If the energy sector can get some relief, the overall market will as well. Ed Yardeni, of Yardeni Research, notes that S&P 500 earnings fell 14.1% in 3Q15 over 3Q14. But that becomes a 3.4% rise in earnings when the drag from the energy sector is removed. Of course it’s a lot easier to do that math on paper with conjecture than it will be for energy to actually recover.
The turnaround will need to happen soon. History shows that corporate profits tend to drive the ups and downs of the business cycle. Profitable companies increase advertising spending, increase capital investment, hire new workers, and raise pay to poach talent from other companies. Unprofitable companies shrink.
The chart above shows how the decline in forward-earnings growth (red line) since crude oil peaked in 2014 has already had a negative impact on real capital spending (blue line). Thus, it’s no surprise Q4 GDP growth slowed.
The economy is hurting as low oil prices have had a net negative effect on the economy. The good news: The latest data show forward-earnings growth has pushed back into positive territory. With oil prices closing the week near $34 a barrel, up from a low of $27.56 seen earlier in the month, let’s hope the profits turnaround can continue.
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Gaining Energy
The most-interesting development on the trading front has been the sudden rise of big-cap energy. The stocks are still down big for the year, but they are suddenly catching a bid. One of my favorite mantras is, “Something that can’t happen, won’t happen.” It is not precisely apropos in this case, but it’s applicable to the price of crude oil and its effect on the Persian Gulf and Russia.
Sub-$30 oil probably cannot go on forever because companies will go bankrupt and countries will blow up, taking supply out of the market and restoring equilibrium. If that’s true, then investors will try to catch the turn of oil back toward the high $30s early (“buy the rumor, sell the news,”) and that’s what appears to be happening. These early buyers may be early but value investors are used to the pain, and there’s little denying that prices are very low.
I was talking to an executive at a major Texas oil conglomerate on Thursday who has seen the value of his company stock go down dramatically, but he has faith that management has been through these booms and busts before and will steer the ship to come out on the other side with their Stetsons and pride intact. The best oil men (and women) are risk-takers and risk-managers par excellence, and it seems that institutions are figuring that well-run companies, like Kinder Morgan (KMI), will find a way to win as they have for decades.
The most-important contributor of good humor in the group Thursday was speculation of potential, but so far unfounded, coordinated production cuts from Russia and OPEC. In the morning, crude spiked on word that Russian Energy Minister Alexander Novak said that Saudi Arabia had proposed production cuts of up to 5% by each oil-producing country. He also noted that there was a proposal for a February meeting between OPEC and non-OPEC countries at the oil minister level. However, some OPEC delegates said no meeting had been planned, but that a production cut had been floated by Venezuela and Algeria.
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Who do you believe? Despite oil’s recent moves, there is still a great deal of skepticism about any potential cooperation. The Saudis have focused on fighting for market share, while there have been a number of reports about Russia’s challenges in curbing production given significant private well ownership and the problems associated with the halting of pumps under harsh winter conditions. The difficulty of shutting down production wells cannot be underestimated; it is expensive, and it can be very hard to get the wells working again once the pressure is relieved. Yet these are details; ultimately the best companies will survive.
On the macro front, the latest report on durable-goods orders was significantly softer than expectations. The headline number registered a 5.1% month-over-month drop in December. That was lower than consensus estimates for a 0.3% to 0.7% decline and below November’s downwardly revised -0.5% level. The reading was the fourth decline in the past five months and capped an overall drop of 0.6% for 2015.
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One Direction
Jason Goepfert produced another of his valuable studies on unique price behavior after the close on Tuesday last week. He noted that the large gain for stocks on Tuesday, Jan. 26, was just as lopsided in terms of the volume of buying as Monday, Jan. 25, was lopsided in its selling, and as the buying on Friday, Jan. 22. All three were “all or nothing days” in which the market stormed in a single direction up, down, and then up again.
He reports that the only other time in 60 years we have seen back-to-back-to-back all-or-nothing days was in August and October 2011, the latter of which was a major bottom of the past few years. Whether this is a function of high-frequency traders or whatever else, Goepfert says, such lopsided days have become more common.
Speaking more technically, Jan. 26 marked the second day out of the past three that more than 80% of stocks on the NYSE advanced, and more than 80% of the volume flowed into those stocks. The chart above shows every date since 1950 where this has occurred, along with returns in the S&P 500 going forward.
As you can see, such concentrated buying pressure was almost universally bullish prior to the past decade, when it became more common. Still, returns going forward were mostly good, especially longer term, he notes.
Bottom line: Judging from this study and others, Goepfert figures that the most-likely scenario from super-negative conditions like we saw in mid-January week is for a multi-week to multi-month relief rally, even if we’re in the midst of a new bear market. The most-comparable time period, he observes, would be January 2008. Back then, stocks bounced for several months before cascading into the financial crisis that autumn and winter.
Best wishes,
Jon Markman
P.S. In case you missed Larry Edelson grill CNBC contributors Boris Schlossberg and Kathy Lien on the small economy — and the currency — most likely to generate potential gains of up to 1,587% in 2016 … you can watch it online TODAY only!
The investment strategy and opinions expressed in this article are those of the author’s and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.
