The Standard & Poor’s 500, closing at 2015 on October 9, is within spitting distance of the 2020 level that marked the high point before a hefty decline ended the August and September rallies.
With early results from earnings season at Monsanto (MON), Yum! Brands YUM), and now Alcoa (AA) all falling disappointingly short of Wall Street expectations, there’s good reason to think that third quarter earnings will result in another retreat from the highs.
On the plus side, none of these three stocks are the kind of bellwether stocks that determine the tone of the entire market. Alcoa, which was once an industrial stock to conjure with, isn’t very good at predicting the course of the entire market anymore.
On the down side, some of the trends even in these early returns are exactly the sort that should worry the overall market. Monsanto disappointed on weakness in developing economies; Yum and Alcoa showed slower than expected growth in China. Alcoa downgraded its estimates for China and now predicts a 22% to 24% drop in demand for aluminum for the manufacture of heavy trucks in China. That’s especially important because, Zack’s points out, a decline in truck production has often preceded recession in China.
There is some hope in Alcoa’s guidance, though.The company sees the current surplus in aluminum switching to a deficit in 2016 as global aluminum demand grows by 6.5% in 2015. Aluminum prices are down 40% from their peak in 2011 and down 11% this year.
Not everyone agrees with Alcoa. Morgan Stanley, for example, sees aluminum remaining in surplus in 2016 and Bloomberg sys the glut might even get worse as capacity grows in China.
And there we have the make or break question for this rally. So far commodities and emerging market stocks have moved up on a weak dollar, and speculation that we’re about to see the end of a supply glut in oil, iron ore, copper, and aluminum among other commodities. Speculation was enough while stocks drove toward the old highs, but now that we’re at those highs I think investors are going to need some evidence that the supply/demand balance is about to shift in producers’ favor.
Freeport McMoRan Copper and Gold (FCX) is a prime example of this shift in dynamic. As of the close on October 9, the shares were up 51% from the September 28 low. But with the stock up 50%, investors and traders are looking for some evidence of a sustainable recovery. Shares of Freeport McMoRan copper up just 0.22% at the close on Friday. Alcoa’s shares were down 6.81% on its earnings news. Freeport McMoRan reports earnings on October 22. Think we might see some profit taking before that report?
Spread that profit-taking across the market and you’re looking at an end to the current rally.
I’m going to use the current five-day (and counting) weak dollar rally to sell the Greenbrier Companies (GBX) out of my Jubak’s Picks portfolio. The stock is up 14% from September 28 to the close today at $35.18.
Greenbrier has bounced so hard in this rally because the maker of railroad cars is doubly leveraged to the U.S. energy boom. Oil and natural gas liquids from the country’s shale geologies have had, frequently, to travel by rail since these new production areas aren’t well served by the existing pipeline system. That had meant soaring demand for the tank cars that Greenbrier builds (and for the new, safer cars that government regulations are gradually phasing in.) And with the railroads making a very nice dollar from transporting this oil they had placed so many orders for new cars that Greenbrier’s backlog soared.
With a recovery during this rally in oil prices, Greenbrier has felt double upside leverage.
But this same double leverage that led the shares to bounce so strongly in this rally is exactly the double leverage that took Greenbrier down to $30.86 on September 28 from a 52-week high of $67.45. With oil producers in shale regions cutting back on production—even if not significantly until lately—that meant less oil to ship. With those same companies reducing capital spending there was less gear and fewer supplies headed to the oil fields. And with the railroads seeing their own revenue drop, they slowed the pace of capital spending on new cars.
Greenbrier has a huge backlog of orders—even with the slowdown in the pace of new orders—to work through so the company is in no danger of succumbing to financial pressures. And the stock is very cheap on a trailing 12-month basis with a price of earnings ratio of just 6.58 on last year’s earnings.
