For a PDF version of the below commentary please click here Weekly Letter 2-8-2016

Commentary at a glance:

– So much for a sustained rally in the markets; they were clobbered last week.

– With Iowa behind them, presidential hopefuls move on to New Hampshire.

– Fourth quarter earnings results deteriorated slightly last week here in the US.

– Chinese New Year celebrations this week have the main Chinese stock market closed all week.

– Economic news releases last week were very negative, painting a concerning picture.

 

Market Wrap-Up: Last week was a rough week for the US and global stock markets as investors seemed to be selling a wide variety of assets in favor of sitting in cash on the sidelines. The main driving force of the week was anticipation surrounding the US Federal Reserve’s interest rate decisions over the coming 11 months as the Fed weighs the strength of the labor markets as well as price stability and many other factors in its decision making process. The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The charts this week include the closest levels of support to the downside to indicate where support for each of the indexes could lay in the near future (these levels are drawn with red horizontal lines). For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 2-8-16

This week I adjusted the starting date on the above charts from 6/30/2015 to 9/30/2015 so it is easier to see what has been happening recently in the markets. I left the support level in the same spots they have been for the past few weeks. From a technical perspective, the NASDAQ (lower left pane above) is clearly the worst of the three major US indexes as it broke down below its most recent support level by a significant amount. It is now in an area that has very little support until you look way back on the charts. In fact, you would have to look back all of the way to October 20th of 2014 to find a closing price for the NASDAQ that is at or below the current level. Much of the decline in the NASDAQ over the past week was driven by a few high profile earnings results that, while they may have not been dismal in their earnings numbers for the fourth quarter of 2015, held some very negative comments about the future earnings expectations. The S&P 500 takes the middle position in terms of technical strength after looking at the performance of the last week and the Dow is in the lead. One other positive aspect of the Dow is that there have already been a significant number of component companies that have released their earnings results for the fourth quarter of 2015, meaning there is less chance of a downside surprise. One curious part of the week last week, in terms of charts and numbers, was the movement of the VIX (lower right pane above).

 

Typically, during a week that turns out to be so negative, the VIX (fear gauge for the markets) moves in much bigger movements relative to the markets than we saw last week. If the markets are down 5 percent plus, like the NASDAQ was last week, the VIX historically should have spiked upward by more than 30 percent. However, last week the VIX only moved up by 16 percent. This divergence from normal in the relationship between the VIX and the markets most likely means there was not a signal factor that pushed the markets lower last week and that the events that pushed the markets lower were one-off events. The VIX is very good at predicting volatility in areas where there are large dislocations, such as a dislocation in the Chinese economy hitting the global financial markets. This type of macro risk to the global economy is very quickly accounted for by the VIX as traders around the world adjust their positions very quickly and thus move the VIX. With moves completely unknown, events like single company earnings results pushing the entire markets around, the VIX does not have time to move; it is a predictive indicator, not a reactive indicator and the VIX does not predict one off events.

 

Going forward, the markets will likely continue to be very volatile as the underlying problems that have caused the recent volatility are not likely to go away any time soon. “Is the US headed for a recession?” is a question I received a few times last week. No, I don’t think the US is currently headed into a recession. A bear market for the stock market, potentially, but not highly likely. At least it’s not likely to be a sustained bear market; maybe more of a bull market pullback. There are too many positive developments in the US economy for a full blown recession to start at this point, especially when you consider that much of the drag on the economy and corporate earnings is driven by the decline that we have seen in oil prices. Remember that pull backs in the markets are healthy and normal. What is not normal is going for extended periods of time without a pullback of at least 10 percent, which we achieved for years in the three major indexes until July and August of last year.

 

National News: National news last week focused on politics and earnings season, in addition to the wild movements we saw in the US financial markets. As we draw closer and closer to the Presidential election, politics will play a bigger and bigger part in the news media and potentially on the financial markets. Last week, Iowa became the first state in the country to cast their vote for who should get the nomination in both the Republican and Democratic races. The Democratic side of the night was much closer than anyone had thought as Bernie Sanders pulled out a virtual tie with Hillary Clinton, with the decision going to Clinton by just 0.2% of the vote. The Republican side of the aisle was also interesting as Donald Trump, who came into the event riding a nice lead, was easily beaten by Ted Cruz and almost fell all of the way to third after Marco Rubio had an unexpectedly strong evening. Seeing that Trump was not as strong as he was thought to be emboldened some of the Republican candidates who went on the offensive in New Hampshire (the next state to cast their votes; Tuesday evening). For his part, Trump took the loss better than many people had expected, only calling out voter fraud for a few days and then moving on to the next battle ground where he holds an even bigger lead. The markets did not react to the results of the Iowa primary, but they do seem to be watching the Democratic ticket very closely with fear that if Sanders gets the nomination he could try to make some sweeping changes to the investment world as he tries to even the playing field between the wealthy and the poor. While the political shenanigans flowed freely last week, so too did the corporate earnings results as the fourth quarter 2015 earnings season continued to move forward.

 

Last week was a busy week for earnings releases. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

ADT 7% Comcast -1% Marsh & McLennan 1%
Aetna 14% ConocoPhillips -41% Metlife -10%
Aflac 5% Dow Chemical 33% News -5%
Allstate 20% Dunkin’ Brands 4% Occidental Petroleum -21%
Alphabet 6% Estee Lauder 12% Pfizer 2%
AmerisourceBergen 2% Exxon Mobil 5% Piper Jaffray 94%
Aptargroup 5% General Motors 12% Post Holdings 108%
Archer Daniels Midland -6% Gilead Sciences 12% Ralph Lauren 8%
Arrow Electronics 7% GoPro -75% Rent-A-Center 4%
Arthur J Gallagher 5% Hain Celestial 6% Sally Beauty 19%
Buffalo Wild Wings -10% Hanesbrands -4% Sysco 17%
Callaway Golf 8% Hillenbrand -7% Tyson Foods 33%
Cardinal Health 4% Jones Lang LaSalle -7% Waddell & Reed 0%
Chipotle Mexican Grill 17% Level 3 0% Wynn Resorts pushed
Church & Dwight 0% LinkedIn 0% Yahoo! -60%
Clorox 9% ManpowerGroup 10% Yum! Brands 3%

 

There were a few surprises in the results of corporate America last week as several companies saw much worse than anticipated results. GoPro is a prime example of such results after the company announced that sales had slowed down a lot on its newest model camera. Integrated oil companies also made some negative headlines last week as ConocoPhillips and Occidental Petroleum both missed earning expectations, while Exxon bucked the trend and beat expectations (though they lowered their expectations so much that it was easy to jump over such a low bar). One home town favorite that beat expectations, despite having a very difficult fourth quarter, was Chipotle, as the outbreaks of various food poisoning incidents took a big bite out of their earnings for the quarter, but the damage was better than had been anticipated.

 

According to Factset Research, we have seen 315 (63 percent) of the S&P 500 companies release their results for the fourth quarter of 2015. Of the 315 that have released, 70 percent have met or beaten earnings estimates, while 30 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 48 percent of the companies have beaten estimates, while 52 percent have fallen short. The earnings per share number fell by about 2 percent with the releases last week as earnings, especially from the oil and gas companies, continue to negatively impact the overall index. The markets have been especially brutal to technology companies that just made this quarter’s earnings estimates, but guided lower their expectations of the future. There is no larger example of this than the LinkedIn trading that occurred on Friday. On Friday, LinkedIn was down nearly 44 percent after the company lowered guidance for 2016 and announced that it was moving around some business units. The company literally saw more than $12 billion in market cap wiped away in just a matter of minutes. According to Factset so far, there have been 71 companies that have released forward guidance for 2016 and of those 71 companies 57 have issued negative guidance, while only 14 have issued positive guidance.

