Tom Essaye Featured in Forbes.com – Stocks Struggling To Break Free Of Oil’s Slide

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By Steve Schaefer at Forbes.com

It’s oil’s market, stocks are just living in it.

That’s the most common takeaway from the first few trading days of 2015, as the months-long punishing of oil prices and energy stocks keeps broader market averages mired in negative territory.

If oil, junk bonds and the ruble are rolling over, expect equities to fall in concert, according to Tom Essaye, author of the Sevens Report. When that trio is pushing toward fresh lows, “the stock market will go down in sympathy.”

Tuesday the trend continued, with a short-lived morning rally in stocks evarporating as oil prices slumped further below the $50 mark. West Texas crude dropped more than 4% to below $48 a barrel, while Brent slumped 4.5% to $50.71. The S&P 500 fell 1%, with energy its worst-performing sector by a wide margin.

FactSet senior earnings analyst John Butters points out that analysts still seem optimistic on the sector — energy is tied with healthcare for the highest percentage of buy ratings in any sector (57%) and companies like SchlumbergerSLB -0.04%, Kinder Morgan KMI -0.6%, Phillips 66 PSX -1.25%, EOG Resources EOG +1.16%and Williams Companies boast buy rankings from more than 80% of Street analysts who cover them — even though earnings are expected to fall more than 19% in 2015.

Citigroup’s Tobias Levkovich points to the chart below, which shows that while 2015 earnings expectations have plunged in the energy sector, 2016 have been little changed.

energy chart

Perhaps that’s because analysts think the selloff is overdone and has created some undervalued opportunities. More likely it’s because the damage in the energy sector has come so rapidly the analysts haven’t even had a chance yet to turn their attention to future years.

At some level, bargain-seekers will think oil and energy stocks are worth buying, but Essaye warns that the true oil shakeout some are waiting for may be a bit further off than they think.

A global supply glut barreling up against weakening economic growth is a well-understood factor in oil’s slide, but another element Essaye points to is the potential breathing room oil companies have thanks to hedging strategies.

Companies that hedged their 2015 production at prices around $90 or more per barrel can likely stay afloat longer than outsiders like OPEC anticipated, given that those hedges are now “in the money in a big way,” according to Essaye. Net short positions held by producers have leaped from 15 million contracts in August to 77 million last week.

“Bottom line, shale producers are not yet feeling the “full on” pain from the roughly 50% selloff thanks to their hedging strategies,” Essaye says. “Sso we can expect production to remain high and fundamentals to remain very bearish.” He expects oil to head toward $45 a barrel in the near term.

In a recent letter to clients, Forest Value Fund’s Thomas Forester notes that the sliding prices in oil have been considerably worse than the broader declines in other industrial commodities, which might be explained away in part by the end of the Federal Reserve’s monthly asset purchases – which provided cheap money that sloshed into emerging economies like China’s – and the strengthening dollar.

 

http://www.forbes.com/sites/steveschaefer/2015/01/06/stocks-struggling-to-break-free-of-oils-slide/

4 Hedges for the Systemic Oil Problem

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The plunge in oil prices has been a big scare for the markets, particularly since early December. As of this writing (Jan. 8), the cost of a barrel of Brent crude oil had fallen below $50, a key support line that could lead to accelerated selling from spooked traders. The selling in the oil patch has been the driving force behind the selling in stocks at the very tail end of 2014, and through the first few trading days of 2015. And while the bulls have managed to perk back up over the past couple of sessions, the fear of a continued oil slick that takes down the value of many risk assets remains at the forefront of nearly every perceptive investor’s mind.

Subscribers to The 7:00’s Report will recall that in early December, we gave specific recommendations for traders and investors looking to hedge those falling oil prices. The rational then was that if oil continues to collapse (and it has) then we could cause what I called “systemic stress” in the markets.

During the acute plunge in oil prices from Dec. 3 to Dec. 16, stocks also plunged, with the S&P 500 sinking nearly 5%. However, the combined performance of the four hedges that we recommended during this same time period (equally weighted) produced a stellar 6.9% return.

Now, I must go on record as saying that despite the plunge in oil prices over the past several months, I do not think we are about to see an oil inspired collapse in stocks (trading during the latter part of this week buttress that theory). I do, however, think that if you harbor the justifiable concern that oil prices will continue to fall, and that this will bring out more bears out of hibernation, then the following four hedges will keep your money safe from the systemic oil problem.

