~$70 a barrel crude (ii)

Two factors are moving the Energy sector higher.  The obvious one is the higher oil price during a normally seasonally weak time.  In addition, though, the market is actively looking for alternatives to IT.  It isn’t that the bright long-term future for this sector has dimmed.  It’s that near-term valuations for IT have risen to the point that Wall Street wants to see more concrete evidence of high growth–in the form of superior future earnings reports–before it’s willing to bid the stocks significantly higher.  With IT shunted to the sidelines for now, the market is not being a picky as it might be otherwise about alternatives such as Energy and Consumer discretionary.

The fancy term for what’s going on now is “counter-trend rally.”  It can go on for months.


As to the oils,

–a higher crude oil price is clearly a positive for the exploration and proudction companies that produce the stuff.  In particular, all but the least adept shale oil drillers must now be making money.  This is where investment activity will be centered, I think.


–refiners and marketers, who have benefitted from lower costs are now facing higher prices.  So they’re net losers.  Long/short investors will be reversing their positions to now be short refiners and long e&p.


–the biggest multinational integrateds are a puzzle.  On the one hand, they traditionally make most of their money from finding and producing crude.  On the other, they’ve spent very heavily over the past decade on mega-projects that depend for their viability on $100+ oil.  This has been a horrible mistake.  Shale oil output will likely keep crude well short of $100 for a very long time.

Yes, the big multinationals have all taken significant writeoffs on these ill-starred projects.  But, in theory at least, writeoffs aren’t supposed to create future profits.  They can only eliminate capital costs that there’s no chance of recovering.  As these projects come online, they’ll likely produce strong positive cash flow (recovery of upfront costs already on the balance sheet) but little profit.

The question in my mind is how the market will value this cash flow.  As I see it–value investors might argue otherwise–most stock market participants buy earnings, not cash generation.  Small companies in this situation would likely be acquired by larger rivals.  But the firms I’m talking about–ExxonMobil, Shell, BP…–are probably too big for that.  Will they turn themselves into quasi-bonds by paying out most of this cash in dividends?  I have no idea.

Two thoughts:

—–why fool around with the multinationals when the shale oil companies are clear winners?

—–as/when the integrateds start to show relative strength, we have to begin to consider that the party may be over.  So watch them.

is the S&P expensive?

I’ve been reading a lot of commentary recently that maintains stocks are generally expensive.  Sometimes the commentators even recommend selling, although in true Wall Street strategist style, they’re not very specific about how much to sell or how deep they think the downside risk is.

The standard argument is that if you compare the PE ratio of the S&P today with its past, the current number, just about 25x, is unusually high.

That’s correct.

What I haven’t see anyone do, however, is consider the price of stocks against the price of alternative liquid investments–cash and bonds.  That would tell you what to do with the money if you sell stocks.  It would also tell you that bonds are much more expensive than stocks.

The yield on the 10-year Treasury is currently 2.23%.  That’s the equivalent of a PE of about 44x.  The return on cash is worse.  Cash, however, protects principal from capital loss, except in the most dire circumstances–ones where you’re thinking you should have bought canned goods and a cabin in the woods..

In addition, I think the most likely course for interest rates in the US is for them to rise.  When this has happened in the past, bond prices have fallen while stocks have gone basically sideways.  There’s no guarantee this will happen with stocks again.  But rising rates are always bad news for bonds.

What is surprising to me about current market movements is that stocks continue to be so strong during a time of typical seasonal weakness.





how important is the Trump economic agenda for stocks?

Personally, I’m not a big Donald Trump fan.

In this post, however, I’m taking off my hat as a human being and putting on my hat as a portfolio manager to give my thoughts on how the Trump economic agenda may affect stocks over the coming months.

How I read events so far:

through 1/31/17

–the S&P 500 rose by 10% from the surprise Trump presidential victory through yearend.  Leading sectors were Materials, Industrials and Energy.  The three were all potential beneficiaries of the Trump platform–infrastructure spending, developing domestic energy sources and promoting domestic manufacturing

–the dollar rose by about 7% against the euro.  This came from a combination of hope for accelerating economic growth, and belief that greater fiscal stimulus would allow the Fed to raise short-term interest rates at a faster-than-consensus pace

–promise to reform corporate taxes, to reduce the top tax rate from the present 35% to perhaps 20%, while eliminating loopholes.  Why?  The rate is unusually high in world terms and a key reason for US corporations shifting operations abroad.  My back-of-the-envelope calculation is that tax reform could boost the profits of the S&P 500 by around 10%.  I think it’s reasonable to assume that a large portion of this potential gain was being baked into stock prices prior to the inauguration


during 2017

–stock gains, sector rotation.  the S&P 500 has risen by a further 10% since January 1st.  However, the 4Q16 leaders have ceased outperforming.  The big winners have been IT, Healthcare and Consumer Discretionary–all beneficiaries of an expanding, but not red-hot economy, and the first two with substantial non-dollar exposure

–dollar weakness.  the euro went basically sideways/slightly up from early January until April.  Since then, the euro has reversed course, gaining 10% vs the US$.  It’s now about 8% higher than it was the day before the election.  The yen is a more complicated story, because Bank of Japan policy is to weaken the currency against trading partners’.  The dollar has also strengthened against the yen during 4Q16 and has weakened since.  The yen is now about 6% weaker against the dollar than it was in early November.

my take

The poor performance of infrastructure spending beneficiaries since January suggests to me that there’s little expectation on Wall Street today that Mr. Trump will deliver on his promises in this area any time soon.  So not a worry.

