Market Minutes for the week of February 5th:
“[The] ‘tail is wagging the dog’ is a phrase used to describe an instance when a less important part of a situation has too much influence over the most important part.” – James DePorre
Here is what I am thinking and hearing: 1.) Computerized trading strikes fear in the hearts of investors once again this week. 2.) The unwinding of “short volatility” and “risk parity” strategies by leveraged “actors” who don’t care about balance sheets, income statements and intrinsic value, have once again produced a “flash crash” that has again undermined the integrity of the markets and their ability to find fair price discovery. It’s all wrong. 3.) The fact that Wall Street has turned “volatility” into an asset class is absurd and is to be blamed for the chaos this week. The VIX and its inverse cousin XIV (packaged in an ETF or ETN), have been growing in popularity in the last year as a way to place leveraged bets on volatility or the lack of volatility. Over the last year, volatility in the markets declined to never-before seen lows and the “guaranteed” and “easy money” trade was to “short” volatility using the XIV (VelocityShares Daily Inverse VIX Short-Term ETNs). How’s that for a mouthful of a financially engineered “asset class.” 4.) Big-time volatility returned to the markets last Thursday, Friday and Monday (triggered by higher wage costs in the employment report) for the first time in over a year. Those who held the XIV, saw its value decline by 90% in Monday’s regular and after-hour’s session. 5.) As the “benign” and “easy money” trade using borrowed money blew up, destroying those holding the dynamite stick, those caught in the wreckage were forced to sell as fast as possible, stock positions in the form of S&P, NASDAQ and DJIA ETFs to cover their exposure. This is what gave us a -1,600 intraday Dow on Monday and a 500 drop out of the chute on Tuesday morning. 6.) Financially engineered products have the risk of unintended consequences and these “products” are bad news. The exchange-traded XIV had $1.5 billion in assets, and when it blew up on Monday, it took the DJIA down 1,500 points in 40 minutes. The SEC should take a hard look at them to see if they serve a purpose to the investing public. Given what we have just experienced, I say absolutely no way. They do not deserve a place in any asset allocation model. 7.) The creator of this wealth disruptive “asset class”, Credit Suisse, has said they will liquidate and terminate XIV for good. BlackRock, the world’s largest asset manager, has called for immediate regulation of such “products.” Leon Cooperman CEO of Omega Advisors: “I’d implore however the regulators and the financial services industry to deal with the crazy instruments that have been created that are destroying the best capital market in the world…The decline was just absolutely crazy. Nothing to do with economics.” Hopefully, the SEC will begin to take notice. 8.) This week’s market turmoil has hit investor sentiment. Investor Intelligence said that bulls fell to 54.4 from a 66 reading last week while Bears rose to 15.5. The 16-week run of Bulls above 60 was the longest time frame on record. 9.) The “unwinding” of the Daily Inverse XIV Short-Term ETN and other volatility related “products” may take some time (days/weeks) to wipe out the last holders standing, so I am expecting heightened anxiety for a while. 10.) We must remember, the indices are being sold as baskets of stocks (packaged in ETFs) by computer programs. What’s going on has virtually nothing to do with the economy or interest rates. The best approach to this is to NOT be misled by the indices. They simply do not reflect the health of individual stocks. We must respect the price movement of the indies, but we should also recognize that many stocks are undergoing some temporary price movement that won’t last long. We stand ready to buy the indiscriminate selling, remembering that short-term market trends ALWAYS over shoot, both on the upside and downside.
The University of Michigan Consumer Sentiment Survey found that U.S. consumer sentiment was stronger than expected in the January final reading of 95.7, only 0.2 points down from December’s 95.9 reading.
The Atlanta Fed tracker, GDPNow, says that it is forecasting 4% GDP growth in the 1st quarter after inputs from last Friday’s employment report.
St. Louis Fed head James Bullard (this year, a non-voting committee member), earlier in the week sought to calm the market’s inflation fears by saying that a strong labor market doesn’t mean a jump in inflation is imminent. In a speech to the University of Kentucky’s Gatton College of Business and Economics, Bullard said: “I caution against interpreting good news from the labor markets as translating directly into higher inflation. The empirical relationship between these variables [wages and inflation] has broken down in recent years and may be close to zero. Continued strong labor market performance is unlikely to translate into meaningfully higher inflation.”
Blaine Rollins CFA, CEO and founder of 361 Capital: “Until the global economies begin to cool, it seems more than certain that interest rates will continue their upward trajectory. And, we are seeing plenty of evidence in Q1 earnings call notes that wages and freight/shipping costs are on the rise. For companies to improve their margins, they will need to increase their use of technology and grab efficiencies wherever they can; and they will need to idle or sell underperforming assets and capacity.”
