ROHR COMMENTARY Discussing Equities Divorce from Energy Excerpt for MyTradingBuddy
Friday, February 26, 2016 (late)
In some ways it was a classical example of “how the cookie crumbles” (i.e. problematic) in a “you’ll know it when you see it” kind of situation. The broken heart is the disappointment quite a few equities bears feel on the equity trend – energy market trend breakup. They were counting on the weakness of energy to continue to weigh on the equities. That said, nobody could have possibly predicted the actual fine line inflection point where that relationship might dissolve. Yet as with real divorce, one side or the other typically feels they got the best of the situation.
“YOU WIN” would seem to be the message to US equities on their recent ability to defy energy market weakness. And that is indeed very recent, as in Thursday morning. We will explore the market activity specifics below. Yet, YOU WIN is also probably the message the US equities are sharing with the US public on the financial relief flowing from lower energy prices. Could this possibly be the long-awaited ‘energy price drop dividend’ finally seeping into the equities psychology?
We will also explore the equities-energy dynamic further below, even if many of you are already familiar with it. When and how weaker energy was going to evolve from energy ‘pressure’ to energy ‘pleasure’ for the equities was always going to be problematic. It was simply going to happen whenever it happened after all of the angst over lower Crude Oil prices ostensibly being good for the consumer and economy, yet still weighing on the equities throughout late last year and early 2016.
And in this case that evolution into the equities no longer being burdened quite so much when the energy market weakened just happened to be Thursday morning’s divergent intermarket activity. It was also more glaringly apparent in comparison to what had transpired a mere 24 hours earlier on Wednesday’s equities Agony and Ecstasy. And we will be sharing that fine line assessment below.
But first, the energy pressure on equities…
Energy finance is a mess
There has been much analysis of this, so we are just going to cite a couple of sources for the most recent assessment of the risk. Obviously all of the benefits that flow from the lower energy costs to developed economy businesses and consumers have been pre-empted since late last year by concerns over the shaky financial position of the industry. That is due to the rush to garner the yields from what appeared to be very attractive low interest loans when energy prices were at much higher levels.
According to the recent article Banks analyze risk of lending to energy companies by the Pittsburgh Tribune-Review’s Chris Fleisher:
Risky loans to oil and gas companies have heightened regulators’ concerns. The energy industry’s aggressive expansion and exploration from 2010 to 2014 “led to increases in leverage, making many borrowers more susceptible to a protracted decline in commodity prices,” according to a November report from the Office of Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp. In June, OCC examiners said they would keep an eye on “banks’ actions to assess, monitor, and manage both direct and indirect exposures to the oil and gas sector, given the recent decline in oil prices and the potential for a protracted period of low or volatile prices.”
…but it is not a looming crisis
Yet the general assessment is that the big banks have strong enough balance sheets to withstand any energy loan write-offs. Here’s respected Credit Lyonnais Securities Asia banking sector analyst Michael Mayo on CNBC noting that if every single energy loan on JP Morgan’s books needed to be charged off it would have enough capital cover it eight times over.
And other aspects of its business, especially the major consumer loan portfolio, are in excellent shape and actually benefit from the weaker energy prices. And that is just the sort of influence that many folks have been expecting (too often prematurely since late last year) to assist the equities instead of weigh on them. Well folks, that inflection point may have finally arrived.
Fine line equities – energy intermarket indications
This is not to say that there will not potentially be times when significant energy market weakness weighs heavily on equities again in the short run. Yet there are certain times when only those who are watching the short term swings can see the evolution of the psychology. This is the advantage of having an Evolutionary Trend View (ETV) that opens ones’ market perception to the potential prismatic inflection points where the same ostensible influence has an opposite effect to the activity up to that point.
Between Wednesday morning and Thursday morning the difference in the equities response to the April Crude Oil future trading down into a very similar level was striking.
As a picture is worth a thousand, or possibly at least a hundred of them in this case, this is summed up in the graphic on the left. Quite simply, when the April Crude Oil future fell from near 34.00 into the 32.00 area on Tuesday, it derailed the March S&P 500 future rally above 1,925-32 back down to 1,916.
But the real fireworks were on the April Crude Oil future drop to the 31.00-30.50 area on Wednesday. While we had noted that anything short of a failure back below 30.00 should not be that big a deal for equities, the March S&P 500 future gapped lower and tested the key 1,892 area support early Wednesday. Yet once it was clear the energy market was not going to weaken further, the equities rallied back and Closed $14 higher on the day up at 1,930.
