Brouwer & JanachowskiJanuary 22, 2016
A better week. In markets that are directional and emotional, few large buyers stepped up. But we heard from Mario Draghi at the ECB that policies would be “reviewed and reconsidered”. Admittedly, the Fed is in a blackout period before its first meeting since it raised rates. So the news from the ECB was welcome and stocks rallied.
The underlying story was oil. In addition to the chronic oversupply, there are developments worth noting:
- Saudi Arabia: not much uncontrolled news comes out of the kingdom so here’s a timely piece on why the world’s cheapest oil producer will pump regardless of price. It’s a combination of geo-political angst with Iran, a growing and youthful population and a 40-year attempt to diversify away from oil. It’s no secret they are running down the sovereign wealth fund. It has fallen from around $750bn a year ago to $630bn in November, a drain of about $10bn a month. We expect those to continue into 2016, accounting for some of the general weakness in capital markets.
- Oil Demand: is notoriously difficult to predict or track, but this week the IEA raised oil consumption for 2015. In other words, they understated actual results. It’s thus possible that oil inventory is lower than stated.
- MLPs: we are early into results season but one leading MLP pipeline company announced an unchanged distribution and a successful placement of long-term financing. These companies have been beaten up mainly because of this:
…which shows the real price of oil near 20-year lows. But some of the U.S. pipeline companies have solid financials, lower capital needs and long-term contracts. The broad index of MLPs yields around 10%, which even discounted for any cuts, is four times the U.S. Treasury 10-year yield or the S&P 500.
Two other quick points:
- Emerging Markets: remain very fraught. But here is a broad reminder why we like them. The top line shows growth of emerging compared to developed countries.
The differential is about as wide as it has been. We also notice valuations have diverged markedly. The U.S. market trades at a Price to Book of 2.6 while Emerging Markets trade at 1.5.
- Bear or Correction?: There is plenty of talk that a 20% stock market fall is a bear market and 10% a correction. This puts small caps in bear territory and the S&P 500 as a correction. But these definitions are arbitrary and recent. We prefer a measure of depth, dispersion and duration. We have some depth. We don't have dispersion. We don't have duration. That puts us in the correction mode. Which makes us uncomfortable but not unsettled.
Bottom Line: Look for a Fed induced bounce next week. Meanwhile long duration and high quality bonds provide relief.
And a salutary reminder why all ETFs are not what they seem.
--Christian Thwaites, Brouwer & Janachowski, LLC
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