Hedge #1: ProShares Short MSCI Emerging Mark (ETF) (EUM)

We have recommended the ProShares Short MSCI Emerging Mark (ETF) (EUM) to readers for a few months now because we continue to believe that if we see systemic stresses begin to appear, they will hit emerging markets exceptionally hard, and very early. That’s because emerging markets have been some of the biggest beneficiaries of this multi-year stretch for yield, and the region has some of the most mispriced bonds on the planet. A drop in EM currencies and bonds will result in a drop in EM stocks, and that means holding EUM will allow your portfolio to rise, as this fund is inversely correlated to the benchmark MSCI Emerging Markets Index.

Hedge #2: ProShares Short High Yield (SJB)

Junk bonds are the canary in the coal mine for risk assets, and as such they tend to fall hard and fast with any type of systemic risk, including the risk of plunging oil prices. Taking advantage of a collapsing junk bond market is the ProShares Short High Yield (SJB), a fund designed to deliver the inverse of the high yield corporate bond index. The only problem with SJB is that, from a volume standpoint, it’s a trade-by-appointment fund (meaning it only trades around 30K shares per day). To combat this liquidity issue you can also short the SPDR Barclays Capital High Yield Bnd ETF (JNK) or the iShares iBoxx $ High Yid Corp Bond (ETF) (HYG).

Hedge #3: ProShares UltraShort Oil & Gas (DUG)

If oil keeps going down, then you’ll want to own an inverse oil fund that’s pegged to both the oil and gas services stocks. That’s simple enough, but why not own one that has a little leverage, and that delivers twice the inverse of oil prices? That’s what you get with the ProShares UltraShort Oil & Gas (DUG). Now, because of the leverage, this fund is a trading vehicle only, and should not be used for medium- or long-term holders. Yet for a properly timed flyer on falling oil prices, DUG can be a superstar.

Hedge #4: WisdomTree Europe Hedged Equity ETF (HEDJ)

I originally suggested this hedge as part of a “Long HEDJ/short SPX” pair trade based on the idea that the WisdomTree Europe Hedged Equity ETF (HEDJ) doesn’t have any energy exposure, and that energy stocks would weigh primarily on US equity indices such as the S&P 500. Due to fears of a Greek exit, or “Grexit” from the EU, this trade hasn’t really worked too well as an outright hedge. However, he logic behind this hedge still applies, and if the geopolitical issue of Greece and the EU are resolved, look to put this hedge back on for systemic oil risk.

 

Your Weekly Economic Update

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Below is an excerpt from the “Economic Section” of the Sevens Report originally released on 12.29.14

Economic Update

Last Week

There were two key takeaways from last week’s economic data: First, the U.S. consumer re-emerged in the 2nd and 3rd quarters of 2014, and was the main driver of growth in the U.S. economy during the second half of 2014. Second, the stronger U.S. dollar is starting to have an impact on the economy and we should expect further moderation in manufacturing metrics going forward. Importantly, this moderation in the manufacturing sector isn’t a bad thing as long as the landscape continues to improve for the U.S. consumer. It’s much more positive for the U.S. economy to be led by a resurgence of the U.S. consumer than continued manufacturing growth (because consumer spending is nearly 70% of the U.S. economy).

The key number from last week was the final revision of the Q3 2014 GDP report. Final GDP was 5.0% saar (beating the 4.3% expectation), and the gains were driven by consumer spending. PCE (broad consumer spending) was revised higher to 3.2% from 2.2% while Gross Domestic Purchases (the amount of goods purchased by the country regardless of where the goods came from) was revised to 5.0% from 4.1%.

Again, those who are skeptical of the recovery will point out that a lot of the uptick in consumer spending came from increased healthcare expenses, and that is true. But the bottom line is these are healthy numbers for the economy, and they again underscore the shift we are seeing from a manufacturing-led recovery, to a consumer-led recovery (which again is much more healthy and positive for risk assets).

Case in point, November Durable Goods missed estimates, as the headline was weaker than expected. Meanwhile new orders for Non-Defense Capital Goods Excluding Aircraft were flat month-over-month and the rolling 3-month moving average fell by 1%. The soft Durable Goods report confirmed the lackluster PMIs we saw in November and December. To be clear, it’s not like manufacturing activity is falling out of bed, but we are seeing some moderation due to the stronger dollar, which again is “ok” as long as it’s accompanied by a surging consumer.

From an investment standpoint, this shift from a manufacturing-led recovery to a consumer-led recovery is important, because we can expect continued outperformance from consumer-leveraged names (RTH, consumer finance companies) and, generally speaking, underperformance from industrials with heavy foreign revenue exposure. That isn’t a particularly insightful observation, but it’s something to think about as you plan asset allocations for early 2015. (During the last several years, industrials have soundly outperformed consumer names, so double-check to make sure you’re not too heavy in stodgy, goods-producing, foreign-leveraged manufacturers and industrials.)