The Institute of Supply Management said its non-manufacturing (services) index for January rose to 59.9 from 55.9 in December and the service sector continued its expansion for the 96th consecutive month.
In the 1st quarter, the Federal Reserve will begin to cut back its balance sheet at a pace of up to $20 billion per month (an increase from a $10 billion monthly pace in the 4th quarter of 2017). Then it will increase to $30 billion per month in the 2nd quarter, $40 billion in the 3rd quarter and $50 billion in the 4th quarter. After that, the Fed is estimating it would continue that $50 billion monthly pace until they are satisfied with the size of the balance sheet.
This is important because the Fed is selling bonds, not buying them like they did under QE. This increased supply along with larger monthly refunding auctions of Treasuries (more supply), will no doubt put upward pressure on 10- and 30-year interest rates.
Real estate data provider CoreLogic says that home prices rose 6.6% nationally for the 12 months ending December. It is the 4th month in a row where annual increases were higher than in the prior month. The top three “overvalued” metro areas in CoreLogic’s analysis were: Las Vegas +11.2%, Denver +8.1% and Los Angeles +7.8%.
According to Factset, so far this year, 50% of the companies in the S&P 500 have reported actual Q4 results for 2017. With regards to earnings, more companies are reporting actual EPS above estimates (75%), when measured against the 5-year average. In totality, companies are reporting earnings that are 4.0% above the estimates. Looking at sales, more companies (80%) are reporting actual sales above estimates versus the 5-year average.
LPL Research/Factset has found that there have been 13 Januarys where the S&P 500 has returned 5.0% or better for the month. For the rest of the year, the average gain was 15.8%. For the full year, the average gain was 24.8%. The average intra-year pullback was -10.7%. Stay tuned!
According to Preqin Private Equity Online, there is now over $1.04 trillion in private equity “dry powder” ready for investment opportunities.
Bloomberg observes that America’s factories are having difficulty keeping up with demand. The average lead time for capital expenditures risen 7.9% in January to 150 days. This marks the longest span in 22 years according to data compiled by the ISM (Institute for Supply Management).
China’s Caixin manufacturing index for January was unchanged at 51.5 but still holds at the best levels since August and the one-year outlook climbed to a 4-month high. The Caixin services index rose by 8 points to 54.7. In line with that data, China’s exports rose by 11.1% in January.
Japan’s services PMI for January rose by 8 points to 51.9 which is about in line with its average 2017 reading of 52.
The Eurozone’s manufacturing PMI for January was unchanged from December’s record high of 60.6, reflecting the best economic growth the region has seen since 2007. The Eurozone’s services PMI for January was revised higher to 58 and was up from 54.3 in December.
Germany reported good trade data for December. Exports rose another 0.3% month over month after a big 4.1% jump in November. The 10-year German Bund has now risen to a high of 0.78%. A little over a year ago, that yield hovered near zero.
The Financial Times reports that for German businessman Ralf Schlesselmann, these are good times as well. Mr. Schlesselmann manages a 100-year old family business that makes wooden pallets in Assendorf (near Hanover). The company is keeping busy trying to keep up with the rise in orders. Mr. Schlesselmann says: “We’re seeing increased demand from all sectors, we’re very close to full capacity.”
The U.K.’s manufacturing PMI dropped to 55.3 in January from 56.2 in December. That’s still the lowest point since June of 2017 but the pace of economic growth remains healthy with a rise in export orders. The U.K.’s services PMI fell to 53 in January from 54.2 in December.
South Korea’s exports rose by 22.2% year over year in January. Leading the export growth were semiconductors, machinery and chemicals. Geographically speaking, they were the strongest within the Asian region.
U.S. crude oil production exceeded 10 million barrels per day in November for the first time since 1970 when production peaked followed by a decades long decline. The U.S. is currently the third largest oil producer, and its status is growing. Russia is the largest with production at around 11 million barrels a day. The U.S. output threatens that of Saudi Arabia at 10.6 million barrels a day after the Saudis cut back production due to the OPEC deal with Russia and others to keep oil off the market. According to IHS Markit Vice Chairman Dan Yergin, U.S. oil production is expected to expand past 12 million barrels per day in 2019.
FOX Sports has reached a deal with the NFL to broadcast “Thursday Night Football” through 2023. This arrangement marks the fifth media rights deal between Fox Sports and the NFL. After the $52.4 billion deal with Disney, Twentieth Century Fox is focusing on TV news and sports.
According to Nielsen, ratings for the Super Bowl between the Eagles and Patriots on NBC tumbled 7% year over year and hit their lowest point since 2009. The drop of nearly 8 million viewers is a move that follows the trend in declining viewership during the regular-season.
