Stock Market Today – A Very Important Week Ahead

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Although nearly every week is replete with news, economic events and all manner of market-moving headlines, not all weeks are created equal.

This week is, in fact, the first really important macro-economic week of 2015, and while there aren’t a huge number of economic events, what we do have on tap is extremely important.

Obviously, the clear highlight this week is the European Central Bank (ECB) meeting on Thursday. We’ll be previewing the particulars of the meeting in the coming days, but given the Swiss National Bank (SNB) decision last week to de-peg the franc from the euro, it seems that expectations are high for something big from the ECB QE plan.

At this point, 500 billion euros remains a key level to watch. I suspect that anything below this level will be considering underwhelming.

Now, in addition to the ECB we also get the global January flash PMIs Wednesday night/Thursday morning. Given the concerns about global growth and global deflation, these metrics are very important, as the market needs a confidence boost about the pace of growth globally.

Specifically, China and Europe remain in focus, especially following the downbeat Chinese growth data Monday night and the ECB decision looming Thursday morning. And, for the first time in a few months, even the US data will be watched closely. On an absolute level it should be fine, but right now the key is just how much momentum the US manufacturing sector is losing.

If we see a sharp deceleration in US manufacturing data, it may weigh further on sentiment. Now, staying in the US, we also get the latest round of housing data via housing starts on Wednesday, and existing home sales on Friday. Keep in mind that housing has quietly lost a bit of positive momentum over the past two months, and some stabilization in that data will help provide a boost to market confidence.

For 2015, the global economy is estimated to expand by 3%, which is down from a projected 3.4% growth rate in June. In 2016, the World Bank thinks growth will come in at 3.3%, which is down from the prior estimate for 3.5% growth.

Bottom line: This week is key, because it is an opportunity for the ECB and economic data to help partially vanquish the growing concerns about the pace of global growth and disinflation. If the PMIs are decent (meaning China and Europe stay above 50), and the ECB does something powerful (i.e. QE greater than 500 billion), the outlook for the global economy could be a lot better as we head into Greek elections Sunday.

The World Bank Slashes Growth, and Traders Thrash Copper

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The World Bank thinks global growth will be slower than originally estimated. On Tuesday, the lender issued its semiannual Global Economic Prospects report, and for global growth bulls the outlook wasn’t very encouraging.

For 2015, the global economy is estimated to expand by 3%, which is down from a projected 3.4% growth rate in June. In 2016, the World Bank thinks growth will come in at 3.3%, which is down from the prior estimate for 3.5% growth.

While most investors would be well served to take the World Bank’s estimates with the proverbial grain of salt, one thing we do know is that traders often take these data projections serious—at least in the short-term. We saw just that in Tuesday trade, as growth concerns weighed on commodities, most notably copper, which traded down nearly 5% in the session.

It is often said that copper has a Ph.D. in global economics, which just means that copper prices are a good indicator of the health of an economy. When the economy is trending lower, then usually we’ll see that reflected in copper prices—and that’s precisely what happened Tuesday, and what’s happened in copper via the iPath DJ-UBS Copper SubTR ETN (JJC). This copper exchange-traded note is down some 17.2% over the past three months, a move that betrays just how fearful traders have become about the prospects for global growth.

More broadly, the spot price of copper has been in a bearish downtrend now really since the spring 2011 highs, but most recently lower energy costs and weak demand specifically out of China, the world’s largest consumer of the industrial metal, have pushed prices down to near six-year lows.

copperchart

The collapse in “Dr. Copper,” has been somewhat lost in the oil declines, but clearly this is not a good sign for global growth.

Chinese demand for copper is expected to fall again this year, and that presents a very troubling backdrop for the future of copper prices going forward. The bottom line is clear; copper is falling victim to a combination of low production costs (oversupply) and soft demand expectations, which is resulting in a sharp slide to the downside that we think has room to continue going even lower.

So, if you are long this industrial commodity (and I hope you’re not) then now is the time to rethink the “Dr. Copper” bull trade.

If ECB begins QE …

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Closing Bell Exchange: Oil, Jobs & Wages

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Tom Essaye’s recent interview on “Closing Bell” at CNBC.

5 Macro Risks Keeping Stocks Down

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Markets by their very nature are risky, but sometimes the macro risks are bigger and more dangerous than the bulls can handle. As we kickoff 2015, I see five big macro headwinds facing stocks—headwinds that are likely to limit upside at least in the near term.

In order of near-term importance, they are: 1) What will ECB QE look like? 2) Can oil stabilize? 3) Will we have another “Grexit” scare? 4) Is there really a global deflation threat or is it just oil? and 5) When will the Fed start to tighten and how will markets react?

Of the five, the first four are almost equal in importance with regards to what stocks do over the coming weeks. And, it’s important to note that European QE concerns now have trumped (or equaled) oil contagion worries as the near-term leading indicator for stocks. This was made evident Friday when articles in Bloomberg and Reuters were largely responsible for the drop in stocks (it wasn’t the jobs report).

Keep an eye on the WisdomTree Europe Hedged Equity ETF (HEDJ), a proxy for European stocks, as this fund’s direction will betray how the market assesses those concerns.

It’s key to realize, though, that beyond the very short term, none of the above should be materially negative influences on stocks.

The ECB may disappoint with initial QE, but the bottom line is the ECB knows it has to expand its balance sheet and provide more stimulus, which is bullish for European stocks over the coming months and quarters.

While we haven’t likely seen the low tick yet, oil appears to be trying to stabilize, as prices at these low levels will likely start to have an impact on marginal producers (so the pace of declines should slow), which is what is important from an “oil contagion” standpoint. The global “deflation” scare is mostly linked to oil prices so when they stabilize, so will inflation statistics. Third, the “Grexit” story is likely overdone (the chances of Greece leaving the EU remain very slim, and we know that from the bond markets).

Finally, the concern about the FOMC raising interest rates is a problem for the April time frame (as we approach the potential June “lift off” in the cost of capital).

The point here is that we are likely to see more near-term volatility until the events above get resolved, but I would view any material dip below 2000 in the S&P 500 as a buying opportunity in domestic cyclicals (banks, retailers and tech specifically) and continue to view European market weakness as offering fantastic longer term entry points.

Bottom line: The near term may be bumpy, but we see no reason to materially alter equity allocations.

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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