Is Q.E. Actually Hurting the World Economy?

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There is little doubt in my mind that the world came very close to another “Great Depression.” The credit bubble made trillions of dollars disappear. Central bankers had little choice but to save the banking system and embark on turning on the money printing presses. It seemed crazy at the time that the solution to excess debt is more debt.

The alternative would have seen bank failures, countries defaulting on their debt and consumers facing bankruptcy. No question that the stock market crash of 1929 would have been repeated. However, have Central Bankers gone too far? Is another financial crisis inescapably?

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Most economists would agree that the massive amounts of Quantitative Easing (Q.E.) is having little effect on economic growth. In theory, cheap money would allow corporations to expand production and hire more people. Leading to wage growth and more consumer spending. Cheap money in the form of lower mortgage rates would help revive the housing industry, making housing more affordable for first time home buyers.

In reality, corporations are using financial engineering, borrowing money to buy back their shares which automatically increases their earnings per share. IBM is famous for having decreasing quarterly revenue but increasing earnings because of share buybacks. To avoid paying U.S. taxes on foreign income, Apple sold bonds with ridiculously low yields in order to increase their quarterly dividend.

Money is so cheap that corporations are buying growth through mergers and acquisitions. Instead of creating new jobs, they are getting rid of existing jobs by consolidating their operations.  Corporations are in a catch-22, they need to see stronger consumer demand before investing in more production capacity but demand is unlikely without corporate spending on capital equipment that would create higher paying jobs.

What is clearly lacking in the global economy is demand. There are many factors contributing to this problem, slow wage growth, technology, globalization and an ageing population just to name a few.

JP Morgan CEO Jamie Dimon warned Wednesday that another financial crisis was inevitable, pointing to recent signs of risk in bond markets.

In his annual letter to shareholders, Dimon said another crisis will inevitably impact financial markets. He cited a range of possible triggers for the looming fallout, including geopolitical issues, a collapse in commodity prices or rapid interest rate hikes by the Fed.

In my humble opinion, the bond market bubble has spread to creating a bubble in the stock market. The recent stock-market volatility has caused the Dow Jones Industrial Average and the S&P 500 to lose nearly all of their gains for 2015. Stock prices seem overvalued when viewed in the absence of GDP and earnings growth.

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The monetary duct tape used to rescue the global economy is no longer working. Investors should be cheering any solution that increases consumer demand.

 

 

 

 

 

 

 

Beware of Negative Growth in Corporate Profits

 

 

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My previous blog posts have been leaning towards being more bearish regarding the stock market. The revised forecast for negative growth in corporate profits for the first quarter of 2015 makes me wonder if forecasters will reduce their expectations for the second quarter as well. I find the magnitude of the decline in expectations are somewhat alarming. Previous estimates for the first quarter were for a gain of 8.57 percent, with the second quarter projected at 7.33 percent and the full year at 9.78 percent.

Some Wall Street forecasters are putting a positive spin, by discounting the negative earnings from the oil & gas sector,  claiming that the rest of the S&P earnings will be positive. Energy profits are forecast to tumble 62.51 percent in Q1 and about the same in Q2, with the full-year sector drop pegged at 57.08 percent.

While others point to the strong U.S. dollar as a headwind to weak earnings for the next two quarters.

“Since the end of World War II in 1945, each of the 10 economic recessions has been accompanied by a decline in earnings growth. Only three times during that period did negative earnings not see a recession follow”, according to Sam Stovall, chief equity strategist at S&P Capital IQ.

“While not an official profit recession, as no contraction in EPS growth is currently projected, the full-year growth estimate is getting uncomfortably close to that threshold,” Stovall said in a note to clients this week.

Capital IQ expects the first quarter to show a loss of 2.92 percent for the S&P 500. Expectations for the second quarter, IQ sees a loss of 1.84 percent”.

These conflicting views makes it difficult for me to put money to work in the stock market. I am old school, in the past, the transportation sector has been a good indicator of economic activity. The one year chart below of the transportation ETF (IYT) shows signs of weakness. It is currently trading below its 50 & 100 day moving average and is close to breaking below the 200 day.