 

This week is a big week for earnings season as 65 more component companies of the S&P 500 release their earnings results for the fourth quarter. With so many component companies releasing earnings this week and a large number having already done so, this week will go a long way toward solidifying the overall figures for the percentage of companies beating and missing expectations. The table below shows the companies that have the greatest potential to move the markets highlighted in green:

 

Avon Products Humana Red Robin Gourmet Burgers
Bristow Group Kellogg Tesla Motors
CenturyLink LendingClub Time
Cisco Systems Loews Time Warner
Coca-Cola Molson Coors Brewing Twitter
CVS Health O’Reilly Automotive Walt Disney
Expedia Owens & Minor Wendys
Flowers Foods Pandora Media Western Union
Goodyear Tire & Rubber Panera Bread Whole Foods Market
Groupon PepsiCo World Wrestling Entertainment
Hasbro Prudential Financial Zillow Group

 

The big announcements this week will be consumer facing companies, both in the dining as well as the entertainment industries. Walt Disney will be closely watched to see how much of an impact the lead up to Star Wars being released had on its bottom line as well as park performance around the world. Tesla will be watched to see if it can stay on its lofty growth projections, even after sales of the Tesla SUV have been slightly weaker than anticipated. After what happened to LinkedIn last week, some investors will be closely watching Twitter for signs of upcoming weakness and will likely punish the stock accordingly if any weakness is shown. The last of the earnings that could move the markets are the two big beverage makers of the world, Coca-Cola and Pepsi. Both release their earnings this week. Watch for earnings to move in the same direction, with both either beating or missing expectations.

 

International News: International news last week held nothing new of note as the global financial markets seemed much more concerned about what was going on in the US than anywhere else. In addition to watching the US markets, the international markets seemed to be very keenly watching the oil market, and OPEC in particular, for any signs that it may be having an emergency production meeting at which several members of OPEC would likely be pushing for drastic production cuts in an attempt to boost oil prices. The final story the global markets took note of last week was the launch of a satellite by North Korea, an action that was directly in violation of several UN resolutions. This launch increased the tension between North and South Korea as well as Japan and the rest of the international community; but the launch was not a surprise and North Korea knows the rest of the world will not take any further action than is being currently taking just because of a rocket launch.

 

This week, however, could be a very interesting week as the ECB is scheduled to hold a meeting on Thursday at which interest rates and monetary policy will be discussed and any action taken by the ECB will be decided upon. With such uncertainty in the European markets, low inflation rates, high unemployment rates and uncertainty over the future refugee situation; it is hard to imagine that the ECB will not take some kind of action at this week’s meeting in an attempt to get Europe onto more sure footing. This week will likely not be very interesting in many parts of Asia as the lunar New Year celebrations are taking place in many different countries. China, for instance, has its financial markets closed all week in celebration and it is unlikely that there will be much if any new information about the health of the Chinese economy during the celebrations. China will likely be hoping that the year of the monkey will turn out to be much better than the annus horribilis that 2015 turned out to be.

 

Market Statistics: After enjoying positive performance for the previous two weeks, the three major US indexes moved notably lower last week, giving up most if not all of the recent gains:

 

Index Change Volume
Dow -1.59% Above Average
S&P 500 -3.10% Above Average
NASDAQ -5.44% Above Average

 

Volume remained above the 52-week average level, but much of this was derived from a few key earnings announcements and the markets ensuing movements within those specific stocks. While volume was above the one year average volume levels on all three of the indexes, volume was lower last week than it had been during the past 4 weeks, which means there was less participation in this downward move of the markets than in the previous upwards moves.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Basic Materials 4.13% Oil & Gas Exploration -9.00%
Utilities 2.39% Software -8.43%
Transportation 0.63% Semiconductors -6.32%
Telecommunications 0.10% Technology -6.25%
Infrastructure -0.28% Home Construction -5.51%

Despite the large declines seen in many of the sectors last week, there were four sectors of the markets that managed to pull out positive performance for the week. Basic materials led the way higher after having been one of the worst performing sectors thus far in 2016; the move seemed like a relief rally more than anything else. The remaining three sectors that saw positive performance last week were the classic defensive sectors of the markets: Utilities, Transportation and Telecommunications. Seeing these sectors having the top performance lends even more weight to the theory that last week was purely a risk-off rebalancing week for the financial markets. On the negative side of performance last week, Oil and Gas Exploration was (not surprisingly) the worst performing sector as the price of oil came back down to about $30 to close out the week. Three technology sectors were the next hardest hit last week, thanks in large part of earnings results; Software, Semiconductors and Technology in general all declined by more than 6 percent for the week. Turning in the fifth worst performance last week was the Home Construction sector as uncertainty in the overall economy and the US financial markets appears to be spilling over into the US housing market a little.

The fixed income market acted as one would expect last week, moving higher as demand for the perceived safety of fixed income investments pushed prices higher and yields lower:

Fixed Income Change
Long (20+ years) 1.31%
Middle (7-10 years) 0.73%
Short (less than 1 year) 0.00%
TIPS -0.01%

After seeing the yield push below 2 percent on the 10-year bond last week, it seems the yield could continue to push lower as prices and demand for the safety of government bonds increases. Currency trading volume was a little higher than normal last week, leading into the week-long Chinese New Year holiday, which is taking place this week. The US dollar had a very rough week last week, falling by 2.67 percent against a basket of foreign currencies, with much of the declines coming on decreased chances for a Fed rate hike during 2016. This week, the best and worst currency movements are exactly the opposite of what we saw last week. The best performing currency last week of the major currencies was the Japanese Yen, which gained 3.49 percent against the value of the US dollar, thanks to announcements by the BOJ of new actions being considered to try to improve the Japanese economy. The worst performing (only one to lose value versus the US dollar last week) currency of the major currencies last week was the Australian dollar, as it declined by 0.05 percent against the value of the US dollar. The decline in the Australian dollar last week was not a result of movements in the precious and industrial metals markets as those all pushed higher.

Commodities were mixed over the course of the previous week, as oil pushed lower and metals moved higher:

Metals Change Commodities Change
Gold 5.02% Oil -7.67%
Silver 5.52% Livestock 0.16%
Copper 1.44% Grains -1.99%
Agriculture -0.35%

The overall Goldman Sachs Commodity Index declined by 3.64 percent last week, thanks to a large decline in the price of oil more than offsetting some nice gains in other commodities. Oil prices declined 7.67 percent, taking back half of the positive gains we saw over the previous two weeks last week. The major metals were all higher last week as investors fled toward safety with Gold gaining 5.02 percent for the week, while Silver increased 5.52 percent and Copper went up 1.44 percent. The movements in the Gold market last week also plays into the risk-off trade seen in other sectors and investments last week. Soft commodities were mixed last week with Livestock gaining 0.16 percent, while Grains declined 1.99 percent and Agriculture overall moved lower by 0.35 percent.

