On Nov. 12, 2014, we posted a blog noting that WTI oil prices had fallen from over $100 per barrel in June to just under $80 per barrel. In it, we discussed a scenario in which oil prices would probably have to fall below $70 as our reading of the tea leaves was that OPEC was not coming to the world oil market’s rescue like it had almost universally in the past. Our thought process as laid out in the blog post was that OPEC (mainly Saudi Arabia) was more worried about maintaining market share than it was seeing oil prices head lower. The emergence of non-OPEC oil production, especially U.S. oil shale, was just expanding too rapidly for the liking of the Cartel. Sure enough, on Thanksgiving Day, OPEC held a meeting to discuss cutting production. To the market’s surprise (but, not Winch Financial’s), OPEC did not lower their production quotas and discussed how non-OPEC production and especially U.S. shale oil was growing too rapidly. OPEC decided they would let the market price be set by true supply and demand and were not going to give non-OPEC oil producers a free ride. The oil and energy stock markets were massacred on Black Friday once the market digested what a bold move OPEC had just made while we were busy eating our turkey. Oil prices fell by over 10% to $66.10 and many energy stocks were down over 20% in one trading day. Contrary to market consensus, OPEC did exactly what Winch Financial called for and the energy stocks paid the price like we expected. What now? With oil prices in the mid $60s down from $100 as recently as July and many energy stocks having been cut in half, it appears the consensus is currently to buy the dip in oil prices and energy stock prices. We are not as confident as the market. We do not see the recovery… | Read More »
Author: John Hintz
Oil Prices and Energy Stocks Hit the Skids. Now What?
In June of this year, front month oil prices were trading for approximately $107 and energy stocks were significantly outperforming the stock market for 2014. Now oil prices are under $80 and most energy stocks have entered into a bear market (at least 20% correction). What happened? A combination of two events emerged to lay the foundation for the oil price plunge. First, economic demand (and oil demand) coming out of Europe, South America and China has been quite disappointing. Secondly, oil shale production in the United States has emerged as a significant contributor to oil supply growth. Thus, with oil demand disappointing and oil supply growth strong it has led to an increase in oil inventories and a significant amount of excess oil looking for a home. This has led to a substantial fall in oil prices and a corresponding decline in energy stocks. What happens next? While this is a difficult question to answer, our reading of the tea leaves sees a showdown between OPEC and the United States. Historically, when oil supply and demand would get out of balance OPEC would adjust supply to match demand and avoid sudden oil price declines. It appears OPEC is now playing a market share game. OPEC sees the abundance of oil production growth in the United States and it does not like to see one of its top customers now become a competitor. If OPEC had just adjusted supply downward to make room for the shale oil production in the U.S. they would have had to concede market share. Furthermore, the elevated prices also would have motivated the United States to further grow their shale oil reserves. Thus, OPEC elected to allow oil prices to fall with the hope that it will slow down U.S. shale oil production. Most oil experts estimate that U.S. shale oil production comes at a higher marginal cost than the typical OPEC barrel of oil. … | Read More »
Three key factors to consider as the S&P 500 hits 2,000
With the S&P at approximately 2,000 and approaching all-time highs there are some key factors to be aware of that will be major determinants of whether the bull market cycle continues. Factor 1: Federal Reserve Monetary Policy – On September 17th, the Federal Reserve is going to release their most recent decision on interest rates. While no one is expecting the Fed to raise interest rates today, the consensus market expectations is that the Fed will raise interest rates mid-year 2015. Any hint from the Fed’s press release or Janet Yellen’s comments at a scheduled press conference this afternoon that the Fed might act earlier to move interest rates higher will likely be a negative headwind for the market. A dovish Fed has been a major driver of this bull market and any sign the Fed is becoming more hawkish will be a hurdle the market will have to surpass. Factor 2: European Economic Growth – Recently we have been seeing a significant slowdown in Europe. For example, Italy recently released second quarter 2014 GDP numbers that indicated it was in a recession again. This is the third time Italy has been in a recession since 2008. Germany, the largest economy in Europe, reported a negative GDP figure for the second quarter of 2014, which took the market by surprise. France, the second largest economy in Europe, reported flat growth in its 2014 second quarter GDP release. Shortly after these negative European economic statistics were released, the European Central Bank lowered interest rates and introduced a form of quantitative easing. It is imperative that Europe gains traction and starts posting stronger growth economic figures. Current stock market prices are not pricing in a triple dip recession in Europe and this could be a stumbling block to further market appreciation. Factor 3: China Does Not Experience a Hard Landing – Recent economic data out of China has indicated a sharp slowdown… | Read More »
Risk in the stock market has increased
For those who follow the stock market on a daily basis, there is no denying the risk profile of the market has increased. We believe the chance of a five to 10 percent correction in the S&P 500 has increased. However, if it does occur it will just serve as just a temporary and overdue correction in an extended bull stock market. Why has the risk of a correction increased? It all starts with valuation. Over the past 10 years, the S&P 500 Index has traded at an average price to next 12 month’s earnings per share ratio (“P/E”) of approximately 14x. Currently, the S&P 500 Index trades over 15x on this P/E valuation multiple. Thus, stocks appear a little expensive. Typically, the current small size of the S&P 500 P/E premium to historical averages would not worry us as long as the fundamental tone of the market remained strong. However, there have been a few chinks in the armor that warrant attention and perhaps will constrain further P/E valuation multiple expansion in the S&P 500 and potentially increase stock market volatility. What are the potential concerns? First, the Russia and Ukraine escalating tension is causing stress in the marketplace. The United States and Europe have placed economic sanctions on Russia. These sanctions increase the risk of negative economic consequences in Europe. Given recent weaker economic data signals out of Europe, the threat of an increased negative economic impact from the sanctions is cause for some concern. Secondly, the United States has recently shown some initial signs of inflation picking up. This is a potential concern because it could move up the Federal Reserve’s time frame for increasing interest rates. Any sign the Federal Reserve might increase interest rates earlier than the market assumes is a negative for the overall stock market. How has Winch Financial changed its portfolio positioning given the new risks highlighted? Recently, we raised some cash… | Read More »
Next three weeks will be important for stock market
In the Winch Financial Investment Department it feels like we just completed evaluating first quarter earning’s reports from corporate America. However, it is now time to start digging through second quarter reported results. Approximately 75% of S&P 500 companies will be reporting second quarter results over the next three weeks. While every earning’s season is important, this quarter’s results might be more important than typical. As reported economic data demonstrated firm signs of growth over the past few months, investors bid the stock market up to all-time highs just last week. With most stock market valuation metrics being stretched, it is now incumbent on corporate America to come through with strong earning’s results and guidance for future results. Corporations need to demonstrate that the strong economic data we have been receiving is flowing through to the bottom line. Last night we received results from the first real corporate stalwart in Alcoa. Alcoa delivered strong results that handily beat Wall Street consensus sales and earning’s expectations and offered a favorable fundamental and financial outlook. As I write this short blog, Alcoa’s shares are being rewarded with a 5.7% surge in early trading today and the stock is trading near three-year highs. Alcoa continues to be a core long-term holding of Winch Financial and we are pleased to see the strong corporate results from Alcoa being recognized by investors. While second quarter earning’s season is off to a good start on the heels of Alcoa’s results, it is just the first of many company scorecards the Investment Department will be scrutinizing over the coming month. Given previously mentioned lofty stock market valuations, we are going to need to see more “Alcoa-like” results throughout earnings season to maintain recent stock market strength.