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I will be focusing on changes in revenue (top line growth) over earnings which can easily be skewed. I expect the railroads will show some weak revenue growth because they depend on transporting commodities like oil and coal. Norfolk Southern released an earnings warning on Monday, first quarter earnings per share are expected to be $1.00 per share. That is 15% below the same quarter in 2014 and is primarily due to lower expected revenues.

Take a good look at revenue growth from parcel delivery companies, air freight and trucking companies to confirm that economic activity is getting stronger. Here are a just few names that I am watching.

 

C.H. Robinson CHRW 27-Apr
Ryder Systems R 22-Apr
J.B. Hunt JBHT 14-Apr
United Parcel Service UPS 28-Apr
FedEx FDX 11-Jun
Forward Air Frieght FWRD 21-Apr

The first quarter GDP of 2014 came in at -2.1% but rebounded to 4.6% in the second quarter. Could we have a repeat performance this year? Consumer spending was positive for March after three negative months in a row. The low price of gasoline will add $800 to $1,200 extra dollars this year into consumer pockets. I expect that those dollars will be spent during the second half of 2015!

 As I was writing this post, J.B. Hunt released their earnings report:

J. B. Hunt Transport Services, Inc., (NASDAQ:JBHT) announced first quarter 2015 net earnings of $91.9 million, or diluted earnings per share of 78 cents vs. first quarter 2014 net earnings of $68.7 million, or 58 cents per diluted share.

Total operating revenue for the current quarter was $1.44 billion, compared with $1.41 billion for the first quarter 2014. Current quarter total operating revenue, excluding fuel surcharges, increased 10% vs. first quarter 2014. Intermodal (JBI) load growth was 6% over first quarter 2014 levels.

 

 

 

Tug of War in the Oil Market

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The tug of war continues between the oil bulls and the bears. Volatility continues in the price of oil which was up 6% on Tuesday and was down more than 4% on Wednesday after the Energy Information Agency (EIA) reported an inventory build of 19.95 million barrels (14 year high). This far exceeded the Thomson Reuters estimate of 3.43 million barrels.

The takeover of BG Group by Royal Dutch Shell poses the question whether the oil market has hit a bottom? The oil bulls believe that the halving in the price of crude is similar to the early 2000s when many super-mergers took place. Back then, BP acquired rival Amoco and Arco, Exxon bought Mobil and Chevron merged with Texaco.

The BG acquisition will provide Shell with enhanced positions in competitive new oil and gas projects, in Australia LNG and Brazil deep water. The other interesting point about this deal is the nearly total absence of North American assets. Shell has multiple reasons for buying BG, but more access to North America, is clearly not among them.

What I find fascinating is that 78% of BG Group’s reserves are in natural gas. Another curious fact, Shell has estimated the cost of its proposed LNG export terminal in Kitimat to be up to $40 billion (Canadian). It owns 50% of LNG Canada through its subsidiary Shell Canada Energy.

Paying a 50% premium for BG raises three more questions:

  1. Is the BG takeover based on the current low price of natural gas or oil?
  2. Is it cheaper to buy existing LNG plants than to build new ones?
  3. Is it cheaper to buy existing deep water wells than to drill new ones?

Wild cards in the oil market:

  1. When will Iran’s 30 million barrels stored in oil tankers hit the world market?
  2. When will oil storage in the U.S. reach capacity?
  3. How much of China’s cruel oil imports are going into storage?
  4. When will low oil prices force U.S. share production to actually decline?
  5. When will the Saudis cut production?

The price of oil has been stuck in a trading range but the current tug of war is slanting towards the bull side. According to oil experts, being interview in the business media, the hot money is flowing into oil stocks. The year to date price chart of the U.S. oil ETF (XLE) has moved above its 50 and 100 day moving average.

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I am not an expert when it comes to analysing chart patterns. I do know that the daily trading volumes are on the weak side. I have seen many money managers on business networks indicate that they dipping their toes into oil stocks. They are reluctant to call a bottom but they are buying some large integrated oil stocks and refineries.