With such large declines in the UD last week it was not surprising to see that there were only 4 indexes globally last week that turned in positive gains for the week. The best performing index last week was found in Indonesia and was the Jakarta Composite Index, which turned in a gain of 4.0 percent for the week. The worst performing index last week was found in Italy and was the Milano Italia Borsa Index, which turned in a loss of 7.5 percent as fears over many of the large banking institutions in Italy being in financial trouble seemed to scare investors.

After pushing lower two weeks ago, the VIX reversed course and moved higher last week, gaining back more than it gave up two weeks ago. Overall for the week, the VIX advanced by 15.89 percent, as investors fled the markets on fears that the US economy may be weaker than anticipated. As the markets adjust to various earnings announcements and the uncertainty over the US Fed rate decisions and growth from China, the VIX will likely remain very volatile. The current reading of 23.41 implies that a move of 6.76 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 2/5/2016, returns in my hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model -0.32 % -2.07 % 1.98 %
Aggressive Benchmark -2.03 % -7.41 % -12.12 %
Growth Model -0.48 % -1.81 % 1.43 %
Growth Benchmark -1.58  % -5.78 % -9.44  %
Moderate Model -0.57 % -1.04 % 1.63 %
Moderate Benchmark -1.11 % -4.16 % -6.73 %
Income Model -0.49 % -0.12 % 2.47 %
Income Benchmark -0.55 % -2.06 % -3.32 %
S&P 500 -3.10 % -8.02 % -8.87 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

I made no changes to my models over the course of the previous week as I was defensively positioned going into the week and stayed defensively positioned throughout the week. During weeks of extreme market movements, especially to the downside, it is not uncommon for my models to drastically outperform. This is due to the defensive nature of many of the core equity positions I hold in all models. In addition to the defensive nature of the individual stock holdings in the models, I also currently have a hedging position in my model that goes up when the markets go down in an attempt to offset some of the overall risk in the models. While currently being defensively positioned in all models, I am evaluating when and what to purchase when the market does turn around. Many areas of the markets I have been patiently watching for many months have become even cheaper than they were just a few short months or weeks ago. The areas I am most interested in remain Oil and Gas as well as Transportation.

 

Economic News: Last week the economic news releases were all about employment and the US consumer and the numbers that came out were not positive. There were four releases that significantly missed market expectations (highlighted in red below) and none that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 2/1/2016 Personal Income December 2015 0.30% 0.20%
Negative 2/1/2016 Personal Spending December 2015 0.00% 0.20%
Neutral 2/1/2016 Core PCE Prices December 2015 0.00% 0.10%
Slightly Negative 2/1/2016 ISM Index January 2016 48.2 48.3
Neutral 2/3/2016 ADP Employment Change January 2016 205K 190K
Slightly Negative 2/3/2016 ISM Services January 2016 53.5 55
Neutral 2/4/2016 Initial Claims Previous Week 285K 275K
Neutral 2/4/2016 Continuing Claims Previous Week 2255K 2253K
Negative 2/4/2016 Factory Orders December 2015 -2.90% -2.60%
Negative 2/5/2016 Nonfarm Payrolls January 2016 151K 188K
Negative 2/5/2016 Nonfarm Private Payrolls January 2016 158K 183K
Neutral 2/5/2016 Unemployment Rate January 2016 4.90% 5.00%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week the economic news releases started out on Monday with the release of personal income and spending for the month of December. Personal income came in very close to expectations, showing a gain of 0.3 percent, while personal spending missed expectations, posting a zero change while the market had been expecting a gain of 0.2 percent. No growth in consumer spending is a negative development for the overall health of the economy as the US consumer is a very large percentage of the overall economy. Also released on Monday was the latest reading for the ISM index, which posted a reading of 48.2, which was in line with expectations, but still means that manufacturing overall in the US during the month of January contracted, something we had been seeing out many different regions prior to the release, so it was not very surprising when the contraction was actually released. On Wednesday the ADP employment change figure for the month of January was released and showed that 205,000 jobs had been added during the month, slightly ahead of the expected 190,000. Overall, this release did not differ from expectations enough to cause anyone to change their estimates for the employment figures set to be released later during the week. Later during the day on Wednesday the services side of the ISM was released and it too was below market expectations, but still managed to post a reading over 50, which means there was expansion in the services sector during the month of January in the US. On Thursday, the standard weekly unemployment related figures for the previous week were released with both initial and continuing jobless claims coming in slightly higher than was anticipated, but not enough to cause alarm in the markets. Later during the day on Thursday the factory orders figure for the month of December was released with a decline of 2.9 percent being posted. This decline is now the second month in a row of declines on the indicator as it declined 0.2 percent during the month of December. Factory orders declining is typically a precursor for the economy hitting a slow spot as companies order fewer products from the factories out of precaution for a slowdown potentially coming. Friday was all about employment and the report was mixed. Overall unemployment in the US declined from 5 percent in December down to 4.9 percent in January. The labor force participation rate ticked up one tenth of a percent to 62.7 from 62.6 and we saw wage growth of 0.5 percent during the month (the fastest wage growth that we have seen in a long time). Those previous items were the positive aspects of the releases. The negative aspects of the release were found in the payroll numbers as non-farm public and private payrolls were shown to miss expectations greatly. You may remember that the December payroll numbers were nothing short of great as public payrolls registered 262,000 new jobs and private payrolls racked up 251,000 jobs. January, however was not so kind, with only 151,000 public payroll jobs having been created and only 158,000 private payroll jobs having been created. Both of these numbers are very low and do not even cover the number of new entrants into the job market. Overall, these employment numbers sent a bit of a mixed signal to the market as to how the Fed would look at the employment data. Ultimately, the markets seem to price in that these new data points would not alter the Fed’s thinking on when to increase rates again, but the expected rate hike odds had already been lowered substantially earlier during the week, as mentioned above in the national news section.

 

After last week held so much negative economic news releases, this week should provide a bit of a breather. The releases that could impact the overall markets the most are highlighted below in green:

 

Date Release Release Range Market Expectation
2/9/2016 Wholesale Inventories December 2015 0.00%
2/11/2016 Continuing Claims Previous Week 2250K
2/11/2016 Initial Claims Previous Week 280K
2/12/2016 Retail Sales January 2016 0.20%
2/12/2016 Retail Sales ex-auto January 2016 0.00%
2/12/2016 University of Michigan Consumer Sentiment Index February 2016 92.7

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start on Tuesday with the release of the wholesale inventories figure for the month of December, which is expected to post no change during the month. If this figure comes true it would actually be a slight improvement over the November reading when wholesale inventories were shown to have declined by three tenths of a percent. On Thursday the standard weekly unemployment related figures for the previous week are set to be released with little change expected in either initial or continuing jobless claims. Friday is the big day this week in terms of releases that could impact the overall markets with retail sales for the month of January being set to be released as well as the University of Michigan’s Consumer sentiment Index for the month of February (first estimate). Retail sales are expected to post a gain of 0.2 percent overall during the month of January, which is a notable improvement over the December reading that indicated a decline of 0.1 percent in overall retail sales. Retail sales excluding auto sales, however, are expected to post no change during the month of January, meaning they stayed at the relatively low levels we saw in December. These two readings were somewhat confirmed last week when we saw the poor consumer spending figures come out about the month of December, a trend that likely carried over into January as well. If we see two months in a row of declines, either in overall retail sales or retail sales excluding auto sales, it would be a bad precursor for the US economy moving forward as it would imply that consumers are not confident in the future of the economy. This confidence is also going to be quantified for us on Friday when the University of Michigan releases its first estimate of consumer sentiment for the month of February. Expectations for the release are for no change over the level seen at the end of January, but this indicator can be volatile at times, so anything between 90 and 94 is reasonably possible. In addition to the scheduled economic news releases this week, the market will likely be paying very close attention to Fed Chair Yellen as she speaks before both houses on Congress at her twice per year economic update session on Capitol Hill. While it is unlikely any new information will be released during these sessions, the markets will be looking for any clues as to what the Fed will be doing with interest rates later this year. Right now the markets are predicting that there is a less than 30 percent chance that the Fed can manage to get even one interest rate hike in this year, which is a far cry from the scheduled four increases expected by the Fed late last year for 2016.

