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The risk-on/risk-off market is back again

posted on May 20, 2016 at 6:37 pm
banking_brazil

Step aside global central banks.It’s time for the pattern called risk-on/risk off to set the direction of global financial markets again.

In my book on volatility, Juggling with Knives, I’ve included an entire chapter on correlations between assets and markets. In an Age of Volatility I argue, correlations among asset classes can change over night and the trend  that once drove markets–stocks rise with a stronger dollar, for example–can breakdown so quickly that it throws an entire investment strategy into chaos. (Buy Juggling with Knives at Amazon http://www.amazon.com/Juggling-Knives-Investing-Coming-Volatility/dp/1610394801?ie=UTF8&qid=1463761996&ref_=tmm_hrd_title_0&sr=1-1. )

Well, that’s where we are today now that markets have decided that programs of quantitative easing from central banks–the Federal Reserve, the Bank of Japan, and the European Central Bank–aren’t enough to drive economies or financial markets.

The new pattern is an old pattern, one known as risk-on/risk off.

Yes, the glorious (sarcasm alert) days when money sloshed from one asset class to another as investors decided that the markets felt risk and that this asset felt more or less risky than that asset are back.

The evidence in correlations between asset classes over the last 120 days, compiled by Bloomberg, is rather compelling.

For example, the correlation between an index of 20 emerging-market currencies and global stocks has climbed back to 0.6 to approach its level on April 8. That was the strongest correlation since December 2013. In other words emerging market currencies are moving in lockstep with global stocks. The correlation between commodities climbed to an almost six-year high of 0.7 this month. In late 2014, neither asset had a significant correlation with emerging-market currencies.

Or to take another example, the correlation between the dollar-yen exchange rate and stocks reached 0.7 in February. That was the strongest correlation since Bloomberg began collecting this data in 1987. Since then the correlation has fallen to 0.5. So, yes, while the yen still tends to weaken when equities rally, the move is a bit less strong than earlier in the year.

Why the shift back to a risk-on/risk-off market? Worries over the Brexit referendum next month on United Kingdom membership in the European Union, the chaos that is the U.S. election, a potential June or July interet rate increase from the Fed, the big sell-off in stocks earlier in 2016.

Why is this important? Because the shift in correlations should result in a rethink of some old strategies and consideration of some new possibilities. For example, the new correlations suggest taking a look at going long the Mexican peso, one of the worst performing currencies in 2016, with an increase in commodity (especially oil) prices.

 

Update Freeport and mining sector

posted on January 12, 2016 at 7:29 pm
iron_ore

Update: January 11. News that Arch Coal (ACI) had filed for Chapter 11 bankruptcy under the weight of $4.5 billion in debt didn’t come as a surprise yesterday. Granted the shares fell 31% in the session before trading was halted for news but the stock had already dropped to 83 cents at yesterday’s close.

And it certainly wasn’t surprising that the news from Arch Coal took down shares of other coal companies. Peabody Energy (BTU) plunged 20%, for example. The problem of severely lower demand for coal–plus longer-term pressure to move away from coal in electricity generation in order to combat global warming–has hit all coal companies so it’s not surprising that a bankruptcy filing from Arch Coal would ripple through the sector.

What is surprising–to me anyhow–is now far those ripple extended yesterday given how much damage has already been done to many companies operating in what can most broadly be defined as the “mining sector.” Mining equipment big dog Joy Global (JOY) fell 6.27% for the day even though it was already down 79% for the last 12-months. Copper miner Freeport McMoRan Copper & Gold (FCX),which had already suspended its dividend last month and where shares are down 80% over the last 12 months, fell 20%.

I think that it’s safe to say that we’re seeing another ratcheting down of expected revenue and earnings for this wider universe. JoyGlobal didn’t fall so far yesterday, for instance, because it does so much business with Arch Coal that a bankruptcy filing by that company would have a huge effect of sales and earnings at the mining equipment maker. The drop reflects a belief that Arch won’t be the last bankruptcy filing and that indeed the mining sector is about to enter a period of even greater financial stress which sees a significant number of producers following Arch to bankruptcy court or something worse.

So what do you, as an investor, do about that possibility. It’s be no means a certainty but I do think it’s likely. The analysis I laid out for the rising financial stress on oil producers in 2016 as bank lending gets tighter and as hedges expire applies to other commodity sectors too. (On my subscription site JubakAm.com see my post http://jubakam.com/2015/12/sector-monday-why-the-saudis-will-win-and-then-lose-the-oil-wars-in-2016/.) Unless China’s economic growth rates turn around quickly, which I think is unlikely, then 2016 is going to be ugly indeed.