And with March S&P 500 future back into the 1,925-32 resistance late Wednesday into early Thursday, the burden of proof was back on the bears. It was incumbent upon them to demonstrate the market could fail back below 1,922 to reinvigorate the bearish tendencies. And that most definitely did not occur, as Thursday morning’s early low was 1,922.50 even if there was continued stalling at 1,932 right into lunchtime.
The intermarket divergence could not have been clearer: the March S&P 500 future managed to hold that elevated level even as the April Crude Oil dropped back near the 31.00 area Thursday morning. By the way, the Chinese stock market also exhibited major weakness Thursday morning, which also had previous been a major US equities stressor.
Still negative in spite of energy ‘dividend’
And even if the energy price weakness is indeed going to be a support factor for the developed economies and equities, there are still plenty of negatives. It is also worth noting that part of the energy weakness is indeed demand weakness: the price drops are as much a sign of the softness of the global economy as the oversupply fomented by many central banks’ misguided extreme accommodation pushing investment into marginal business opportunities.
And the weakness of world trade is becoming ever more apparent, and a pernicious sign for the immediate prospects of the world economy. And yet another party weighed in on that this week. This week’s Netherlands World Trade Monitor added its perspective to the other voices noting that world trade was back down to financial crisis levels.
The Financial Times article reviewing that noted that in 2015 “…the value of goods that crossed international borders last year fell 13.8 per cent in dollar terms – the first contraction since 2009.” Further… “the figures also come amid growing concerns that 2016 is already shaping up to be more fraught with dangers for the global economy than previously expected.”
Of course, this is not the first time we have highlighted diminished world trade as a risk factor. Back in August we highlighted the research from various sources that were already warning about this pernicious development. It is historically linked closely with overall economic contractions. As Organization for Economic Cooperation and Development Secretary General Angel Gurria pointed out at its major semi-annual Economic outlook last November, world trade falling to 2.0% or less has only occurred five times in the last 50 years. And each time that was associated with significant global economic contraction.
The recent OECD Interim Economic Outlook update Report for that major semi-annual assessment also focuses on that and the lack of structural reform we have been focused on since early 2015. Overall they downgraded the global economy by 0.30% to just 3.00% for 2016. Within that there were particularly troubling downgrades for some key economies. Especially the allegedly strong US was downgraded by a 0.50% to just 2.00%, and this is supposed to be one of the better global economies. That means it is now below the 2.40% achieved in 2015.50 years.
US economy lacks reform
The degree to which the global economy is suffering from a lack of structural reform is increasingly obvious with each passing month. And among the worst offenders is the US where the highly partisan nature of the politics (actually worse than most other developed economies) means there is not any effort to find middle ground to craft effective reforms.
The interchange between CNBC’s David Faber and fairly prominent House Budget Committee member Representative Chris Van Hollen (Democrat-Maryland) on Wednesday was telling. In the wake of the recent ‘corporate inversions’ where a US firm essentially merges with a foreign company for the major purpose of changing ‘domicile’ to take advantage of the lower foreign tax rate, there is a lot of wailing and gnashing of teeth in the US political class.
Never mind that the inversions are only a major incentive because in their infinite wisdom the US Congress has raised corporate taxes to the point where the executives must change domicile in the interest of their stock holders and stake holders. If the US executives just stand still, the greater after tax earnings of foreign rivals will allow the foreign firms to buy them with their excess retained profits.
Fine art market indication
Another sign of a slowing global economy is reflected in the activity of the richest international individuals who can and do invest in very expensive and very illiquid assets. One of those which is also a major status symbol is the fine art market.
According to this ‘How 2015 may have marked the end of the art market’s boom years’ article in the UK’s respected The Guardian:
“It is worth noting that the art market is really a set of loosely related mini-markets, all of which behave very differently. But for the first time in years we are seeing a similar trend across each of these distinct markets: a slowdown.”
“New records were set at auction, but the overall markets cooled as… collectors in Russia and Brazil felt the pinch.” You can bet that both Chinese and emerging market collectors will also be less prominent in 2016.
“In November, most of the contemporary, impressionist and modern auctions in New York failed to hit their low estimates, a sign that these markets have been pushed far enough.”
And if the rich are feeling the pinch, you can bet it is a sign of the lower investments that will be made in capital investment and hiring by the major corporations that classically drive a sustained expansion. We have seen it many times.
You can talk about extra spending by the ‘middle class’ due to the ‘lower energy price dividend’ all you want. Yet the sustained expansions only come on the back of corporate confidence that business will be better, and their need to invest to head off the challenge from the competition. And that just isn’t out there right now.
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Thanks for your interest.