 

Fun fact of the weekNumber 18 (Peyton Manning) led the way to a victory in Super Bowl 50

 

Frank Tripucka’s number 18 was retired, but Peyton Manning gained Frank’s approval to have it re-issued when he signed with the Denver Broncos in 2012. Tripucka ranked as the first quarterback in Denver history and he completed the first TD throw in American Football League history in 1960.

Source: The Football Database

For a PDF version of the below commentary please click here Weekly Letter 2-1-2016

Commentary at a glance:

– A dismal January for the markets was capped off with a positive week.

– The Iowa caucus is finally upon us and should weed out some candidates.

– The US Federal Reserve released an interesting statement last week.

– We are currently in the heart of earnings season with some positive and negative surprises.

– Oil moved higher last week, thanks mostly to a false story out of Russia.

 

Market Wrap-Up: Last week made it two weeks in a row of gains for the three major US indexes to end the month of January, which was not a positive month by any means for either the US or the global financial markets. The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The charts this week include the closest levels of support to the downside to indicate where support for each of the indexes could lay in the near future (these levels are drawn with red horizontal lines). For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 2-1-16

To start this week I wanted to give everyone a little historical perspective (data back to 1886) for the markets, and the Dow in particular, as there were a lot of news stories over the past week about just how bad of a month January was for investors. The -5.50 percent January return for the Dow was not the worst January on record for the Dow; it was the tenth worst. The worst return for January was in 2009 when the Dow turned in a loss of 8.84 percent for the month. Of the nine times the Dow has started the year with a January return of -5.5 or worse, the return for the year was negative seven times (78 percent). The average decline for the year is -2.98 percent. How well does the January barometer actually work, as it is one of the most quoted market theories about predicting returns available? Overall, the performance of the Dow for the month of January is predictive of the overall direction for the year 71 percent of the time (93 times out of my 131 years of data). It predicts gains better than losses as positive January returns lead to positive full year returns about 78 percent of the time (64 times out of 82 years) and January losses led to negative full year returns about 59 percent of the time (29 times out of 49 years). With the historical numbers in mind, we are likely to see a negative year for the Dow. However, we are likely to see a positive return between the end of January and the end of the year since the return in January was worse than the average loss for the full year. If you would like the full data set and my calculations for all of the above figures, please just let me know and I can send it to you. The other big story the media has been running with the past few weeks is that the amount of volatility we have been seeing in the markets is abnormal.

 

To look into this claim I once again used Dow data and looked back in recent history to 2007 (prior to 2007 there were not large enough point swings to make the cut). In looking at the first 19 days of trading for a new year (in most cases this was the full month of January), 2016 was indeed an unusually choppy month. In 2016 we have seen 6 occurrences (32 percent) of the 19 trading days that saw the Dow have an intraday swing of at least 400 points. 2015 saw just a single day and there were only two such days back in 2008. Other than that, each of the other years did not see any 400 plus point moves in a day for the Dow. When looking at 2-day point swings (trading ranges), the Dow saw 13 of the 19 2-day swings in 2016 see a trading range in excess of 400 points. The next closest was in 2008 when there were 8 occurrences of the Dow trading in a greater than 400 point trading range over a two day period. In short, yes, 2016 was a very volatile start for the Dow, even more volatile than the end of day closing numbers would lead one to believe.

 

With history behind us, it is now time to look at where the indexes currently stand. Last week saw each of the three major US indexes move higher and bounce off of the very low points reached during the past two weeks. When looking at technical strength, the S&P 500 (upper left pane above) looks like it is the strongest with the Dow (upper right pane above) in second place and the NASDAQ (lower left pane above) exhibiting the weakest technical strength. I kept the most recent support levels in place on the charts above as these are still the most technically important levels that can be drawn since upside resistance levels are much higher than current index levels. The VIX (lower right pane above), meanwhile, continues to push lower and is moving ever closer to the average level we have seen over the past year, which is right about the 17 level.

 

National News: National news last week focused on three main topics: the Fed statement released on Wednesday, earnings season and the first of the caucus races being held in Iowa this evening. The Federal Reserve held its FOMC meeting on Tuesday and Wednesday last week, despite much of the government being closed on Tuesday due to the snow storm that socked Washington DC over the weekend. As expected, the Fed did not change interest rates at this meeting, but the markets never thought this was even a possibility. The markets did, however, react to the new language from the Fed in the section of the statement where Fed Chair Yellen mentioned that the Fed is “closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.” This watching “financial developments” seemed to spook the markets a little and the bond market immediately discounted the chance of a rate hike at the March meeting, despite the statement explicitly saying it was still a possibility. Overall, the fixed income market is now pricing in only 2 rate hikes during 2016, both in the last half of the year, while the Fed still seems to be saying it is expecting 4 rate hikes this year. Earning season was the second major topic of the week last week and the results were very mixed.

 

Last week was a busy week for earnings releases. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

American Airlines 2% Halliburton 29% PulteGroup 14%
3M 11% Hanesbrands pushed Raytheon 8%
Alibaba Group 4% Harley-Davidson 16% RLI -14%
Amazon.com -38% Hershey 3% Sherwin-Williams 12%
Apple 1% Honeywell -1% Simon Property 12%
AT&T -2% J & J Snack Foods 3% Sprint 22%
Baker Hughes -110% Johnson & Johnson 1% Stanley Black & Decker 0%
Boeing 19% Kimberly-Clark -1% Stryker 1%
Bristol-Myers Squibb 36% Knight Transportation 13% Swift Transportation 13%
Caterpillar 7% Lockheed Martin 3% Texas Instruments 3%
Chevron -165% Manitowoc 115% Time Warner Cable 1%
Colgate-Palmolive 1% MasterCard 16% Tuesday Morning -25%
eBay 7% McDonald’s 4% Under Armour 4%
Electronic Arts 2% Meredith 4% United States Steel 73%
Eli Lilly 1% Microsoft 13% United Technologies 1%
Facebook 18% Norfolk Southern -6% Visa 1%
Ford Motor 18% Northrop Grumman 10% Whirlpool 5%
Freeport-McMoRan 86% Phillips 66 6% Xcel Energy 0%
General Dynamics 2% Procter & Gamble 6% Xerox 10%

 

Looking quickly at the above table, there is slightly more green than red, suggesting that in aggregate it was a positive week for earnings for these companies. However, the outlooks provided for 2016 by many of the above companies were not very positive and led to many of the stocks declining on the day or the day after they released their results. Oil and Gas companies showed the worst results last week with companies like Baker Hughes and Chevron turning in even worse figures than were expected. Tech giant Apple turned in a positive quarter, beating estimates on the top and bottom line, but the company saw its stock decline the most in a single day in the past 5 years after its outlook for 2016 predicted a decline in overall iPhone sales for the year. Amazon was beat up after shipping costs and margins were seen to have declined during the fourth quarter, despite seeing strong holiday sales. McDonalds was a bright spot last week, of the equity holdings in my models, as the company saw same store sales numbers turn around, as did profits during the quarter after the introduction of the all-day breakfast menu at many locations. Both Visa and MasterCard released their earnings for the fourth quarter, but the data did not show much that was not already known about US consumer spending habits.