But at the same time I’ve also noted that some of the best companies and stocks are now trading at prices that are so low that they constitute, for all intents and purposes, extremely long-dated options. Given how much uncertainty there is about when a recovery in demand might occur–and even more uncertainty about when financial markets might start to anticipate a recovery. (And, of course, there’s the problem/opportunity of potential anticipated recoveries that turn out to be false dawns.)

Way back in 2015 when Brazilian iron ore miner Vale (VALE) was flirting with a drop below $4 a share on its ADRs, I suggested that long term investors consider adding a position of this member of my long-term 50 Stocks portfolio somewhere around $3.70 to $3.20. Well, today the American Depositary Receipts fell another 2.3% to $2.54 per ADR. Vale is now down 68.7% for the last 12 months and 22.8% for 2016 alone. I think that $2.54 for the world’s low cost producer of iron ore is a good price–even with all the turmoil in Brazil and all the extra capacity coming on line from Vale and its peers over the next few years. Is it the best price we’re conceivably going to get in this commodity recession/depression? Doesn’t look like it and I’d be tempted to wait longer for an even better price. However, $2.54 is a reasonable option price for Vale.

But only because, as I read the company’s balance sheet, it is extremely unlikely (never say never in Brazil these days) to go the way of Arch Coal. Vale at $2.54 is an option worth buying because the company is almost certain to be around come the turn in commodities.

I’d say the same thing about Freeport McMoRan and about BHP Billiton (BHP) among the stocks in the long-term 50 Stocks portfolio. Other commodities companies I am not so sure of and after today’s market reaction to the Arch Coal news I think it’s worth going through every commodity stock you still own to calculate the odds of the company being around so you can cash in those cheap options.

I’m doing that right now on the 50 Stocks portfolio and I’ll have recommendations over the next few days on which “long-term commodity options” in that portfolio aren’t worth the risk of holding through 2016.

Arch Coal bankruptcy sinks entire mining sector; copper miner Freeport falls 20%

posted on January 11, 2016 at 9:27 pm
iron_ore

News that Arch Coal (ACI) had filed for Chapter 11 bankruptcy under the weight of $4.5 billion in debt didn’t come as a surprise today. Granted the shares fell 31% in the session before trading was halted for news but the stock had already dropped to 83 cents at yesterday’s close.

And it certainly wasn’t surprising that the news from Arch Coal took down shares of other coal companies. Peabody Energy (BTU) plunged 20%, for example. The problem of severely lower demand for coal–plus longer-term pressure to move away from coal in electricity generation in order to combat global warming–has hit all coal companies so it’s not surprising that a bankruptcy filing from Arch Coal would ripple through the sector.

What is surprising–to me anyhow–is now far those ripple extended today given how much damage has already been done to many companies operating in what can most broadly be defined as the “mining sector.” Mining equipment big dog Joy Global (JOY) fell 6.27% today even though it was already down 79% for the last 12-months. Copper miner Freeport McMoRan Copper & Gold (FCX),which had already suspended its dividend last month and where shares are down 80% over the last 12 months, fell 20% today.

I think that it’s safe to say that we’re seeing another ratcheting down of expected revenue and earnings for this wider universe. JoyGlobal didn’t fall so far today, for instance, because it does so much business with Arch Coal that a bankruptcy filing by that company would have a huge effect of sales and earnings at the mining equipment maker. The drop reflects a belief that Arch won’t be the last bankruptcy filing and that indeed the mining sector is about to enter a period of even greater financial stress which sees a significant number of producers following Arch to bankruptcy court or something worse.

So what do you, as an investor, do about that possibility. It’s be no means a certainty but I do think it’s likely. The analysis I laid out for the rising financial stress on oil producers in 2016 as bank lending gets tighter and as hedges expire applies to other commodity sectors too. (See my post in my subscription site JubakAM.com http://jubakam.com/2015/12/sector-monday-why-the-saudis-will-win-and-then-lose-the-oil-wars-in-2016/.) Unless China’s economic growth rates turn around quickly, which I think is unlikely, then 2016 is going to be ugly indeed.