This Week

It will be another quiet week given the holiday, but the highlight will be the global final manufacturing PMIs on Friday. That said, the most important manufacturing PMI, China’s, won’t be released until next week. So, focus will be on Europe and the U.S. Specifically, the December “flash” PMIs in Europe showed some small signs of life, especially in Germany, so it will be important not see those flash PMIs revised lower.

Here in the U.S., we can expect some more moderation in the ISM Manufacturing PMIs. But again on an absolute basis, the manufacturing sector is still growing; it’s just losing momentum due mainly to the stronger U.S. dollar.

 

Greek Election Update: Is The EU Preparing for a Grexit?

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Greek Election Update (Originally Released 12.29.14)

The biggest event of this holiday week has already come and gone, as the Greek Parliament failed to elect a President and there will not be general elections in early February. PM Samara’s gamble has failed, and as of this writing the Athens stock market is down 11% and European markets are off about 1%.

From an investment standpoint, despite the drop in Greek shares, we do not see this as a negative game changer. To be clear, the reason stocks are down is because the market is afraid the looming election will delay QE by the ECB at the Jan 22nd meeting, not because of a fear Greece will leave the EU or default if Syriza gains a majority. It is important to realize the true “negative” outcome the market is worrying about.

Bottom line, even if Syriza wins the general election, the party has moderated materially and no one is afraid of another default/Greek exit showdown. This is all about QE and frankly we don’t think this results in a delay of QE be the ECB in January, assuming the governing council is planning on doing it already.

So, we do not see this as a negative game changer in our “Europe outperforms” thesis, and we would be patient buyers of this dip.  

 

Financial Newsletter: Stock Market Closes Higher, Energy Stocks Underperform

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Equities
(originally released to subscribers on 12/23/2014)

Market Recap

Stocks drifted higher to start the week yesterday, modestly extending last week’s gains despite declines in energy stocks. The S&P 500 added 0.38%.

Futures were higher before the open yesterday as they rallied in sympathy with global shares, which were broadly higher on ECB stimulus hopes and further stabilization in the Russian ruble and global oil prices. (However the gains in oil turned out to be short-lived.)

It was a relatively quiet open and overall quiet morning session in the U.S. equity markets as stocks drifted sideways, largely ignoring mixed economic data (existing home sales missed while the Chicago Fed survey beat).

After lunch, a combination of further short-covering and trader positioning ahead of this morning’s busy economic calendar helped push the S&P 500 to a fresh all-time-high, albeit amid very low volumes.   There were no real news catalysts yesterday to speak of.

Trading Color

Looking at the market internals, yesterday’s rally to new all-time highs was not very impressive. The S&P 500 badly underperformed the Dow as they gained 0.38% and 0.87%, respectively. Meanwhile the Nasdaq and Russell 2000 largely traded in line with the S&P.

High-beta stocks actually fell 0.10% yesterday while their low-volatility counterparts added 0.63% on the session.

Looking to sector trading, energy was among the worst performers, which was no surprise given the 3%+ drop in WTI futures. Healthcare was the other big underperformer, falling 1%. Gilead led the way lower, down 13% after the largest US drug-benefit manager chose a medication from competitor AbbVie as the “only Hepatitis C treatment approved for patients.”

Meanwhile industrials, consumer discretionary and staple stocks, tech, and financials all handily outperformed—all rising around 1% on the day.

Bottom Line

Stocks hit new highs yesterday but XLE and JNK both declined for the first time since early last week. We are near year end and volumes and liquidity are low, so we could easily see a continued push higher into year end on “nothing” really, but XLE, JNK and the ruble are still the leading indicators of this market.

If yesterday was the start of another roll over in XLE and JNK, then I do not think you want to be buying this rally. Bottom line, keep watching XLE and JNK.

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Short Squeeze in Gold Stalls at Trend Resistance

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GC 12.2.14

Gold futures have been very volatile to start the week thanks to multiple catalysts in the market. Futures initially fell yesterday as Swiss voters rejected a proposal to increase the central bank’s gold holdings. But then news broke that India, one of the world’s largest gold consumers, lifted trade restrictions on gold imports, causing futures to reverse morning losses. Then, yesterday’s rally extended as investors bought up the precious metal as a “safety asset” after the downgrade of Japanese debt by Moody’s.

