Archive for month: January, 2015

Near the top of the influence list for the stock market today, and for the rest of the global financial markets today, as well as for the rest of the week, is the slew of big-time corporate earnings on tap. In fact, the market today will get earnings from Dow Jones Industrial

Average component Microsoft Corporation (NASDAQ:MSFT), as well as other tech giants such as Seagate Technology PLC (NASDAQ:STX) and Texas Instruments Incorporated (NASDAQ:TXN).

At the start of the market today, about 20% of the S&P 500 has reported earnings, and the results have been broadly mixed. Approximately 75% of those firms have beaten estimates, which is a pretty good percentage; however, the results haven’t been as good on the revenue front where the results have been much more in-line with estimates.

So, at least so far, we are not seeing the strong revenue numbers like we saw during Q3 earnings season late last year. I think the single biggest takeaway so far from this earnings season is that between the strong US dollar and the reduction in expected energy company earnings, the expected S&P 500 earnings number has come in somewhat materially from $130/share six months ago to under $125/share now, which does have an effect on valuations.

Using $122/share, at 2,070 the market trades at 17X current year earnings—not prohibitively expensive given 0% interest rates. However, given the macro environment it’s definitely on the high side. Point being, valuation is something we need to keep an eye on if results for the remainder of earnings season continue to disappoint, because valuation could become a mild headwind on the S&P 500 towards 2,100 (it’s one of the reasons I’m cautious about buying up here).

The markets today will start to get resolution in several of the macro overhangs that have weighed on stocks early in 2015, but at 2,070 a lot of “non-negative” resolution is already priced in, and I continue to have a hard time seeing a material positive near-term catalyst that will push stocks to 2,100 and beyond.

Last week’s ECB decision on QE was a positive, as the program will be powerful, and global central bank easing is a general tailwind on stocks. And, while likely a problem for another day, the Greek elections have provided at least some certainty over that hitherto unknown.

As for the remainder of the focus on the markets today, we have the Fed meeting on Wednesday. What we’ll look for here is whether the Fed is getting more “dovish” given the global slowdown and central bank easing. “When/How the Fed will raise rates” is a macro headwind on stocks, so this week will be a mover for the stock market today, and for the remainder of the week, month and quarter.

However, keep in mind, even if the Fed is dovish Wednesday, the market would much prefer a surging economy, rising inflation and higher rates, not continued low rates. Finally, the Russia/Ukraine situation is heating back up as outright fighting between Russian backed rebels and Ukrainian government forces started again over the weekend, and the West is already threatening more sanctions.

Bottom line: In our estimation there remain too many headwinds for a material move higher.

The news last week was bullish for the financial markets around the world, including the US, but I am not a buyer at these levels, and would wait to add to select sectors more towards 2,000 in the S&P 500.

By far the biggest event in the stock market today, not only for the Dow Jones Industrial Average and the S&P 500, but also for the currency, bond and international financial markets today, was the European Central Bank’s (ECB) move to issue even more “QE” than even the most optimistic bulls had anticipated.

In fact, “Super” Mario Draghi lived up to his moniker, juicing financial markets today with a much-bigger-than-expected bond buying program that exceeded estimates both in terms of scope, and size. The result was a near 260-point spike in the Dow Jones Industrial Average, which lead other financial markets today markedly higher in sympathy.

Let’s take a look at the details of the ECB QE, and you’ll see why they caused such a kerfuffle in the markets today.

Size: 60 billion euros per month for 18 months vs. (E) 50 billion for 12 months.

Yes, some are saying the 60 billion per month is a touch misleading because it includes previously announced ABS and CDO purchases, but I think this is missing the bigger point. You see, the ECB QE is really all about the aggregate size of the balance sheet.

The new ECB balance sheet will be over 1.2 trillion euro by September 2015, with room for more. That is far larger than the previously stated 1 trillion euro target—and that, my friends, was the eminent source of the bullishness in the stock market today.

