Brouwer & JanachowskiJanuary 15, 2016
There comes a point in the market cycle where all news is good news. This lasts for a while. And then all news becomes bad news. Right now, it’s all bad news. This week’s data confirmed the bias.
NFIB survey up. Should have been more. Jop Openings flat. Disappointed. Retail sales down. Told you so. Empire manufacturing slump. Worst since Great Recession. And at the end of the week, we had Industrial Production (IP) down 2%, which looked like this:
Now all these points are true. But this is all part of the energy story. We have known for a while that oil was heading south. This week it closed at $29. And anything connected with energy was hit. This means not just the major oil companies, but materials, industrials, commodities and banks. Accident-prone Citibank saw a 30% rise in its non-performing loans because of energy. In the stock market, the picture looks like this:
This is over the last three months but you can see that most of the breakdown came in January.
The main culprits:
- China: yes, the stock market is mostly retail and hyper-volatile but the core problem is that the economy is weakening, the Yuan devaluing and locals are buying dollars in bulk.
- Saudi Arabia: it is desperate to keep Iran production from coming on line and fighting a proxy war in Yemen. Production costs are the lowest in the world at $10bbl compared to the U.S. at $36. And even if their intent is not to put marginal producers out of business, they have to fund a budget deficit approaching 20% of GDP.
- The Fed: their inflation expectations are 2% but markets think it’s 1.6%. That's a big gap and Treasuries rallied this week. The Ten-Year yields 2.03%, which is less than a year ago.
Ok enough. Now what?
- Credit risk will worsen: Moody’s downgraded 68 companies last quarter, a six-year high. Most are energy companies.
- Stocks will move lower in the short term: earnings should trend up but the market needs to cheapen to attract new buyers. The good news is that the price to earnings ratio is now 15% cheaper than it was a year ago and stocks yield 30bps more than the Ten-Year treasury.
- The Eurozone is still pursuing an easy monetary policy: This is good for asset prices. We think the Fed cannot possibly raise rates in the first half of the year. Once the market accepts that, we will see a bounce.
- The economy is not in a recession. Neither employment, the yield curve nor claims point to a recession. Not great. But not a recession.
Bottom Line: Markets are not oversold yet. Only 150 stocks in the S&P 500 are above their 200-day moving average compared to a 380 peak. It’s never a good idea to make decisions in the heat of a rapid market move. But having a plan in place is important. Right now we’re sticking with our stock and bond year-end plan.
Thanks very much, David Bowie. Here's one guaranteed to cheer us up.
--Christian Thwaites, Brouwer & Janachowski, LLC
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