 

According to Factset Research, we have seen 200 (40 percent) of the S&P 500 companies release their results for the fourth quarter of 2015. Of the 200 that have released, 72 percent have met or beaten earnings estimates, while 28 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 50 percent of the companies have beaten estimates, while 50 percent have fallen short. The earnings per share number fell by about 7 percent with the releases last week as earnings, especially from the oil and gas companies, have started to show their negative impact on the overall index. Overall, according to Factset, the blended earnings for the fourth quarter of 2015 is a decline of 5.8 percent when compared to earnings levels from the third quarter of 2015. So far, there have been 39 companies that have released forward guidance for 2016 and of those 39 companies 33 have issued negative guidance, while only 6 have issued positive guidance.

 

This week is a big week for earnings season as 118 more component companies of the S&P 500 release their earnings results for the fourth quarter. With so many component companies releasing earnings this week and a large number having already done so, this week could prove to be the deciding week for the overall earnings season. In the large table below, the companies that have the greatest potential to move the markets are highlighted in green:

 

ADT Comcast Marsh & McLennan
Aetna ConocoPhillips Metlife
Aflac Dow Chemical News
Allstate Dunkin’ Brands Occidental Petroleum
Alphabet Estee Lauder Pfizer
AmerisourceBergen Exxon Mobil Piper Jaffray
Aptargroup General Motors Post Holdings
Archer Daniels Midland Gilead Sciences Ralph Lauren
Arrow Electronics GoPro Rent-A-Center
Arthur J Gallagher Hain Celestial Sally Beauty
Buffalo Wild Wings Hanesbrands Sysco
Callaway Golf Hillenbrand Tyson Foods
Cardinal Health Jones Lang LaSalle Waddell & Reed
Chipotle Mexican Grill Level 3 Wynn Resorts
Church & Dwight LinkedIn Yahoo!
Clorox Manpower Group Yum! Brands

 

The announcement that could move the market the most this week will be the report from Alphabet (Google). Google is such a large company at this point that it touches many different sectors of the global economy and could thus provide some insight into the global mentality of the economy. Large integrated oil companies such as Exxon and ConocoPhillips will be closely watched this week after such a poor showing from the oil companies last week for this earnings season. Church & Dwight and Clorox will also be pretty closely followed as they are considered consumer staple companies and touch such a wide range of US consumers.

 

The final story last week that the financial markets seemed to take notice of was political and was the Iowa caucus race today in Iowa that officially kicks off the Presidential election activity of the year. Leading for the Democratic ticket is Hillary Clinton with Bernie Sanders coming in a close second and in some polls actually ahead of Clinton. On the Republican side of the ticket, there is a bit more of a horse race as there are many more candidates, but only three that legitimately have much of a chance at this point. Donald Trump is currently leading in all of the early polls coming out of Iowa, with Ted Cruz polling second and Marco Rubio polling third. Trump has taken some very unorthodox approaches to this campaign and has said some very politically incorrect things, but none of it seems to be coming back and hurting him in the race. Iowa, however, will be the first true test to see if voters are actually backing Trump as the Republican candidate or if the polling data is just very incorrect. After this evening we should see approximately half of the republican candidates fold and shut down their campaigns; the big question will be who they choose to endorse.

 

International News: International news last week held little new information. There were the obligatory economy figures coming out of China, which were artificially inflated. Even after being inflated, they were still really bad. Other news continued to focus on the volatility in the global oil markets. Oil rallied at the end of the week last week, thanks to a story leaked out of Russia that OPEC was considering an unscheduled production meeting to be held very soon that could lower the overall output of oil being pumped from the group. OPEC, however, came out and said there was no discussion of holding an emergency production meeting and that Russia does not have any sway with OPEC. While this story may have been completely fabricated by Russia, the intended outcomes of the story were realized as oil jumped by nearly 8 percent on the news breaking and then slowly gave some of it back during the trading day. Any price increase, no matter how small, is becoming more and more valuable to Russia as the country tries to keep up its social programs that run almost entirely on oil revenues, which have been severely cut over the past 18 months.

 

Market Statistics: Global financial markets made it two weeks in a row of gains, ending a dismal month of January on a high note last week:

 

Index Change Volume
Dow 2.32% Above Average
S&P 500 1.75% Above Average
NASDAQ 0.50% Above Average

 

Volume continued to be above average last week as all three of the major US indexes added to the gains experienced two weeks ago. Much of the movement of the indexes last week was dictated by earnings announcements. The lack of performance last week from the NASDAQ was due to poor returns on Netflix, Apple and Amazon, after they each announced their latest quarterly results. On the flip side, several of the Dow 30 component companies released better than anticipated results and turned in a very strong week.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Oil & Gas Exploration 5.52% Biotechnology -7.28%
Energy 5.05% Pharmaceuticals -3.62%
Natural Resources 4.98% Healthcare -2.27%
Global Real Estate 4.26% Medical Devices -1.18%
Consumer Staples 3.88% Software -0.92%

With the price of oil moving higher over the course of the previous week it was not surprising to see that Oil and Gas exploration turned in the best performance of the week, gaining a little more than five and a half percent. Energy and natural resources also pushed higher on the coat tails of oil and hopes that the global economy has bottomed out. Consumer Staples last week were largely driven by corporate earnings, but the earnings were strong enough to push the sector into the top 5 performers for the week, which is rare given the positive overall performance for the week. On the negative side, Biotechnology took the hardest hit last week, declining by more than 7 percent on both negative earnings announcements as well as investors taking risk out of their investments and pulling the highest beta sector, which has recently been biotechnology. Pharmaceuticals and Healthcare, as well as medical devices, all declined by large amounts in what looks like sympathy trading off the biotechnology decline.

Despite the continued rally we saw in the equity markets last week, the fixed income market was not as adversely affected as one would have expected. Much of the move last week in the fixed income market was due to the Fed statement and the markets’ disbelief that the Fed will actually increase interest rates in March:

Fixed Income Change
Long (20+ years) 1.56%
Middle (7-10 years) 1.15%
Short (less than 1 year) 0.01%
TIPS 1.32%

The 10-year US government bond didn’t change much in terms of yield as it ended last week with a yield of 1.95 percent, just like it started the week. The fixed income market is currently pricing in two or less moves in the Fed funds rate this year, while the Fed is still touting that it could increase rates 4 times during 2016. Currency trading volume was average last week, but may be a little higher than usual this week leading up to the week-long Chinese New Year holiday. The US dollar was flat against a basket of international currencies last week, turning in zero in terms of total movement for the week. The best performing currency last week of the major currencies was the Australian dollar, which gained 1.00 percent against the value of the US dollar, thanks to the strong performance of commodities last week. The worst performing currency of the major currencies last week was the Japanese Yen, as it declined by 1.89 percent against the value of the US dollar, as the government in Japan continued to weaken its currency in order to help boost its exporting business.

