Two down days in a row–a big trend given the volatility in oil price trends recently. As of the close on Tuesday, August 30, October futures for West Texas Intermediate, the U.S. benchmark, were down 0.28% to $46.22 a barrel. The selling comes as a Bloomberg survey showed that traders expect a climb in crude inventories of 1.5 million barrels in the U.S. Energy Information Administration report due for release tomorrow.
The decline is, in my opinion, reflection of exactly how uncertain oil markets are about the pace of any rebalancing of supply and demand. The market moves up on hopes that OPEC, or somebody, will reduce production, and then falls when those hopes turn out to be unfounded.
Crude peaked at $51.23 a barrel on June 8 and then entered a bear market as the price fell to $40.06 on August 1. That was followed by a bull market as oil climbed to $48.52 a barrel on August 19. The recent two-day decline put a stop to that bull. Is another bear to follow? That trend would take oil back to the $40 level that has marked recent lows.
Trading volume in the October futures today is running about 10% below the 100-day moving average.
In other words, it’s August and light volumes make big swings more likely.
So far the markets believe the Fed was just bluffing in Jackson Hole speeches on September interest rate increase
Last week Federal Reserve chair Janet Yellen tried to convince financial markets in her speech at the Fed’s annual Jackson Hole get-together that an interest rate increase at the central bank’s September 21 meeting was still a possibility. But just as the market has brushed off earlier similar comments from the heads of the Atlanta and San Francisco Federal Reserve Banks, this week has opened with financial markets saying in essence No way. The Fed won’t raise interest rates, financial markets are convinced, before the November election and it won’t raise interest rates with the Bank of Japan and the European Central Bank still committed to more stimulus.
Talk from the Fed of a September increase–no matter how strong the August jobs report is on Friday–is just talk, markets continue to maintain. (Economists expect that the economy created 180,000 net new jobs in August. That would still be a strong performance if below the 255,000 jobs created in July.)
Today, August 29, the Standard & Poor’s 500 climbed 0.52% to 2180.38. (Oil fell with West Texas Intermediate off 1.41% to $46.97 a barrel. The decline was enough to put an end to the oil bull market that started on August 18.)
Longer range talk at the Jackson Hole meeting veered in two radically different directions.
Some heavy hitters, including Charles Sims (a Nobel-prize-winner in economics in 2011,) warned that central banks, including the Fed, have made a critical policy mistake by insisting that monetary tools alone are sufficient to tackle the current paucity of economic growth. It’s beyond time, these critics say, for national governments to put fiscal policy to work on increasing growth.
Other speakers focused on signs that the current period of negative real interest rates–in the United States the Fed Funds rate is 0.25% to 0.5% with inflation running at 1.6%–and negative nominal (that is before considering the impact of inflation) interest rates in Europe and Japan is likely to be with us for a long, long time. Research from the San Francisco Fed, presented at the conference, argued that the Fed Funds rate would be just 1% in 2026. At the Fed’s normal pace of 25 basis points per move that would mean just two or three interest rate increases not in 2016 and 2017 but over the next decade.
For today, at least, the financial markets have focused on the positive news (from a market perspective) of a likely pass on September 21 on any interest rate increase and projections of a very long period with very low interest rates not much higher than they are today.
The disquieting warnings about the difficulty of tackling current problems of very low economic growth don’t seem to have made it onto the market’s worry list as August comes to a close.
Greetings from Norway.
I’m in the land of fjords, Viking ships, and stave churches. It’s a quick trip with a few days in Oslo (where we are now) and then a train ride over the mountains to Bergen and some fjord-seeing with a flight back on Saturday. The site will be dark for this week with normal posting to resume on Monday, August 29.
Hope everyone is enjoying the last days of summer.
Update August 19, 2016. It’s not often that you’ll see a stock climb 13.49% on the day when the company announces that full year sales will fall 10%, worse than the 9% drop it had forecast earlier.
But that’s the story today for Deere (DE.) The stock’s move, I think, says as much about the market consensus about economic and earnings growth–or actually the lack thereof–as it does about Deere itself.
Deere announced today, August 19, earnings of $1.55 a share for the June quarter, up a scant 2 cents a share from the $1.53 that Deere earned in the June quarter of 2015.
That scant earnings growth, however, was hugely better than the 94 cents a share that Wall Street analysts had been projecting. Analyst pessimism was fully justified because Deere’s business is at a cyclical low. A record corn crop this year has sent grain prices–and farm incomes–falling and sales of Deere’s farm equipment closely track the rise and fall of farm incomes. Tractor inventories are a a seasonal record and there’s no sign of an early turn around in sales. Revenue fell to $5.86 billion for the quarter, from $6.84 billion in the June quarter of 2015, and well short of the $6.06 billion in revenue forecast by Wall Street.