Risk Sharing: The sovereign bond purchases will be “Pari-Passu.”

The ECB said sovereign bond purchases would be pari-passu (meaning all bond purchasers can will be regarded equally, and thus repaid at the same time), which is important because it won’t result in an offset of private market debt purchases. Despite not including total risk sharing across the ECB, and as such putting default risk on the balance sheet of the national central banks, the bottom line is that the chance of default (which is really all that matters here) on much of the QE debt remains very low, and will not be an inhibitor to the success of the program.

Unanimity of the Decision: All Parties Thus Concur

Whether the Germans were on board with the ECB QE was a topic of concern for the markets today. While there was no actual vote (so we can’t see who was for it or against it), Draghi said in the press conference that there was unanimity in using QE as a legal monetary policy tool. This strongly implies the Germans, while likely reluctant, will not try to derail the program.

I believe the stock market today reflects the bullish response to the ECB QE, not just here at home but particularly with respect to European equities. In fact, if you are looking to buy the ECB QE then I think the best way to do so is with an exchange-traded fund (ETF) such as the Wisdom Tree Europe Hedged Equity ETF (HEDJ).

This fund already is significantly outperforming the S&P 500 year to date (7% vs. 1%), and I suspect this can continue over the coming weeks and months.

Interestingly, I was surprised yesterday while watching the analysis/reaction to the ECB QE announcement, as some of it seemed to focus on the economic implications of the details of QE.
We don’t actually know if QE helps an economy, even after six years of it here in the United States. However, we are interested in stock market returns, and we do know pretty well that QE makes nominal stock prices go up (see UK stocks, Japan stocks and US stocks).

My initial bullish thesis on Europe was based on the proposition of an expanded balance sheet, and seeing as the ECB is committed to an even larger and open-ended balance sheet expansion than most had previously anticipated, I view this as even more European equities bullish.

From an investment standpoint, I continue to like HEDJ as the single best way to play “Europe” broadly, as it also protects you from a decline in the currency. And despite the falling currency, I still like country-specific and sector-specific ETFs such as the iShares MSCI Italy Capped (EWI), Global X FTSE Portugal 20 ETF (PGAL), and the iShares MSCI Europe Financials (EUFN).

While these respective ETFs are not protected from the drop in the euro (and it will weigh on returns for US investors) I believe the potential upside in these ETFs is more than enough to warrant taking on the currency risk. To use a crude analogy, HEDJ is like the S&P 500, while the remaining ETFs are like cyclicals sectors—and thus they will be more volatile than HEDJ in both a rising and falling tide.

Bottom line: For anyone other than those with a very short-term outlook, I think you can begin to leg in to HEDJ or the other positions. And, if you already own them, I think adding to them gradually on a schedule over the next week or two will prove prescient.

One of the most notable oil “bullish” memes floating around the trading pits is all about declining rig counts in the United States, and how the falling number of drilling operations is a “game changer” for the oil markets that ultimately will lead to a bottom in energy prices.

That meme, however, is simply not true, and history backs this claim up.

First, while rig counts have indeed dropped from a recent high of 1,931 in September to 1,675 as of last week, this doesn’t necessarily mean lower oil supply in the pipeline. Though this may seem bullish on the surface, it actually isn’t, and that’s because total US production is still expected to rise between 5% and 10% next year. The reason is because the rigs that are being shut down are low-production/exploratory-type rigs that don’t contribute to a lot of production anyway.

Second, many analysts are focused on oil producers’ published “break-even” prices as they try to pinpoint a fundamental price floor (many of which we have already crashed through). But, there is speculation that a lot of those published numbers are misleading, and that as prices continue to fall producers will only try to pump more in an effort to stay profitable.

Put simply—the producers often lie about where their “break even” really is.

Supporting this idea is the recent history in the natural gas market, which saw production boom in the last several years cause prices to plummet, much like we have seen in the global crude oil market over the past six months.