The bear has been unrelenting, critically wounding the stock market bull since the start of the year. However, it is more accurate to say that the mighty bull has been attacked by a maul of bears.
Consider the following, as we attempt to explain why we still believe the bull will survive this grizzly attack:
(1) The Fed.
It’s always easiest to blame the Fed for any calamity in the financial markets since Fed officials regularly remind us how they have everything under control. In this case, last year’s 12/16 “one-and-done” rate hike certainly contributed to the carnage so far this year. That’s because, on January 3, Fed Vice Chair Stanley Fischer reiterated the message embedded in the 12/16 “Dot Plot” of the federal funds rate forecasts of the members of the FOMC. He said that the Fed’s definition of additional “gradual” hikes this year amounted to four of them.
He took a more direct swipe at the markets in a 1/6 CNBC interview with Steve Liesman. Once again, “Fischer agreed with the latest ‘Dot Plot’ indicating three to four interest-rate hikes in 2016. He said, ‘Those numbers are in the ballpark.’ Fischer then was asked about the divergence between the more dovish view of the market and that of the FOMC. Fischer responded, ‘Well, we watch what the market thinks, but we can’t be led by what the market thinks. We’ve got to make our own analysis. We make our own analysis and our analysis says the market is underestimating where we are going to be. You know, you can’t rule out that there is some probability they are right because there is uncertainty. But we think that they are too low.’”
The stock market clearly views four rate hikes as too much too fast. Fischer and his colleagues should be starting to have second thoughts about hiking rates again, as I discussed yesterday, especially given the unrelenting rout in stock prices and the freefalling price of oil. In addition, the latest batch of US economic indicators certainly doesn’t support FRB-NY President Bill Dudley’s recent assessment that the US economy is on “sound footing” and better able to “withstand downside shocks.”
Retail sales were weak in December, though the warm weather may have distorted the results by depressing winter clothing sales. However, housing starts fell 2.5% despite the warm weather, which should have boosted such activity, though heavy rains in some parts of the country might account for the weakness. The core CPI rose just 0.1% last month, kept in check by moderating medical care costs, as drug price increases have eased. Rents rose 0.2% after a similar gain in November. A strong dollar as well as bloated inventories may be dampening prices for some goods. Apparel prices declined for a fourth straight month. Prices for new motor vehicles dipped 0.1%.
A couple of FOMC members already are expressing doubts about raising interest rates again anytime soon. The “stock market vigilantes” may persuade more of them that one-and-done at the end of last year was more than enough for now.
Of course, on a daily trading basis since the start of the year, it’s fairly clear that the equity bull has been sinking in a pool of oil. Yesterday’s FT included an article titled “IEA warns oil market could ‘drown in oversupply’.” According to the story, the oil market is about to get flooded “as a rise in Iranian output offsets production cuts elsewhere, threatening a further price collapse, the world’s leading energy forecaster has said. In a stark assessment of the challenges facing the global oil industry, the International Energy Agency warned on Tuesday of an overhang of at least 1m barrels a day for a third consecutive year in 2016.”
Oil prices have tumbled 75% in 18 months as the largest producer countries have refused to cut back, with supplies and inventories ballooning to near-record levels. Indeed, crude oil output in the US and Canada rose to a record high of 13.1mbd during November, while Saudi Arabia continued to pump over 10.0mbd. US crude oil inventories totaled a staggering 483 million barrels on January 8, almost 100 million barrels more than a year ago.
The S&P 500 Energy stock price index is down 47.3% since its record high on June 23, 2014, weighing down the S&P 500, which is down 5.3% over the same period. Other sectors have been adversely affected by the disaster for energy companies as they slash their capital spending, with negative consequences for the global economy. That certainly has weighed on the Industrials sector. Previously, Joe reported that 30% of S&P 500 capital spending, was attributable to energy companies in 2014. That certainly would explain the weakness in nondefense capital goods spending (excluding aircraft) since 2014, though this measure is holding up relatively well nonetheless, under the circumstances.
(3) Credit & wealth.
In my meetings with accounts in London this week, as in similar meetings in NYC last week, a few money managers raised the specter of the 2008 financial contagion. They fear that the collapse in oil prices will have a similar contagion effect on credit as did the subprime mortgage problem. I noted that this time the excesses in the oil patch were financed in the capital markets rather than the banks with their highly leveraged credit derivatives. In my opinion, the former can absorb losses much better than the latter, reducing the risks of a widespread credit crunch.
However, the banks do have some exposure. The 1/15 FT included an article titled “Big US banks reveal oil price damage.” According to the story: “Citigroup, the fourth biggest by assets, said on Friday morning that it had recorded a 32 per cent rise in non-performing corporate loans in the fourth quarter from the previous year, mainly related to its North American energy book. Wells Fargo, the number three by assets, said net charges came to $831m in the period, up from $731m in the third, mainly due to oil and gas. A day earlier JPMorgan Chase, the number one, said it was ‘watching closely’ for spillover effects. If oil stayed around present levels of $30 a barrel, it said it would be forced to add up to $750m to reserves this year — which is roughly one-third of the benefit it expects from higher net interest income.”
There is also concern that the negative wealth effect on oil exporters will depress demand for luxury goods, and that their sovereign wealth funds will be forced to sell their stocks to maintain their governments’ social welfare commitments. A 1/19 article on Bloomberg was titled “Shrinking Sovereign Wealth Funds Are Ducking Davos.” It observed: “Across the Middle East, central Asia, Africa and Latin America, governments are tapping the reserves accumulated during the good times. Petrodollars are pouring out of a myriad of vehicles: sovereign wealth funds, stabilization funds, development funds and the foreign-exchange reserves sitting in central banks.” While wealth fund assets aren’t big enough to move markets alone, they do account for 5%-10% of global assets, and they can have an impact on market sentiment.
(4) Death notice.
While Mark Twain was in London, someone started a rumor that he was gravely ill. It was followed by a rumor that he had died. According to a widely repeated legend, one major American newspaper actually printed his obituary and, when Twain was told about this by a reporter, he quipped: “The reports of my death are greatly exaggerated.”
The bull has certainly been gravely wounded. However, it may be too soon to print a death notice. That doesn’t mean that the current 11.9% correction from the high of 2109.79 on November 3 couldn’t add up to a 20%-plus selloff, which would mark a bear market.
However, it could be a fairly short one. That’s partly because the attack by the bears has been so sudden, vicious, and from all directions. Given how much and how quickly oil prices have plunged, we should soon find out how much damage the oil shock is doing to the global economy and financial markets. If it’s not as bad as so widely feared, then stocks could stage a big rebound once investors start to believe that the price of oil has finally found the bottom of the barrel.
That doesn’t mean there won’t be other issues to worry about, such as a hard-landing in China, the disintegration of the eurozone, and another Fed rate hike.
Dr. Ed Yardeni
is the President of Yardeni Research, Inc., a provider of independent global investment strategy research. To read more of his blogs, CLICK HERE NOW.
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