What analysts did under-estimate, though, was Deere’s ability to cut costs and then cut them some more. For the quarter Deere managed a 16% reduction in the cost of sales. That isn’t a one-time reduction either. By the end of 2018 Deere expects to boost pretax income by at least $500 million–even if the current farm downturn continues, Deere CFO Rajesh Kalathur said in a post-earnings release conference call. Today the company raised its forecast for net income for the full fiscal year that ends in October 2016 to $1.35 billion from a May forecast of $1.2 billion.
Is this kind of earnings growth based on cost-cutting worth a 13.49% one-day jump in the share price? Maybe not in an economy and stock market were companies are finding it easy to grow top line revenue and bottom line earnings.
But that isn’t the economy or the stock market we have right now. Earnings for the Standard & Poor’s 500 stocks were down again this quarter and are now forecast to fall again in the third quarter, although by a smaller percentage. A drop in third quarter earnings would mark a sixth straight drop in quarterly earnings. That’s a real earnings recession.
In that context earnings from cost cutting (or any source, in fact) look really good–especially if a company can produce a cost reduction in the neighborhood of 16% and also forecast that it believes that it can continue to cut costs even as the company’s business continues to limp along the bottom of a deep cyclical downturn.
Deere has been a member of my 50 stocks portfolio since December 30, 2008. The shares are up 131.93% in that period as of the close on August 19. The stock comes with a decent 2.75% yield.
Given the kind of cost cutting that Deere has promised and that management looks capable, on the record, of delivering, I’d certainly hold onto these shares. The trailing 12-month PE ratio is just 16.92. The shares are down 2.1% over the last year and up only 14.49% for 2016 to date.
There’s really nothing wrong with the shares of Capital One Financial (COF) that a stronger U.S. economy, a more confident U.S.consumer, and an interest rate increase–or two–from the Federal Reserve wouldn’t fix.
It’s just that I don’t see any of these in the cards in the near term–December at the earliest for a move by the Federal Reserve. And the Fed seems to be deep into holding the course until it can collect some evidence that inflation is a real danger (especially with an election looming.)
I bought shares of Capital One for my Jubak Picks portfolio back on December 10, 2015, when it looked like the Fed might actually deliver not just a December interest rate increase but two more increases in 2016. That would have given banks a big boost toward higher net interest margins on their capital and would have been a sign that the Fed was optimistic about the U.S. economy.
If those interest rate increases aren’t pending and if faith in the economy seems increasingly a matter of faith and not data, I think it’s time to call this buy “premature” and sell these shares. Shares of Capital One are up 18% from the June 27 low as of the close today, August 18. (But my position in these shares is still down 13.66% since that December purchase.) That recent gain brings them pushing up against the 200-day moving average at $69.57 and to a position near the top of their recent volatility range as sketched by the Bollinger Bands indicator. The stock has shown a recent pattern of lower highs with the shares failing to reach the April 26 high of $75.91 or the May 27 high of $73.83. The July 14 high was $68.85. By all these measures Capital One is starting to look, if not expensive, at least stretched.
The bank’s second quarter results fed into my decision to sell because they show a bank that is itself acting as if it sees dangers in the economy. For the second quarter, Capital One reported operating earnings of $1.76 a share, slightly below the Wall Street consensus at $1.86.
The miss was largely the result of a build in reserves as the bank added $465 million to the money it has put aside for troubled loans and credit card accounts. $298 million went toward reserves for the bank’s big U.S. credit card business, but the bank also set aside $58 million largely for its subprime auto loan portfolio.
The caution evidenced in the results as of the end of June looked well founded when the bank reported on July operations recently. Credit losses in its international credit card business rose 12 basis points to 3.64%. Credit losses were down 12 basis points from June but up 76 basis points year over year. Dollar delinquencies rose 18 basis points as percentage of loans from June. Credit card loss rates historically improve in the second quarter at Capital One and then increase again in the fourth quarter.
In its second quarter earnings call bank management said that it expects to see margin compression in the second half of the year driven by declining margins on auto loans and by the current and continuing low level of interest rates. (In July credit losses from auto loans increased by 25 basis points to 1.71% from June. That’s only a tick higher than the 1.70% rate of credit losses in June 2015.
Wall Street analysts have been lowering their earnings estimates for the third and fourth quarters of 2016. The consensus estimate of $2.08 for the third quarter 30 days ago is now down to 1.96 a share. For the fourth quarter the consensus estimate of 30 days ago at $1.70 has crept lower to $1.66 a share.
I still like the bank’s credit card business as a driver of future revenue growth but I just think the current interest rate environment makes it very hard for the bank to generate earnings growth from this business.
Time to review these shares when Fed policy clearly turns toward higher interest rates.