Insurance claims from last year’s wildfires in California reached $11.8 billion. 2017 marked the most expensive series of wildfires in the state’s history. The majority of the claims came from Northern California’s wine country fires.
According to Moneyish.com, one anonymous San Diego Girl Scout entrepreneur sold 300 boxes of cookies in less than six hours by setting up shop outside the Urbn Leaf marijuana dispensary last weekend. She’s not the first scout to capitalize on cannabis users to “spark” cookie sales. In 2016 a Portland Girl Scout also went viral for selling her baked goods outside of the Foster Buds Marijuana Dispensary. In a very short period of time, she easily exceeded her 35-box goal and raised the money to go to a summer horse camp.
How insane is Denver’s residential real estate market? A small, early 1900s three-bedroom, two-bathroom bungalow just south of the downtown is listed at $500,000 and had almost 100 showings in a three-day period. The same story exists, lack of inventory and rising demand. According to Zillow, there were close to 26% fewer homes for sale in Denver in January versus a year ago at the same time.
According to John Arnold@ the West Virginia Gazette, “In the past 10 years, drug companies shipped 20.8 million prescription painkillers to two pharmacies four blocks apart in a West Virginia town residents. How can we stop this???
What were JPMorgan Chase’s Jamie Dimon, Amazon’s Jeff Bezos and Berkshire Hathaway’s Warren Buffett doing when they announced last week, the formation of a company to improve employee health benefits? They have lost patience with skyrocketing healthcare costs. Warren Buffett calls the ballooning costs, “…a hungry tapeworm on the American economy” and collectively, these “accomplished” businessmen think they can deliver lower costs to their employees through their own single-payer system. Jamie Court, president of Consumer Watchdog says: “There’s a lot of frustration with the high cost of health insurance, yet government’s offering almost no systemic solutions. It’s as big a change as I’ve seen in the market in years. Bezos, Dimon and Buffett are basically creating the nucleus of a single payer system where ‘the bigger the buyer, the better the price rules,’ only they’re doing it with business acumen on a micro-level rather than opening it up on a grand scale to competing interest groups that often stifle government’s innovation. Bigger purchasers get better deals.”
According to an article in the Wall Street Journal, banks are shuttering branches at the quickest rate in decades. They are leaving less profitable regions and are finding less of a demand for tellers for routine customer transactions.
Last Friday, Fed head Janet Yellen, on her last day on the job, punished Wells Fargo with new sanctions for its recently-revealed malpractices and fake accounts scandal exposed in 2016. The Federal reserve has instructed the bank to replace four on the board of directors and has restricted the bank’s asset limit to $1.95 trillion (as of December 31, 2017). Wednesday, S&P cut Wells Fargo’s credit rating to A- from A on “continued elevated regulatory risk for Wells.”
UPS has ordered an additional 14 Boeing 747-8 freight jets worth about $5.65 billion. This brings its total to 28, counting the jumbos it ordered in 2016. UPS also ordered 4 new Boeing 767’s, worth $848.8 million at list prices. The company said that its intra-U.S., next day and deferred air shipments are expanding to record levels and its international component has yielded four consecutive quarters of double-digit export shipment growth. David Abney, the chairman and CEO of UPS said: “To support this strong customer demand, we continue to invest in additional air capacity, providing the critical link our customers need to markets around the world.”
The International Air Transport Association said that air freight demand rose by 9% in 2017 from a year earlier, the fastest growth rate since 2010.
According to the Wall Street Journal, Google and Saudi Arabia state-owned oil giant Aramco are considering building a large technology hub in the region.
Steve Wynn has resigned as CEO of Wynn Resorts Ltd., a result of the numerous and ongoing sexual misconduct allegations leveled against him.
Seeking Alpha’s Clark Schultz reports, “Tesla is planning a significant expansion of its selling presence at Home Depot…Special areas of ~800 Home Depot stores in the U.S. will be outfitted during the first half of this year with solar products and staffed by Tesla employees.”
Kroger has announced that it will sell its convenience store business unit to EG Group for $2.15 billion. The company’s supermarket fuel centers and it’s Turkey Hill Dairy are not part of the sale.
The Bon-Ton department store chain has filed for Chapter 11 bankruptcy protection and is in the midst of closing more than 40 stores across the U.S.
Chipmaker Broadcom has sweetened its offer for Qualcomm by 24% to more than $121 billion. Broadcom has said that this will be their “best and final offer.”
The Wall Street Journal reports that Apple Music subscriptions are growing by about 5% monthly compared to Spotify’s 2%. However, Spotify continues to grow slightly faster and is larger globally. Currently Spotify has 70 million global subscribers to Apple’s 36 million.