Commodities were mixed over the course of the previous week, as agriculture turned in the sole negative performance for the week:

Metals Change Commodities Change
Gold 1.86% Oil 4.10%
Silver 1.57% Livestock 1.04%
Copper 3.24% Grains 0.55%
Agriculture -0.70%

The overall Goldman Sachs Commodity Index gained 3.53 percent last week, thanks to a second week in a row of broad based increases in commodity prices. Oil prices gained 4.10 percent, giving oil a two week gain of 13.66 percent, one of the strongest two week periods we have seen in the last 18 months. The major metals were all higher last week with Gold gaining 1.86 percent for the week, while Silver increased 1.57 percent and Copper went up 3.24 percent. Precious metals seemed to be rallying on the hope that the global economy is recovering from the recent slowdown—a call that I think may be a little early. Soft commodities were mixed last week with Livestock gaining 1.04 percent, while Grains gained 0.55 percent and Agriculture overall moved lower by 0.70 percent.

The global markets were mainly positive last week with nearly all of the markets booking gains. The best performing index last week was found in the Philippines and was the PSE Index, which turned in a gain of 7.7 percent for the week after giving up nearly 4 percent two weeks ago and being the worst performing index in the world. The worst performing index last week was found in China and was the Shanghai Se Composite Index, which turned in a loss of 6.1 percent for the week on fears that the government in China may not have the ability to turn the economy around quickly.

The VIX was volatile last week, but ended the week with two days of declines and ultimately pushed lower for the week. Overall for the week, the VIX declined by 9.58 percent, giving the VIX a two week total decline of more than 25 percent. As the markets adjust to various earnings announcements and the uncertainty over the US Fed and growth from China, the VIX will likely remain very volatile. The current reading of 20.20 implies that a move of 5.83 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 1/29/2016, returns in my hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model 2.09 % -1.85 % 2.32 %
Aggressive Benchmark 1.73 % -5.49 % -10.30 %
Growth Model 1.87 % -1.33 % 1.92 %
Growth Benchmark 1.35  % -4.27 % -7.99  %
Moderate Model 1.58 % -0.47 % 2.21 %
Moderate Benchmark 0.96 % -3.05 % -5.68 %
Income Model 1.48 % 0.38 % 2.97 %
Income Benchmark 0.48 % -1.52 % -2.79 %
S&P 500 1.75 % -5.07 % -5.96 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

I made no changes to my models over the course of the previous week as I was defensively positioned going into the week and remained so throughout. The performance last week was almost entirely driven by the individual stock positions owned in each model performing much better than anticipated in the volatile market. Some of this out performance was due to earnings announcements and some was due to market movements of sectors in general. The hedging positions I still have in the models did not detract from performance as much as expected last week and was actually accredited to performance during the two negative trading days last week. Given the current uncertain outlook for the markets in general, I am keeping my hedging positions in place, but am actively watching to see if and when it is time to start stepping out of the positions and moving toward a more fully long position.

 

Economic News: Last week was a busy week for economic news releases as we finally got a few positive numbers about the health of the US consumer and economy. There were two releases that significantly beat market expectations (highlighted in green below) and one that significantly missed market expectations (highlighted in red below):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 1/26/2016 Case-Shiller 20-city Index November 2015 5.80% 5.80%
Positive 1/26/2016 Consumer Confidence January 2016 98.1 96.8
Neutral 1/27/2016 New Home Sales December 2015 544K 506K
Neutral 1/28/2016 Initial Claims Previous Week 278K 285K
Neutral 1/28/2016 Continuing Claims Previous Week 2268K 2230K
Neutral 1/28/2016 Durable Orders December 2015 -5.10% -0.50%
Negative 1/28/2016 Durable Goods -ex transportation December 2015 -1.20% -0.10%
Neutral 1/28/2016 Pending Home Sales December 2015 0.10% 0.80%
Slightly Negative 1/29/2016 GDP-Adv. Q4 2015 0.70% 0.90%
Positive 1/29/2016 Chicago PMI January 2016 55.6 45
Slightly Negative 1/29/2016 University of Michigan Consumer Sentiment Index January 2016 92.0 93.2

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week the economic news releases started out on Tuesday with the release of the Case-Shiller 20-City Home Price index, which saw a gain of 5.8 percent during the month of November on a year over year basis. While a nice positive number, the release had little impact on the US housing market as the data was so stale. A release on Tuesday that did have a noticeable impact was the consumer confidence figure for the month of January, as measured by the government. Expectations for the release had been for a reading of 96.8, but the release came in at 98.1, the highest reading in the past 3 months. The positive feel from the confidence report was short lived, however, as contradictory consumer data came out on Thursday in the form of durable goods orders. On Thursday, durable goods orders (big ticket items) for the month of December were shown to have declined by 5.1 percent, while the market had been expecting a decline of 0.5 percent. The main culprit for the decline, according to the release, was a decline in aircraft sales during the month. However, even when transportation was removed from the equation, durable goods sales for the month of December still declined by 1.2 percent, while the market had been expecting a decline of only 0.1 percent. These numbers contradict the confidence numbers earlier in the week and set up the scenario of consumers being very confident, but not actually spending as the spending numbers have been continually declining recently. On Friday the advanced estimate for fourth quarter GDP here in the US, as calculated by the government, was released and showed a gain of 0.7 percent during the quarter, which is slightly lower than the 0.9 percent that was expected by the market. Offsetting some of the negative vibes for the day on Friday was a very positive development from the Chicago PMI figure, which showed a very unexpected turn from contracting (under 50 reading) to an expansionary reading (over 50). Expectations had been for the Chicago PMI to come in at 45, but the print came in at 55.6, one of the largest upside surprises we have seen in a long time. If we start to see the other manufacturing regions follow the lead in Chicago, it could be very beneficial to the overall health of the US economy. Wrapping up the week this week is the release of the University of Michigan’s Consumer Sentiment Index for the month of January (final estimate) and it is expected to be slightly lower than the reading at the end of December. This report is also counter to the government’s reading of consumer confidence released earlier during the week.

 

This week is all about employment as we get the monthly numbers from the government about the employment situation in the US for the month of January. The five releases that could impact the overall markets the most are highlighted below in green:

 

Date Release Release Range Market Expectation
2/1/2016 Personal Income December 2015 0.20%
2/1/2016 Personal Spending December 2015 0.20%
2/1/2016 Core PCE Prices December 2015 0.10%
2/1/2016 ISM Index January 2016 48.3
2/3/2016 ADP Employment Change January 2016 190K
2/3/2016 ISM Services January 2016 55
2/4/2016 Initial Claims Previous Week 275K
2/4/2016 Continuing Claims Previous Week 2253K
2/4/2016 Factory Orders December 2015 -2.60%
2/5/2016 Nonfarm Payrolls January 2016 188K
2/5/2016 Nonfarm Private Payrolls January 2016 183K
2/5/2016 Unemployment Rate January 2016 5.00%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts out on Monday with the release of personal income and spending for the month of December, which are both expected to show an increase of 0.2 percent during the month. Also released on Monday is the overall PCE price change for December, which is expected to show a gain of only 0.1 percent, which is far below the target level the Fed would like to see. Wrapping up the day on Monday is the release of the ISM Index for the month of January, which is expected to show a contraction in the overall manufacturing in the US during the month, despite the strong figure seen out of Chicago PMI last week. On Wednesday the Services side of the ISM is set to be released with expectations that it will show a modest expansion during the month of January. Also released on Wednesday is the first of the employment related figures for the week, the ADP employment change figure for the month of January, which is expected to post a gain of 190,000 jobs during the month. On Thursday the standard weekly unemployment related figures are set to be released with both initial and continuing jobless claims expected to show a slight improvement over the previous week’s reading. Also released on Thursday is the latest factory orders figure for the month of December, which is expected to show a decline in factory orders of 2.6 percent during December, as companies slowed down their ordering process after seeing weaker than expected sales during the holiday season. On Friday the releases everyone has been waiting for will finally be released, those being the nonfarm public and private payroll figures and the overall unemployment rate in the US during the month of January. Expectations are for the both payroll figures to remain weak, below 200,000, while the overall unemployment figure is expected to remain at 5.0 percent for the month. In addition to these figures, wage growth and labor force participation as well as several other measures of unemployment are set to be released at the same time. These figures in aggregate could push the markets around if the readings change enough so that investors think the Fed will be recalculating its thoughts on the current US labor market. If the numbers all come in as expected it is unlikely that these releases will have much impact on the overall markets. In addition to the scheduled economic news releases this week there are also three speeches being made by three different Fed officials that the market will be closely monitoring after the FOMC statement released last week. Any or all of these speeches have the potential to move the markets around this week.