But at the same time I’ve also noted that some of the best companies and stocks are now trading at prices that are so low that they constitute, for all intents and purposes, extremely long-dated options. Given how much uncertainty there is about when a recovery in demand might occur–and even more uncertainty about when financial markets might start to anticipate a recovery. (And, of course, there’s the problem/opportunity of potential anticipated recoveries that turn out to be false dawns.)

Way back in 2015 when Brazilian iron ore miner Vale (VALE) was flirting with a drop below $4 a share on its ADRs, I suggested that long term investors consider adding a position of this member of my long-term 50 Stocks portfolio somewhere around $3.70 to $3.20. Well, today the American Depositary Receipts fell another 2.3% to $2.54 per ADR. Vale is now down 68.7% for the last 12 months and 22.8% for 2016 alone. I think that $2.54 for the world’s low cost producer of iron ore is a good price–even with all the turmoil in Brazil and all the extra capacity coming on line from Vale and its peers over the next few years. Is it the best price we’re conceivably going to get in this commodity recession/depression? Doesn’t look like it and I’d be tempted to wait longer for an even better price. However, $2.54 is a reasonable option price for Vale.

But only because, as I read the company’s balance sheet, it is extremely unlikely (never say never in Brazil these days) to go the way of Arch Coal. Vale at $2.54 is an option worth buying because the company is almost certain to be around come the turn in commodities.

I’d say the same thing about Freeport McMoRan and about BHP Billiton (BHP) among the stocks in the long-term 50 Stocks portfolio–although I think both are worth waiting on here for a lower price. Other commodities companies I am not so sure of and after today’s market reaction to the Arch Coal news I think it’s worth going through every commodity stock you still own to calculate the odds of the company being around so you can cash in those cheap options.

I’m doing that right now on the 50 Stocks portfolio and I’ll have recommendations tomorrow on which “long-term commodity options” in that portfolio aren’t worth the risk of holding through 2016.

Ugly earnings by Monsanto today say sector selection will count during third quarter reporting season

posted on October 7, 2015 at 7:33 pm
corn

The really ugly earnings report delivered today by Monsanto (MON) should go a long way toward clarifying the debate over calendar third quarter earnings. The company announced a loss of 19 cents a share for its fiscal fourth quarter that ended on August 31 and said that earnings would remain weak through 2016. Analysts had expected a loss of 3 cents a share. The company also reported that it cut 2,600 jobs or about 12% of its total workforce.

What’s that you say—you didn’t know there is a debate over earnings for the calendar third quarter? Earnings per share for the stocks in the Standard & Poor’s 500 are projected by Wall Street analysts to fall by 6.9% in the quarter.

End of debate, no?

Well, no. There’s a good possibility that the projected decline in S&P 500 earnings overstates the weakness in the quarter. The index, in comparison to the actual economy, over-weights the energy sector. Which raises the possibility that overall corporate profits—outside the energy sector–are better than projections for the S&P index indicate.

That side of the debate scores some points in the Federal Reserve’s report “Nonfinancial Corporate Business Profits.” In the calendar second quarter, corporate profits by the Fed’s measure climbed 11% year over year. That’s the most since the fourth quarter of 2012. In contrast the S&P 500 showed a decline in corporate profits of 2%, according to Bloomberg.

Goldman Sachs has an explanation for the disparity. The plunge in oil prices, revenue and earnings that is hammering energy company profits is one side of the positive effects of ultra low interest rates, low energy costs, and restrained wage growth has been good for company profits everywhere outside of the energy sector. Income in the third quarter is projected by S&P to grow by 10% or more in telecommunications, technology, consumer discretionary, and health care.

The big wild card for the overall earnings picture is the strong dollar. How will that affect profits for big U.S. exporters?

From the evidence in Monsanto’s report today, companies with big exposure to the negative effects of a strong dollar, with big exposure to commodities markets, and with big exposure to emerging economies are going to show disappointingly weak earnings.  Monsanto took a hit as a strong dollar damped sales across Latin America and as the company continued to cut prices (although the worst of that seems to be over.) Monsanto continued to face pressure on its Roundup product from generic glyphosate with farmers looking to save money in the face of commodity price pressures. Brazil, where the economy is in recession, added to the decline in profits.

It would be a good strategy to focus on sectors experiencing solid profit growth and stay away from laggards—but if growth at the laggards is bad enough, it can, history says, take the entire market into a downturn.

Very careful and very selective buying would seem to be in order on dips in the stronger sectors of the market.

Today Wall Street talks up Glencore–showing just a little bit of self interest

posted on September 29, 2015 at 7:23 pm
coal car

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.



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