian oil production looks a bit like the chart of asset-backed commercial paper outstanding prior to the financial crisis of 2008.

The high-yield bond market has been hard hit by the sudden risk aversion of investors, particularly those who bought energy-related bonds. Many have been seeking safety in lower-yielding US Treasuries. The Bank of America Merrill Lynch US high-yield corporate bond yield rose from the year’s low of 5.15% on June 24 to Friday’s 7.04%, the highest since July 27, 2012. The spread over 10-year Treasury yields widened over this period by 237bps from 257bps to 494bps.

Today's Morning Briefing: The Energy Bubble. (1) Worrying about the Middle East in the Midwest. (2) Too much of a good thing? (3) US consumers are happy shoppers. (4) Widespread shopping spree. (5) Consumers of last resort. (6) Definition of a bubble fits oil’s boom/bust. (7) High-yield market highly stressed. (8) Capital is drying up for drillers. (9) Submerging oil economies. (10) Fed in 2015: None and done? (11) Can US offset all the rest? (12) Iranian surrogates threatening Saudis. (13) Still bullish. (14) Focus on market-weight-rated S&P 500 Retailers. (More for subscribers.)