Bulls raged back in a big way during the week of trading ending August 28 to erase some of the massive losses experienced from the May 2015 highs of 2,013 on the S&P 500. Though no longer staring down at 1,800, the S&P 500 still closed comfortably shy of 2,000. No matter what next week will bring, almost everybody is expecting more volatility. Could this then mean that we’re back to normal? The market has a very interesting way of disappointing the majority of investors the majority of the time.
Here are 3 observations that are worth noting.
1. The Fed Doesn’t Have the Right Data…Yet
The stark reality is one of two things: a) either the Fed knows exactly what’s going on and is doing all that it can to assuage the markets of another “panic” fall, or b) the Fed doesn’t really believe that the capital markets lead, and sometimes drive, future economic activity. Why are we saying this?
Well, yesterday, Moody’s released its ‘Weekly Market Outlook,’ and while it was titled, Corporate Credit Cycle Is Past Its Prime, that’s not what got our attention. Tucked away on page 15, written in bold blue, was the following: Financial market turmoil has brought corporate bond issuance to a near standstill. To us, it looks as if the collapse in Chinese and other markets around the world, including the US, have choked off confidence, even if access to capital remains fluid.
We brushed this observation off, until Friday, when Federal Reserve Bank of St. Louis President James Bullard said “that volatility in financial markets hasn’t dented the good outlook for the US economy.” If Moody’s is right, and businesses are re-considering or delaying debt-funded growth projects, the implications on the trajectory of US economic growth will be material. The Fed probably doesn’t just yet have a great understanding of the situation, and savvy market observers are betting that means no rate hike…perhaps for the foreseeable future.
But then again, what’s a measly quarter point next month? Now you see why markets are so volatile.
2. Venezuela Rallies Oil Markets
The price of WTI crude oil (USO) has now railed nearly 20% from its ~$38 price tag just a few days ago, and some commenters have jokingly remarked that in just a few more percent, we’ll now be in an “oil bull market.”
Without a doubt, the collapse in crude oil prices has been quite painful for the whole value chain, save refiners which have benefited from relatively more resilient refined-product demand. In the Midwest of the US, for example, consumers haven’t received any reprieve from dropping crude oil prices, with the cost at the pump near $3 per gallon.
We found out this week that OPEC-member nation Venezuela wants to talk things over with the cartel, calling for an emergency meeting before the scheduled one in December. The stronger OPEC members (Saudi Arabia, Kuwait, and the UAE), however, have reportedly already rebuffed previous calls for a meeting (one earlier this month from Algeria), and we would expect OPEC to do the same with Venezuela.
What we think the stronger members of OPEC know well, and what oil market observers may be discounting, is that an emergency meeting may not matter. If OPEC should happen to cut, US-based producers or Russia will easily replace the supply glut accordingly, in our view. OPEC has learned from past cycles and is determined not to cede share. Inter-OPEC assistance is probably a more likely scenario than production cuts by the cartel.
We think OPEC is operating to put US independents out of business, much like Amazon (AMZN) has done to brick-and-mortars. Why should OPEC cut production when some $500 billion (that’s a half a trillion dollars) is needed to keep the oil industry afloat? According to Bloomberg, debt issued by ~170 oil companies is showing signs of distress (yielding greater than 10%), and the “ratio of net debt to earnings is the highest in two decades.” We continue to believe that even the dividends of some of the sector bellwethers, including Chevron (CVX) and ConocoPhillips (COP), are in question. Newfield Exploration (NFX) is another that we’re watching closely.
OPEC is winning this war. All it has to do is endure a little more pain for just a little longer. We think the cartel knows that slowing production will not benefit member nations, and Venezuela and Algeria may be looking more for assistance than anything else. Crude oil is likely headed lower still, but degrees of extreme pessimism, which have started to creep into the markets, have made us a little more cautious on the coming doomsday scenario.
If everyone’s expecting calamity, it probably won’t happen.
3. We Think Icahn Has Made a Mistake
We like Mr. Icahn very much.
We never met him, but we’ve found that he tends to be very active in our best ideas, and frankly, he’s done a lot of good things for the Best Ideas Newsletter portfolio as a result. Part of the strong share-price runs in Apple (AAPL) and eBay (EBAY), for example, were in part a result of his bringing attention to their vast market mis-pricings.
On an unrelated (but somewhat related eBay) note, PayPal (PYPL) announced yesterday that it is effectively raising its fees on its top vendor merchants—those that receive a merchant volume discount. Look for a guidance raise. We continue to include PayPal in the Best Ideas Newsletter portfolio in part because of its pricing power and the high switching costs merchants face.
Accepting Presidential hopeful Donald Trump’s nomination for Treasury Secretary may have been a huge surprise, but for others, Carl Icahn’s move into Freeport McMoran’s (FCX) shares was the bigger news. The problem with this new activist stake, unlike some of his other endeavors, is that no matter how efficient the copper and gold miner becomes under his influence, Freeport McMoran will remain beholden to the price of these metals.
Though others may disagree, we’re viewing Mr. Icahn’s entrance into this market more as a gamble on higher commodity prices than on any pure activist intentions. The announcement has lifted hopes for commodity producers, in any case.
Related tickers: CPER, GLD, XLE, SPY, DIA