Amazon’s cloud revenue grew by 45% in the 4th quarter and generated an extra $5.11 billion above estimates. Amazon Web Services leads the cloud market, but Microsoft’s Azure had a 98% growth rate vs Amazon’s 45%.
Amazon CEO Jeff Bezos said the company will “double down” on the Alexa (smart speaker) market after blowing past “very optimistic 2017 projections.”
Ford Motor recently said that it is straining to keep up with demand for the $90,000 Lincoln Navigator, the luxury SUV in the company’s line. Sales for January were up 97.5% over a year ago in the same period. Kelly Blue Book says that the success of the car is largely due to the updated design, Ford’s first redesign on the vehicle in over a decade.
Ford Motor’s sales for January were down by 6.6% to 161,143 units. Passenger car sales down -23%. SUV sales down -5.9% and truck sales up +2.2%.
General Motors sales for January were higher by 1.3% to 198,548 units. Sales by brand: Chevrolet up +5.0%. GMC down -11.4%. Buick up +4.0%. Cadillac down -3.9%.
Toyota sales for January rose by 16.8% to 167,056 units. Truck sales were up +26%. Sales by brand: Toyota up +17%. Lexus up 15%.
According to Seeking Alpha’s Clark Schultz, “UPS plans to make more than $12 billion in investments to expand its logistics network, increase pension funding and position the company to “further enhance shareholder value”. ‘This $12 billion investment program is an outgrowth of the opportunity for tax savings created by the Tax and Jobs Act,’ says UPS CEO David Abney.
Edwards Lifesciences reports 4th quarter earnings of $0.94 per share on revenue of $888.5 million, an increase of 15.7% year over year. Nice quarter.
PayPal reports 4th quarter earnings of $0.55 per share on revenue of $3.75 billion, an increase of 25.8% year over year.
eBay reports 4th quarter earnings of $0.59 per share on revenue of $2.61 billion, an increase of 8.8% year over year.
UPS reports 4th quarter earnings of $1.67 per share on revenue of $18.83 billion, an increase of 11.2% year over year.
McDonald’s reports 4th quarter earnings of $1.71 per share on revenue of $5.34 billion, a decrease of 11.4% year over year.
AT&T reports 4th quarter earnings of $0.78 per share on revenue of $41.7 billion, a decrease of 0.3% year over year.
Visa reports 4th quarter earnings of $1.08 per share on revenue of $4.86 billion, an increase of 9.0% year over year.
Exxon Mobil reports 4th quarter earnings of $0.88 per share on revenue of $66.52 billion, an increase of 17.9% year over year.
General Motors reports 4th quarter earnings of $1.65 per share on revenue of $37.7 billion, a decrease of 5.5% year over year.
Walt Disney reports fiscal 1st quarter earnings of $1.89 per share on revenue of $15.35 billion, an increase of 3.9% year over year.
Chipotle Mexican Grill reports 4th quarter earnings of $1.34 per share on revenue of $1.1 billion, an increase of 7.8% year over year.
Cognizant Technologies reports 4th quarter earnings of $1.03 per share on revenue of $3.83 billion, an increase of 10.7% year over year.
Tesla reports 4th quarter earnings of -$3.04 per share on revenue of $3.29 billion, an increase of 44.3% year over year. Impressive.
Activision Blizzard reports 4th quarter earnings of $0.45 per share on revenue of $2.64 billion, an increase of 7.8% year over year.
GrubHub reports 4th quarter earnings of $0.37 per share on revenue of $205 million, an increase of 49.2% year over year. Wow….that’s huge.
Next week: Earnings from: Coca-Cola, Deere & Co., Under Armour, PepsiCo, Shake Shack, Campbell Soup Co., J.M. Smucker and Cisco Systems. Economic reports: U.S. Housing Starts for January, U.S. Retail Sales for January, CPI (Consumer Price Index) and PPI (Producer Price Index) for January, Philly FED Manufacturing Index for January and U.S. Industrial Production for January.
WTI crude oil: $59.69 per barrel. 10-year U.S. Treasury note: 2.81%. Gold: $1,320 per ounce. 30-year mortgage: 4.32%. Last year at this time: 4.17%.
Sources: Real Money Pro, CNBC, 361 Capital, First Trust Economics, MarketWatch, Seeking Alpha, Reuters, Bloomberg, Estimize.com, U.S. Trust Economics, The Rev Shark and John A.F. Smith.
Disclosure: This publication shall not constitute an offer to sell or the solicitation of any offer to buy or sell any securities of the companies mentioned. This publication is solely a compilation of recent news releases from the sources cited above.
Ken Beach, President and Managing Partner of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.