A massive short squeeze then ensued that pushed gold through $1200, but as with most short squeezes, there was little conviction and this morning gold is back down through $1200/oz. Gold remains very volatile at these levels, and we maintain a general downward bias short term as the dollar remains strong.

The technicals confirmed that position on the charts early this week as the trend-line drawn from the August highs across the top of the highs of the last short squeeze (that occurred in late Sept.-early Oct.) halted this weeks rally. .

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Global Flash PMI Analysis

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Global November Flash Manufacturing PMIs

  • Chinese PMI 50.0 vs. (E) 50.2.
  • German PMI 50.0 vs. (E) 51.5.
  • EMU PMI 51.3 vs. 50.9.
  • US PMI: 54.7 vs. 56.5.

Takeaway

The biggest disappointment in the data was the German PMI, which very surprisingly plunged to 50.0. This was the biggest negative of all the reports, although the broader EMU manufacturing PMI helped offset some of the negativity of the German report. (European markets would have been down even more if the EMU number hasn’t beat.) Bottom line, the flash PMIs signal that the European economy is still under pressure, and the positive effects of the ECB stimulus haven’t started helping materially, yet. This disappointing reading isn’t altering my opinion that Europe can outperform. However, the data weren’t that bad, and my opinion is based more on negative sentiment and ECB balance sheet expansion more than economic recovery. Case in point, while Europe sold off yesterday, it’s still up for the week.

Turning to the U.S., there were more conflicting data. The manufacturing PMIs missed expectations and hit the lowest levels since January, while the Philly Fed manufacturing survey surged higher to 40.8 (I don’t think I’ve ever seen a number that high). Generally, the national flash PMIs are the better gauge of manufacturing activity, and although they missed estimates, a reading of 54 still is healthy and it’s not going to make anyone nervous about the pace of growth in the U.S.

Finally, the Chinese number hit 50.0, just missing expectations. While the media focused on output dropping below 50, the number wasn’t that far from expectations and new orders (the leading indicator of the report) remain positive.

The pace of growth in China seems to be stable. While there are downside risks, the government remains committed to stimulus where needed, and that’s softening the blow of the “miss.”

Bottom line, they weren’t good numbers but they weren’t enough to materially change the outlook of a very slightly growing global economy.

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Time to Buy XLE?

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XLE 11.21.14

Time to Buy XLE?

Fundamentally, the outlook for oil remains broadly the same: Waiting on OPEC. But, as we discussed earlier this week, most major energy companies are not aggressively shutting in aggregate production, as increases from profitable wells are offsetting shut-ins from high-cost wells.

From a macro standpoint, pressure is mounting on OPEC, the Iranian negotiations may be breaking down and miss the late November deadline, and calls for sub $70 oil are very loud. So, we have energy stocks that are sharply off the highs and some potential positive catalysts on the horizon (OPEC meeting next week). So, to a point, XLE now has some “ok” fundamentals and potentially positive-turning technicals. Obviously this is a high risk/high return prospect, but XLE is worth a look especially if it breaks through that 50-day MA, which it should do today.

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Housing Starts Data Better than Headline Suggests in October 2014

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Housing Starts

  • October Housing Starts were 1.009M (saar) vs. (E) 1.028M (saar).

Takeaway

The housing starts number was a miss on the headline but the details were actually good.

As always with housing starts, the two key numbers are single family housing starts and single family building permits (which led starts by 3-6 months).

Single family “starts” rose 4.2% in October and the September number was revised higher to 4.2%. Also, single family permits rose 1.4% in October.

The drop in the headline number was due to multi-family housing units declining 15.4% in October. But, the reason we look at this number is to get a gauge of the single family housing market, and yesterday’s data implied that demand for housing (specifically new homes) remains very healthy, and nothing in the number would make us doubt the housing recovery.

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FOMC Minutes Analysis

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FOMC Minutes

The FOMC minutes didn’t contain many surprises, but on balance they did confirm that the FOMC is more committed to normalizing policy than the market thought before the October meeting.

Yesterday I focused on the difference between market-based and sentiment-based inflation expectations, and so too did the Fed in its minutes. The takeaway is that “most” Fed officials looked at the declines in market-based measures of inflation expectations as “noise” rather than a rising deflation threat.

The FOMC also cited that sentiment-based indicators of inflation expectations remain stable. While inflation likely would decline in the near term thanks to commodity prices, the committee remained confident they would reach their 2% goal sooner than later.

I know this is somewhat tedious, but it’s important, because the bottom line is that, as long as sentiment-based inflation expectations remain stable, the drop in market-based inflation expectations will not make the Fed more dovish.

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