The problem, though, is that despite the current rally, I don’t see a turn in the company’s business happening nearly as early as some Wall Street analysts do. For 2016 the consensus estimate is now at $6.27, a solid pick up from the $5.79 of 2015 and one reason that the forward multiple is a very low 5.11.
But that consensus estimate hides a huge disagreement about earnings for 2016. The high estimate for that year is $6.95 per share, but the low estimate us just $4.91. That’s a $2.00 a share swing and the trend in the consensus estimate for 2016 has been downward, going from $6.32 90 days ago to $6.20 seven days ago (before a rebound to $6.27 in the current rally.)
I think what we’re seeing is a gradual coming to terms by Wall Street that the energy bear in U.S. share regions is deeper and longer than many forecasts still project.
I’d like to revisit Greenbrier once those lower estimates are in the Wall Street forecast. But right now I’d like to watch from the sidelines.
As of the close on October 5, I’ve got a 43.9% loss in Greenbrier since I added it to the Jubak’s Picks portfolio on November 18, 2014.
Today, August 24, has been like two days (maybe three) in one. (Yesterday in my Saturday Night Quarterback post on my paid JubakAM.com site I told readers to watch to see if Monday brought a bounce or a continued decline. Well… how about both?)
First, there was the continued global rout that began in Asia—with the Shanghai Composite index closing down 8.49% and even the Japanese Nikkei 225 index participating in the downturn with a loss of 4.6%.
U.S. stocks opened hugely lower with the Dow Jones Industrial Average plunging 1000 points at the open for a 6.6% loss and the Standard & Poor’s 500 tumbling to a 5.3% decline. But then U.S. stocks rallied into midday and held on to much of those gains so that at 2:30 p.m. New York time the Dow was “only” off by 363.5 points (2.21%) and the Standard & Poor’s was down “only 2.64%.
And then, as U.S.markets moved toward the close, U.S. stocks fell again with the Dow Jones Industrial Average down 3.57% at the close and the S&P 500 falling by 3.94%. The swing in the NASDAQ was even wilder with a 6.6% loss “rallying” to a 2.16% loss by 2:30 p.m and then falling to a 3.82% loss as of the close.
There is actually some logic to the day’s action. The big worry is slowing global growth with the epicenter for that potential financial earthquake in China’s economy. So it’s “logical” that Shanghai would take the worst of the hit and that economies that export a lot to China would fall in concert. Europe’s biggest export economy, Germany, saw its DAX stock index down 4.7% at the close.
On the other hand, once traders and investors had a chance to get over their early shock at yet another big down day in Shanghai, it was “logical” for U.S. stocks to take back much of their early losses. The U.S. economy looks to be growing at a better than expected—if still modest rate—in the second and third quarters and with its huge domestic market, the U.S. economy has proportionately less exposure to global export growth or decline. Certainly a 2.2% loss in the Dow Industrial Average is nothing to cheer about, but it is nonetheless a comparatively better performance.
Volatility on the S&P 500 as measured by the CBOE volatility index, the VIX, soared in the morning to 53.29 as of 9:55 a.m. from a prior close at 28.03 before moving up again to 35.13 as of 2:30. That’s still a 43% pop in what is known as the fear index but that’s still a lot better than the 90% jump in the index at its high. (A higher index number indicates that options on the S&P 500 have moved up in price as more traders and investors decide to buy in order to hedge against market volatility.)
The rally within a down day didn’t stem the commodity markets from turning in another dismal performance. U.S. benchmark West Texas Intermediate crude, which breached the psychologically important $40 a barrel price intraday on Friday fell another 3.73% as of 2:30 p.m. New York time to $38.94 a barrel. Brent benchmark crude fell 4.18% to $43.56 a barrel. That move and the continued closing of the price gap between the U.S and the Brent global benchmark also has its logic if the U.S. economy will turn in relatively better growth than the global economy.
The Bloomberg Commodity Index fell to its lowest level since August 1999. Copper prices, a key indicator of expectations for global growth, fell 4% to the lowest level since 2009 on the London Metal Exchange.