 

Fun fact of the weekRussia: an oil economy.

 

A picture is worth a thousand words, so three charts must be worth at least a couple hundred words. This was a great graphic that was recently run in the Wall Street Journal that shows the impact of falling oil prices on Russia:

Russia Oil 2-1-16

Source: Wall Street Journal http://www.wsj.com/articles/for-russia-oil-collapse-has-soviet-echoes-1441215966

So January felt like a horrible month for most investors watching their accounts closely, but we did manage to end the month on a high note gaining 2.47% on Friday for the Dow.

How does this January performance stack up again previous Previous years for the Dow?

In looking back at all of the Dow data going back to 1886 the decline in 2016 of -5.50 percent ranks the 10th worst decline for the month. below are the worst 20 Januaries for the Dow:

January Losses

What does a start like this to the year mean for the markets?

The average full year return for the 9 years that saw a worse start to the year is -2.98 %

The best year was 2009 when the Dow gained 18.82 % for the year after starting January being down 8.84 %

The worst year was 1910 when the Dow lost 17.86 % for the year after having given up 7.21 % during January

January Losses Full year

Did not have fun with the volatility in your investments during January? Try active wealth management find out more at our webpage http://www.callahancapital.com or shoot me an e-mail peter@callahancapital.com to find out more about how we management investment risks in our portfolios.

 

For a PDF version of the below commentary please click here Weekly Letter 1-25-2016

Commentary at a glance:

– US markets slid the first half of trading last week, only to rally during the second half.

– The Dow experienced a more than 530 point swing on Wednesday.

– The World Economic Forum took place last week and had some very interesting sessions.

– Fourth quarter earnings season continues with this week being a very important week.

– Oil briefly dipped below $27 before moving higher to end the week.

 

Market Wrap-Up: Last week saw the US financial markets turn around and move higher at the end of the week after having started the week moving lower and seeing two of the three major US indexes break below their key support levels. The movements last week were done on surprisingly high volume as the weekly volume was more than 130 percent of the 52-week average across all three indexes, despite there only being four trading days last week. The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The charts this week include the closest levels of support to the downside to indicate where support for each of the indexes could lay in the near future (these levels are drawn with red horizontal lines). For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 1-25-16

From a technical perspective, last week presented a very interesting divergence in thought. The week started with two of the three major indexes (NASDAQ and S&P 500) both breaking down below their technical support levels and looking like they could move substantially lower given the fact that there were no other major supports within 5 percent of their closing prices on Tuesday. On Wednesday, it looked like they were going to make a run at some much lower, long lost support levels, but as oil turned around mid-day, so did the markets. The Dow saw a particularly stunning turnaround as the index traded in a range that was 530 points wide in just the single day. The spillover continued into Thursday as the US markets rallied hard and continued to rally to close out the week on Friday. The primary reason for the rally at the end of the week was the upward move in the price of oil after hitting a more than 12-year low intraday on Wednesday. With oil rallying more than 10 percent over just two days, many pundits in the media were saying the rally was being fueled by short selling oil traders that had to cover their positions and book the profits many of them had seen build up over the recent decline in oil prices. Short selling involves betting against an investment and profiting when the investment declines; so someone selling short oil would have made a lot of money as the price declined. It seems a little hard to believe that oil rallying was the primary catalyst behind the gains seen at the end of the week in the equity markets. More likely, the gains were produced at a time when many people thought the indexes had seen the bottom and they wanted to jump in and not miss out on the potential bull market charging ahead once again. It just so happens that we saw the Dow near the very psychological level of 16,000 and the NASDAQ near 4,500 when the market turned. Investors’ psychology says that round numbers, especially in the hundreds and thousands are mental support levels for the indexes and points at which many individual investors will buy back into the market if they have any money sitting on the sidelines. This most likely had more of an overall impact on the markets than just the price movements of oil.

 

The rally that ended last week will start this week in a very fragile position as investors who are hoping they timed the market perfectly last week are not going to sit and let the market move against them for a long period of time. The money that chases market tops and bottoms is notoriously skittish and will likely bail out at the first major sign of weakness in the markets. Despite the VIX declining by more than 16 percent during trading on Friday, it still remains very elevated when compared to the levels at which it spent the majority of the last year. We will likely see the VIX continue to be very volatile as none of the problems that underpinned the recently volatility (China’s weakness and declining oil prices) look like they have any meaningful reason to reverse course at this point. This week is a big week for earnings announcements, discussed in much more detail below, and this could create the deciding factor between the markets keeping the rally alive or seeing the bears once again take control of the market movements.

 

National News: After watching oil fall to a multiyear low to start the shortened trading week last week, the media attention turned to earnings season. Just when they were focused fully on earnings season, the market turned around and shot upward, thanks in part to short sellers having to cover their position in oil. With oil rebounding more than 8 percent on Friday, it was not surprising to see that the broader markets followed suit. With the major snow storm snarling up the Federal Government in Washington DC and the Fed’s FOMC meeting not expected to hold any major revelations this week, the national financial media will likely move back to earnings season to produce the news.

 

Last week was a busy week for earnings releases as many well-known companies released their fourth quarter results during the shortened trading week. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

American Express 9% Goldman Sachs 23% Precision Castparts pushed
Bank of America 4% IBM 2% Southwest Airlines 0%
Bank of New York 6% J B Hunt Transport 1% Starbucks 2%
Charles Schwab 0% Johnson Controls pushed Travelers 7%
Cree 38% Kansas City Southern 12% Union Pacific -8%
Delta Air Lines -1% Kinder Morgan 59% United Airlines -2%
eBay pushed Morgan Stanley 23% Unitedhealth 2%
General Electric 4% Netflix 250% Verizon 1%

 

Netflix was the big standout stock last week in terms of earnings reports as the company reported earnings that easily beat market expectations. As is normally the case for Netflix, however, investors were more interested in the number of new subscribers, both in the US and internationally. Here in the US Netflix grew its subscription base by 14 percent, while its international subscriber base grew by 64 percent. Revenue at Netflix grew by 23 percent, when compared to the same time last year, to $1.8 billion. Wall Street took this as a positive sign for the company going forward, but acknowledges that keeping these growth rates will be difficult over the longer term with some of Tuesday’s trading movements for the stock showing the difficulty as the stock swung in a more than 13 percent trading range during the day. A lot of investors watch Netflix as one of the technology bell whether companies as it represents a new age technology that is slowly taking over an older technology (cable TV). Last week also saw a significant number of large banks report their earnings. Overall earnings at the big banks were positive, but the outlooks were uncertain when listening to the quarterly results, as presented by management form the various banks. Morgan Stanley and Goldman Sachs both turned in surprises to the upside of 23 percent when looking at earnings per shares, while Bank of America and Bank of New York turned in mid single-digit gains. Interestingly, last week two of the major airlines, Delta and United both missed expectations, despite the cost of jet fuel being near multi-year lows throughout much of the quarter. If airlines can’t make money with fuel costs being so low it is hard to see a time when they would be able to fly high. Maybe they can at least lock in some of these low oil prices for the longer term with futures contracts.

