Here’s what I’m thinking about on my paid JubakAM.com site today–when to buy industrials like GE and Cummins
My regular sector Monday post today on my paid JubakAM.com site takes a look at industrials such as GE, Cumins, Caterpillar, Johnson Controls and more and concludes the sector might be worth buying in a couple of weeks. Of course, a lot depends on the general trend in the markets. My mosts recent post on the subscription site looks at the turn in Wall Street forecasts to the dark side for 2015 and the tendency of negative forecasts to move stocks lower–perhaps to the August low at 1867 or the October low at 1820.
That’s what I’m working on at my subscription JubakAM.com site–I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway.
And, of course, there’s an ulterior motive: If you decide that you’d like more detail on those posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
Glencore (GLNCY), the commodities and trading group that fell 28% yesterday, rebounded almost 17% today as Wall Street investment banks and their analysts declared that the sell off had been overdone.
Of course, you’re entitled to a bit of skepticism about that conclusion since many of these defenders have a bit of self-interest in the game. For example, Citigroup, one of the strongest defenders of Glencore today—“The market response is overdone. In the event that the equity market continues to express its unwillingness to value the business fairly, the company management should take the company private”—was part of the syndicate that took Glencore public in 2011—which resulted in $240 million in fees for investment bankers–and has worked on other Glencore deals since then, including the 2012 acquisition of coal miner Xstrata. That deal resulted in $140 million in fees for members of an investment banking syndicate that included JPMorgan Chase, Deutsche Bank, Goldman Sachs, Nomura Holdings, and, of course, Citigroup.
One of the reasons to take Wall Street with a grain of salt on Glencore now is that it’s the 2012 acquisition of Xstrata that is at the heart of Glencore’s current troubles. In that deal Glencore paid $29 billion (in Glencore shares) for Xstrata, then the world’s largest coal exporter. Glencore owns more than 30 coalmines in Australia, Colombia, and South Africa.
In retrospect Glencore bought Xstrata near the peak for thermal coal (coal for burning in power plants) at $150 a metric ton. Thermal coal sold on September 22, 2015 for $46.85 a metric ton.
That 70% drop in the price of coal presents two problems for Glencore now. First, it has slashed cash flow and earnings at Glencore. In the first half of 2015, Glencore saw adjusted net profits of $882 million, down from $2 billion in the first half of 2014. That’s a big deal for a company with a debt-to-equity ratio of 104%, roughly double the debt burden at Rio Tinto (RIO) and BHP Billiton. Second, with coal prices down and a recovery looming far down the road, if ever, as utilities move away from burning coal to generate electricity, Glencore has fewer attractive assets to sell in order to reduce debt. That leaves the company looking at selling shares in order to pay down debt. Any sale of shares would certainly reduce the stake that existing shareholders own in the company. And that would be especially painful if the financial markets decide that they don’t want to pay very much for Glencore’s commodity-sector assets, especially its coal assets.
Glencore (GLNCY in New York) had a bad day. A very bad day. The New York traded ADRs (American Depositary Receipts) of the commodities trading and mining company were down 28% for the day.
Commodities and mining stocks in general aren’t having a great day. The financial markets are again selling off these sectors on fears that growth in China is slowing and that demand for commodities will continue to fall. Giant Brazilian iron ore miner Vale (VALE) was down another 9.96%. Diversified BHP Billiton (BHP) was down 4.36%; Rio Tinto (RIO) tumbled 4.58%, and Freeport McMoRan Copper and Gold (FCX) plunged 9.08% on the day.
But there’s a huge difference between a 28% drop and a 4.4% or even a 10% decline. What’s so special about Glencore?
Three weeks ago Glencore CEO Ivan Glasenberg announced a debt-reduction plan that included selling part of its agricultural business and a $2.5 billion sale of new shares in an attempt to reduce Glencore’s debt to $20 billion from $30 billion. Goldman Sachs is out saying that if commodities fall another 5% Glencore would not be able to maintain its current credit rating. Both Moody’s Investors Service and Standard and Poor’s have negative outlooks on the company, which they rate Baa2 and BBB respectively. Investment bank Investec has said that in the absence of substantial restructuring, if commodity prices remain at current levels the company could see almost all of its equity value disappear.
The current down cycle in commodity demand and prices hasn’t yet resulted in much in the way of large production cuts. In copper, for example, Glencore and Freeport McMoRan have announced big production cuts for 2016 and those “big” cuts amount to just 500,000 metric tons or about 2% of total world annual supply. Bank of America Merrill Lynch calculates that the copper market needs another 500,000-ton reduction in supply before demand exceeds supply.
In this situation—with supply falling so slowly and for some commodities (such as iron ore) still not falling at all—the strength of a company’s balance sheet has become more important than the size of its reserves or the productivity of its mines. Without a strong enough balance sheet to get to a turnaround in commodity prices, whenever that might happen, an eventual recovery in commodity prices is irrelevant.
That’s why financial markets are focused on issues such as BHP Billiton’s promise to maintain its current dividend and where the cash flow to sustain that dividend might be come from. And whether Chesapeake Energy (CHK) has enough attractive assets to sell at a decent price to continue to reduce debt. And it’s why commodity producers continue to cut capital spending. The most spectacular example of that today is Royal Dutch Shell’s (RDS) decision to cease all drilling in the Arctic. (The fact that the company spent $7 billion on its first test well and found only indications of oil and gas might have something to do with the decision too.)