Are we looking at a yearend melt up?
I think the odds are good, very good indeed that we’ll see one of those big, all-animal-spirits-on-deck upward moves in U.S. stocks from now until at least mid-December.
Assuming, and at this point I think this is a relatively safe assumption after Monday’s report of a very disappointing 5.6% month to month drop in pending home sales in September, that the markets can get past this week’s October 30 meeting of the Federal Reserve’s Open Market Committee without a move by the U.S. central bank to cut back on its $85 billion a month in stimulus.
I think the Standard & Poor’s 500 stock index could easily break 1850—the index closed at 1760 on Friday, October 25, within the next six weeks. That would add another 5 percentage points of return to what is already an extraordinary year for U.S. stocks. As of October 25, the year-to-date return for the S&P 500 was 25.4%.
But an end of the year melt up wouldn’t be all good news for traders and investors.
As the term implies, with its echo of “melt down,” stocks can fall hard after a melt up. In a melt up valuations run far away from any fundamentals in the economy, the market, or individual stocks. A melt up is driven by momentum as investors who have profited from the market’s gains greedily chase more and as investors who have been on the sidelines decide that they can’t take missing out any longer and join the party. Worries about risk go out the window and often it’s the riskiest assets that climb the fastest. In a melt up the last of every group of investors except the permanently bearish throws in the towel and finally puts cash into the market.
A melt up can be the last blow off before a market dive.
“Can be” is, of course, the key problem. Melt ups don’t have to end in corrections or market dives. Best-case fundamental wishes can turn out to be true, and provide support for valuations at exactly the right time. Extravagant hopes for the future can yield to even more extravagant hopes. Markets can calmly go through a period of consolidation rather than dropping to support levels.
Let’s start at the beginning and work through the important points one by one: Read more
Waiting for tomorrow’s jobs numbers: Will good news be bad news, or will bad news be good news, or vice-versa?
After trading as low as 1598.23 around noon New York time today, the Standard & Poor’s 500 index finished the day at 1622.56, or a gain of 0.84%.
It ‘s clear that the driver for the market today is related to tomorrow’s jobs report for May. And that makes sense since the Federal Reserve has said that its decision on when to begin tapering off its monthly $85 billion in purchases of Treasuries and mortgage-backed assets will depend on the data.
But it’s not clear to me what the action in the financial markets today means that markets are anticipating tomorrow. Would a disappointment—something lower than the 159,000 net jobs projected by economists surveyed by Briefing.com—lead to a move up because markets would decide that such bad news would put off the chances of tapering off purchases from the Fed? Or would markets retreat on that news because it would be a sign of weaker than expected economic growth in the United States?
Complicating the read is the influence of the yen/dollar exchange rate. An appreciating yen has put an end to the rally in Japanese stocks. Would a stronger or weaker jobs number tomorrow send the yen back down?
I don’t think you can tell much of anything from today’s U.S. market action. After the declines of the last few days, the move up today might be nothing more than a squaring of positions before the uncertainty in tomorrow’s news.
But on a slightly longer perspective than the next 24 hours, it looks like we’ve seen major unwinding of positions short the yen and long U.S. Treasuries. The move below 99 yen to the dollar today looks like it triggered another round of stop loss selling that took the dollar down further (and the yen up to 96 to the dollar.) Hedge funds have taken punishing losses in May on their bets against the yen, for Japanese equities, and for U.S. Treasuries. I think the last stage of the Treasury market retreat has been fed by some of these funds exiting losing positions.
Certainly that kind of reversal in positioning can lead to buying where we’ve seen selling (and vice-versa.) And it can also lead to a directionless market as traders try to find a trend.
Of those alternatives, I’d vote for “directionless” just because there’s no much uncertainty ahead of the June and July meetings of the Federal Reserve.
But, gosh, don’t we live interesting times?