The weakness in the dollar has two aspects:

—–it acts as an economic and stock market stimulus.  For a euro-oriented investor, for example, the S&P 500 has barely moved this year.  In other words, to some degree this year’s stock market rise is being triggered by the currency decline

—–it’s also a function of lowered expectations for interest rate rises in the near future.

Both indicate, I think, a tempering of 4Q16 economic expectations for the US.  The fact that the dollar has basically given up its post-election gains argues that this isn’t a worry either.

Substantial tax reform would likely mean a 10% boost to S&P 500 earnings–and therefore arguably a 10% rise in stock prices. A good chunk of this potential positive was factored into stock prices, I think, in late 2016 – early 2017.  The worry that Mr. Trump will not deliver on taxes may have already put a ceiling on stocks around where they are now.  If concrete evidence of Washington dysfunction around the tax topic emerges, that might easily clip 5% off the current S&P 500 level.

a rainy Friday in August in New York

August is the month when many senior portfolio managers are away from the office on vacation.  So big decisions on portfolio structure tend not to be made.

Friday is the day of the week when short-term traders’ thoughts turn to flattening their books so they won’t carry risk over the weekend.

It’s raining, which sparks thoughts in traders of sleeping in or leaving work early.

Add all that up, and the heavy betting should be that US stocks will likely move sideways in the morning and fade off toward the close.

That means this is a good day to stand on the sidelines and size up the tone of the market.


In pre-market trading, tech is up and bricks-and-mortar retailing (on the earnings miss by Foot Locker) is down.  …nothing new about this.  At some point there will doubtless be a fierce counter-trend rally.  But the negative earnings surprises are still provoking severe selloffs.  So I don’t think today is the day.

Pundits are speculating about the damaging effects on his political agenda of Mr. Trump’s apparent defense of neo-Nazis in Charlottesville.  …but the Trump trade has been MIA since January, with the US a laggard among world stock markets during Mr. Trump’s time in office so far.  Yes, there may be residual hope for corporate tax reform from the administration, which this latest demonstration of the president’s ineptness as a executive could arguably undermine.  My guess is, however, that he is already well understood.

Two questions for today:

–will the market perform more strongly than the season and the weather are suggesting? This would be evidence that there’s still an untapped reservoir of bullishness waiting for somewhat better prices to express itself.

–should we be buying in the afternoon if it’s weaker than I expect?  My answer is No.  I think there is a lot of untapped bullishness, but we’re in a slowly rising channel whose present ceiling is less than 2500 on the S&P 500.   That’s not enough upside for me.  I’m also content to wait for any incipient bearishness to play itself out further.

It will be interesting to see how today plays out.


…finally, internet again

I’ve been travelling in the rural Northwest the past week and have had only intermittent internet access   …until now.

Stepping back from the day-to-day, has its advantages, though.  Having little up-to-the-minute data, I’ve been forced to look at the longer-range stock market picture. 
The first two or three months after the election, the dollar and stocks both rose as investors celebrated the presidential results.  The strongest groups were Energy, Materials and Industrials–the ones that would benefit both from an acceleration in economic growth and implementation of the professed Trump agenda of tax reform and infrastructure spending.

This period ended rght around the inaguration.  It was replaced by a market that embraced secular growth areas of Technology and Healthcare.  The dollar began to drift downward, as well.  This sector/currency shift was partly, I think, a rotation from leaders to laggards that happens in every market that’s not going sideways.  Part was also concern that delivering on the Trump agenda might not be as easy as investors had supposed over the previous months.

During 2Q17, the stock market began to understand how deep the problems are that the Republican party and the adminstration are having in getting anything done.  The main direct consequence of this loss of confidence has been a sharp fall in the dollar, I think, on the idea that failure of the administration and congress to engineer fisal stimulus would translate into a slower pace of interest rate increases by the Fed.  A weaker dollar benefits multinationals, so IT continued to be a winner, along with many members of the Staples group, which also has large foreign exposure.

This last movement has also played itself out in recent weeks, I think.  The market as a whole, and major tech stocks in particular, have begun to move sideways, expressing Wall Street’s belief (mine, too) that they’ve gone up enough for now.  As I see it, action has been based chiefly on relative valuation– rotations deeper into IT via smaller stocks and back into the Trump stock winners of late 2016.  
The kind of movement described in the last paragrah doesn’t typically last long.  At some point, the market will return to the question of whether structural reform in Washington is possible.  As I see it, the underlying notion investors now have is that important change can and will happen, although people may have substantially different pictures of how this will occur.  

It seems to me that as long as investors hold this belief, the US stock market will move sideways to up, driven by earnings gains.