The XLE has 28% of its value composed of Exxon and Chevron shares. Both of these companies report their earnings on April 30th along with Royal Dutch Shell. BP earnings come out two days earlier on April 28th and I have mention in a previous post that I own some bearish BP puts in my play money account. By the way,  the BP puts are currently under water but it is money that I can afford to lose.

Remember, trading in the oil market is being dominated by hedge funds with very deep pockets.

 

 

 

 

 

 

 

 

 

Spring Cleaning Your portfolio, Start With Junk Bonds!

 

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Wall Street has a bad habit of putting a bunch of junk into a nice package and changing the label. Junk bonds have been repackaged into “High Yield” ETFs and many retirees looking for income have ignored the default risk. Junk bonds are issued by companies that have low credit ratings, high debt to equity ratios or face  financial difficulty.

One lesson that I learned from the financial crisis is you can’t blindly trust Wall Street. Let me remind you that these are the same people that approved sub-prime mortgages to unqualified borrowers. Packaged these mortgages into investment grade Mortgage Back Securities knowing that there was a high degree of default risk.

Three Sectors with lower revenue growth and higher default rates

  • The oil and gas industry
  • Base metal mining companies
  • Silver & gold miners

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Add the fact that the Fed will start raising rates sometime in 2015, Greece could leave the Euro zone, the possibility of a correction in the U.S. stock markets and you have the making of a perfect storm. (Check your Target Date Mutual Funds to see if they contain any high yield products)

I briefly discussed the danger of investing in Master Limited Partnerships (MLP) geared to mortgages in my last blog post. They are also popular in the oil & gas sector. The tax benefit is hard to resist since the companies pay no income tax on profits and the money is taxed when unit holders receive distributions. The high dividend yields of over 8% should be a red flag that some of these partnerships are just too good to be true.

cautionBe aware that investors living outside the U.S. are subject to  a 40% withholding tax on income received from a MLP plus retirement accounts are not eligible to receive a foreign tax credit.

If you are new to my blog, I am a bond bear and don’t own bonds in any of my portfolios. We may be years away from getting back to more normal interest rate levels but I see no point in buying bonds with negative  yields. Consider reducing your exposure to bonds along with Wall Street’s high yield income products.

The U.S. stock market returns over the past six years have been much higher than the 20 year average.

Stock Investors Should Expect 6%-7% Annual Return, Buffett Says

“The economy, as measured by gross domestic product, can be expected to grow at an annual rate of about 3 percent over the long term, and inflation of 2 percent would push nominal GDP growth to 5 percent, Buffett said. Stocks will probably rise at about that rate and dividend payments will boost total returns to 6 percent to 7 percent”, he said.

“That math isn’t bad, but it is bad for people who expected long-term returns based on looking in the rear-view mirror,” Buffett said at Berkshire Hathaway Inc.’s annual shareholder meeting in Omaha, Nebraska.

U.S.  economic growth is currently under 3% and could turn negative for the first quarter of 2015. Low oil prices combined with a strong U.S. dollar with keep inflation below 2% plus reduced earnings for the stock market.  The job numbers for March came in at 126,000 which was way below estimates of 240,000 plus January & February numbers were revised lower.  The warning signs suggest that we are not out of woods yet, 2015 stock market returns could be negative this year or below average.

I am not a buy & hold forever like Mr. Buffett nor am I a market timer. My spring cleaning includes  taking some profits by selling some winners like Disney and Starbucks. Two excellent companies that I plan to buy again this summer. Cheaper gasoline will hopefully be spent at Disney theme parks this summer and the “Star Wars”movie franchise will be begin again this Christmas.  I am a little worried that the slow down in China and the stronger U.S. dollar could affect Starbucks’ earnings for the next quarter or two. Besides, I am not a fan of drinking hot coffee during the summer months.

I have also reduced my holdings in some under preforming Canadian Reits that are exposed to Alberta’s oil patch and Reits that own a lot of retail space. Target leaving Canada and last week’s Best Buy’s announcement that it is  closing some Future Shop locations makes me more cautious regarding the Reit sector.

Spring is the season for new beginnings. Get rid of your junk, trim back some of your winners and get ready to plant some new investment seeds.

Do you have a suggestion for a blog post? Leave a comment or email me ricodilello@rogers.com