Saturday, January 16, 2016

On the market, oil, the economy, etc.

So how do we address the "worst" start to a year in stock market history? I put "worst" in quotes because, as I've been preaching of late, periodic breaks (or breakdowns) are in my view essential to the long-term health of the market. Although I won't go so far as to incite the wrath of my readership by proclaiming it the "best" start to a year in history. How about "interesting", "startling", "shocking" or simply "$#@&!!"...

Last week I offered up a look at some simple technicals (here and here), which, digging beyond what I illustrated for you, point to a deeply "oversold" near-term signal (could see a near-term bounce), and potential trouble on a forward trend basis.

Of course the question is, is the market ultimately sending a new-bear-is-upon-us signal or is it simply doing a little housecleaning while remaining in a longer-term bull market? We await the answer...

So, while we're waiting we might as well mess around with the data and see if it offers any clues:

History suggests that if we're worried about deep, prolonged bear markets, we should worry about the timing of the next recession. Being that the Fed's current interest rate policy is on the shortlist of market concerns, we should consider what history says about the time span that has separated the first Fed rate hike in a tightening campaign (like last December 16th) and the onset of the next recession: As it turned out, the average over the past 4 decades has been 32 months; with 15 months being the shortest (those back to back early-80s recessions) and 50 months being the longest. The yellow line represents the Fed funds rate, the blue shaded areas are recessions:     click to enlarge

Fed Funds and Recessions


Of course lately it's a lot about oil. Armies of experts have been telling us that oil has to bottom before stocks can find their footing. Perhaps, but if we're concerned about cheap oil bringing on the next recession, well, history doesn't yet support that concern. In fact, I'd say cheap oil, as well as other commodities, has been a huge stimulator out of past recessions (orange line represents crude oil):    click to enlarge

Oil and Recessions


Here's Bespoke making the point, and addressing a few other inconsistencies :
Typically, the price of oil and gold both rise or are quite stable in the start of bear markets. This is because these assets tend to hold their value during periods of high inflation; high inflation and commodity price appreciation are generally signals of an overheating economy with a Fed chasing it down, rather than an economy growing at a modest mid-expansion pace. Commodity prices and the equity market have had a positive correlation of late, to be sure; but historically the opposite has been true, with high commodity prices reducing consumer spending, real incomes, and choking off activity with Fed rate hikes consistently providing a double-whammy of pain.

CPI growth in this current experience was the lowest leading in and the lowest since, which looks quite different from behavior of other bear market tops. The opposite is true for housing which has grown much faster over the last 24 months and since the bull market top relative to past experiences. Nonfarm Payrolls, Industrial Production, and real personal consumption all look quite robust versus prior experience. The one indicator that does not look healthy versus past experience: ISM manufacturing, which is at its worst level (relative to the start of the bear market we may or may not be in) of any bear market since 1987. That said, it is declining from a much higher level, with no great collapse like 2002 and 2009 ahead of the equity market’s decline. Notably, all other ISM Manufacturing series registered below 45 within two years of the start of that bear market; that’s not a pattern we’ve seen so far, but one we’ll keep an eye on with ISM below 50.

There's so much we can explore on the economy and what it speaks to with regard to past markets; in a nutshell, some sectors are showing pretty solid strength, others real weakness and, on balance, things look just okay for now. Steve Liesman does a good job of summing it up:

The media is always on fire during times like these. The platform is raised for every guru with an opinion. I never cease to be amazed at how, with so many factors at play, so many of these characters seem so utterly committed to their prognostications---positive or negative.

In light of what's been coming at you in the press, you might be wondering, as a friend of mine was recently, what, if anything, in your portfolio might be on the verge of total collapse. So, with that, and you investment clients, in mind, here's how a typical client (TC) portfolio looks in terms of recent trouble-spots (of course there's some variability client by client):

Areas of present concern, per the gurus (not to be facetious, there are indeed legitimate concerns in these areas):

High Yield Bonds, Energy (debt and equity), Materials/Commodities and Emerging Markets.

To begin with, TC has zero direct high yield bond exposure.

As for energy, TC's equity portfolio will range from 5 to 10% energy-related stocks. The energy sector ETF TC holds is comprised of 40 positions, with 70% of its assets in its top 10. Which are: Exxon Mobile, Chevron, Schlumberger, Valero, EOG, Pioneer Natural Resources, Conoco Phillips, Phillips 66 (Buffett's been buying this one hugely of late), Tesoro, and Halliburton.

The energy fund currently pays a dividend in excess of 4%.

We don't see an all-out collapse in these names. In fact, long-term, we see potential opportunity. This is an area we expect to slowly increase as 2016 unfolds...

As for materials; TC's portfolio will range from 7% to 12% of equity exposure. The materials sector ETF TC holds is comprised of 27 positions, with 67% of its assets in the top 10. Which are:

Du Pont, Dow Chemical, Monsanto, Ecolab, Lyondell Basell Industries, Praxair, PPG Industries, Air Products and Chemicals Inc., Sherwin Williams and International Paper,

The materials fund currently pays a 3+% dividend.

Same story as energy... in terms of all-out collapse odds and possible opportunity going forward...

As for Emerging Markets; TC's portfolio ranges from 4% to 8% of equity exposure---typically divided among two emerging market ETFs. One holds 2,953 stocks, the other holds 293. They currently pay dividends of 3+% and 5+% respectively. The average price to earnings ratios of the stocks they hold are presently 11.7 and 8.7 respectively (that's low).

In essence, the companies they hold presently sport earnings and cash flows sufficient to pay very attractive dividends. In a collapse scenario you'd tend to see massive dividend cuts and possibly (it happened with energy) price to earnings ratios rising as earnings plunge at a faster pace than stock prices. All that said, the decline (or "collapse", if you will) in share prices we saw last year, and this, has been stunning.

Do I believe there are huge opportunities to be had in emerging markets going forward? I absolutely do! Do I see huge volatility along the way? I absolutely do!

So, depending on how one might define "collapse", if it means something other than the inevitable, at times dramatic, downward volatility the market has periodically delivered since the beginning of market time, I think TC's in good shape---as long as he/she has a long-term perspective.

Of course we can't close a discussion on the present state of the market without touching on China. Which has been a topic I've addressed consistently, if not ad nauseum, herein for quite some time.

In the following interview Nicholas Consonery does a good job articulating the basis for China's contribution to present-day global market uncertainty, while Stephen Roach's commentary with regard to the rebalancing of the Chinese economy should sound very familiar if you've been reading this blog over the past couple of years.

Be back shortly...

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