Last week’s (September 17) decision not to raise interest rates looks like it has come back to bite the Federal Reserve with a vengeance. By linking an initial increase in short-term interests from the current 0%-0.25% range to turmoil in China and other emerging markets the Fed has succeeded in throwing financial markets into confusion. In my comments on September 17 I said that a decision not to raise interest rates could increase volatility in emerging markets because it would leave traders and investors worried over when the Fed might move http://jubakpicks-1565237904.us-west-2.elb.amazonaws.com/2015/09/17/fed-does-nothing-today-but-speaks-clearly-comments-likely-to-put-more-pressure-on-emerging-markets/ . It now looks like I was too optimistic.
Exactly what is the Fed’s policy? Does the Fed need to see a lessening of volatility in emerging stock markets and developing nation currencies? How much of a lessening? Will a bit less volatility be enough? Does the Fed need complete stability in one market (China) or in all? Does the U.S. central bank need to be convinced that China isn’t about to devalue the yuan again before it moves? (Remember that China’s devaluation of the yuan by what is now 3% against the dollar threw global markets into confusion.)
The Fed had, up until last week, made sending clear signals of policy a priority. But it now looks like the central bank has squandered months of hard work.
And with no one sure what the Fed needs to see before it moves, traders and investors seem inclined to sell on bad news—or indeed on any news–just to be safe.
Almost all the world’s major stock markets are down today. The Dow Jones Industrial Average was down 0.48% at the close and the Standard & Poor’s 500 was down 0.34%%. In Tokyo the Nikkei 225 index was lower by 1.17% over night and in Europe the French CAC 40 fell 1.93% and the German DAX was down 1.92%.
The only exceptions came in China where the Shanghai Composite closed up 0.82% over night and the Shenzhen Composite moved ahead 1.21%. While that may seem counterintuitive—isn’t China the locus of fears about slowing economic growth?—the gains on the mainland Chinese exchanges are completely in line with the recent pattern of massive intervention organized by the Chinese government. That invention has followed a pattern of big purchases by these “friends” of the nation beginning in the afternoon and continuing to the close. And sure enough in today’s session buying began about 1 p.m. Shanghai time that lifted the index from 3124 to a close at 3134, a gain of 29 points from the low of the day and 27 points from the prior close. (Not a huge move, I’ll grant, but not bad under the circumstances.)
Commodity producers and industrial companies were hit on worries about global growth. Freeport McMoRan Copper and Gold (FCX), for example, was down 1.1% as of 1:30 New York time and closed down 0.1%. Caterpillar (CAT) tumbled 6.27% at the close after reducing its forecast for 2015 sales and announcing plans to cut as many as 5,000 jobs.
Federal Reserve chair Janet Yellen gave a speech on inflation tonight after the market close that stuck to the Fed’s assertion that an interest rate increase is still possible in 2015. Did she manage to explain Fed policy on the timing of an interest rate increase with enough clarity to calm traders and investors? I’d like to think so but any optimism is tempered by remembering that clarity isn’t the Fed’s strong suit.
The steady stream of bad news on China’s economy has led economists to predict that the Chinese government will lower its target for growth next year to 6.5% to 7% for 2016. The official target for 2015 was set last March at 7%. (The new official target won’t be set until March 2016.)
Today’s contribution to that stream of bad news came from the preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics. That index dropped to 47.0 in September, below the median estimate of 47.5 in Bloomberg’s survey of economists. (In this index any reading below 50 indicates a contraction in the economy.) September’s reading was a drop from 47.3 in August. The index has been below 50 since March.
Financial markets around the world didn’t like the continued downward trend in the index because it points to lower growth in China and in the global economy next year. In Tokyo the Nikkei 225 fell by 1.92%. The Shanghai and Shenzhen markets declined by 2.19% and 0.83%, respectively. The Dow Industrials and the Standard & Poor’s 500 edged lower.
The economic bad news does suggest a possible future divergence between Chinese stocks and the Chinese economy. The People’s Bank of China has already lowered interest rates five times since November 2014 and reduced requirements for bank reserves. If the Chinese economy threatens to slow, as indicators are indicating, China’s central bank is likely to cut interest rates again. And that, on the historical record, would push up stock prices on mainland exchanges, at least temporarily.
The Chinese economy faces two major challenges over the next year. First, there’s a negative feedback loop in exports. As the global economy slows, so do China’s exports, and that in turn hurts global growth since a very large percentage of China’s exports depend on imports into China of raw materials and sub-assemblies from other countries. Second, falling profits at China’s huge state-controlled enterprise have emphasized the need for reform at these companies. That reform is necessary for China’s long-term economic growth but in the short term those reforms are likely to result in job cuts and a slow down in economic growth. That will be a tough haul since last week an index of manufacturing activity fell to the lowest level since the global financial crisis.
The short term worry in this data as we head into third quarter earnings season in early October is the degree to which large U.S. (and European) companies depend on the Chinese market for revenue growth. The place to look for a reflection of that problem is in corporate projections for the fourth quarter.
In the same Bloomberg poll economists cut their forecasts for third quarter and fourth quarter growth in the Chinese economy to 6.8% (for each quarter) from an earlier projection of 6.9%.