 

According to Factset Research, we have seen 75 (15 percent) of the S&P 500 companies release their results for the fourth quarter of 2015. Of the 75 that have released, 79 percent have met or beaten earnings estimates, while 21 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 49 percent of the companies have beaten estimates, while 51 percent have fallen short. While it is still very early in the reporting season there are still four sectors of the market that have seen 100% of the companies within the sector beat earnings estimates. Those four sectors are: Materials, Healthcare, Energy and Telecom Services. When looking at sales overall, companies on average are reporting sales that are 0.3 percent below market expectations. The same themes that have been playing out during the past few quarters are playing out again during the fourth quarter earnings season, those being: strong US dollar, falling oil and commodity prices and a slowdown in the global economy led by the slowdown in China.

 

This week is a big week for earnings season as nearly 30 percent of the S&P 500 component companies release their earnings results for the fourth quarter. Twelve (40 percent) of the Dow 30 component companies also release their earnings this week, meaning we could see a lot of the market direction this week being driven by corporate earnings. In the large table below, the companies that have the greatest potential to move the markets are highlighted in green:

 

American Airlines Halliburton PulteGroup
3M Hanesbrands Raytheon
Alibaba Group Harley-Davidson RLI
Amazon.com Hershey Sherwin-Williams
Apple Honeywell Simon Property
AT&T J & J Snack Foods Sprint
Baker Hughes Johnson & Johnson Stanley Black & Decker
Boeing Kimberly-Clark Stryker
Bristol-Myers Squibb Knight Transportation Swift Transportation
Caterpillar Lockheed Martin Texas Instruments
Chevron Manitowoc Time Warner Cable
Colgate-Palmolive MasterCard Tuesday Morning
eBay McDonald’s Under Armour
Electronic Arts Meredith United States Steel
Eli Lilly Microsoft United Technologies
Facebook Norfolk Southern Visa
Ford Motor Northrop Grumman Whirlpool
Freeport-McMoRan Phillips 66 Xcel Energy
General Dynamics Procter & Gamble Xerox

 

This week some of the most influential companies in the world release their results and they are sure to be noticed and dissected by Wall Street. Apple is expected to release its earnings on Tuesday and something that had not occurred before is expected by some to potentially happen: iPhone sales fall for the first time on a year-over-year basis. If this were to happen it would likely send Apple’s stock downward and it will push the NASDAQ down with it. That is what happens when Apple is such a pivotal company, making up nearly 15 percent of the overall index. Microsoft, Facebook and Amazon also release their earnings this week, making for what could be further wild moves in the NASDAQ as they make up four of the top five weighted stocks in the index, combining for nearly 30% of the total index. Two non-technology stocks that will be closely watched by the street this week will be VISA and MasterCard as both companies have some of the best data about the US consumer available since so many Americans use one or both of the cards in their everyday lives. With the relative weakness we have been seeing recently in the US consumer, it would not be surprising to see both of these companies report earnings that are at the low end of expectations.

 

International News: International financial news last week focused on a single speech made by the European Central Bank (ECB) President Mario Draghi, which got many investors excited that at least some of the central banks around the world will continue to pump money into the global economy. In a speech President Draghi gave at a press conference held at the conclusion of the ECB rate setting committee, he said the ECB will “review its monetary policy in March.” The ECB, much like the US Federal Reserve’s FOMC, meets monthly, but typically only takes action on a quarterly basis if needed. At its January meeting the ECB decided to leave its benchmark interest rate at the ultra-low level of 0.05 percent and keep its deposit facility rate unchanged at -0.30 percent and the marginal mending rate at 0.30 percent. The lack of rate changes was not the story, however, it was the fact that President Draghi hinted that if oil continued to slide, or even remain at the current low level, and weakness continued to permeate out of China, his target inflation rate of 2 percent was unlikely to be achieved. With his target inflation rate not being reached, he will likely lead the ECB on yet another round of quantitative easing. By adding money into the system in Europe, President Draghi is hoping prices will start to inflate. The ECB is already pushing tens of billions of Euros into the European economy, but it does not seem to be enough to offset the falling oil prices and weakness from abroad. One thing that was not even mentioned was the strain the current refuge crisis could have on some of the strongest European economies and the negative economic impacts that could be seen. The other international news last week also focused on Europe and came out of a small Swiss mountain town called Davos.

 

The World Economic Forum was held last week in Davos and brought together numerous heads of state and business leaders from around the world to talk about the current global issues. The theme this year was the Fourth Industrial Revolution, and there were more than 200 sessions held on a wide variety of topics. One session Wall Street took note of was a session during which the Vice President of China, Li Yuanchao, said that the country’s financial markets were “not yet mature” and that “the Chinese government is going to look after the interests of most of the people, most of the investors.” While he said this he also called out foreign speculators in saying that China is willing to “keep intervening in the financial markets to ensure that a few speculators don’t benefit at the expense of all the other investors.” The markets took this to mean that China will at some point step in and prop up its financial markets, much like it has been doing over the past few months when volatility has been high. These comments about China were seen as positive in Davos, certainly more positive than many of the other comments from people like George Soros as he called for a hard landing in China, as did several other prominent economists. Currently, it looks like George Soros is more correct than the Vice President as the main Chinese stock market remains down nearly 20 percent so far during 2016.

 

Market Statistics: Global financial markets turned in the first positive week of 2016 for the financial markets last week (three weeks into the new year):

 

Index Change Volume
NASDAQ 2.29% Above Average
S&P 500 1.41% Above Average
Dow 0.66% Above Average

 

Overall volume last week was very strong, especially since it was higher than the average full week volume over the 52 weeks, despite there only being four trading days last week because of the market closure on Monday for Martin Luther King Day. Last week was a classic “risk on” trading week in terms of the order of performance of the indexes, with the highest risk NASDAQ turning the best returns, while the S&P 500 was in the middle and the primarily blue chip stock Dow brought up the rear.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Semiconductors 4.72% Regional Banks -1.58%
Infrastructure 3.94% Financial Services -1.22%
Oil & Gas Exploration 3.82% Global Real Estate -1.03%
Commodities 3.75% Broker Dealers -0.36%
Telecommunications 3.38% Financials -0.33%

With oil gaining more than five percent for the week it was not surprising to see that Oil and Gas Exploration made the top 5 sectors last week as well as commodities in general. Semiconductors took top honors last week, thanks to earnings announcements pushing the whole sector higher. Infrastructure came in second last week in what looked like a political move after statements by Bernie Sanders about spending billions of dollars rebuilding infrastructure seemed to get investors excited about the possibilities in the sector. On the flip side, all things financial seemed to feel the pinch. Earnings results were positive by a few of the major banks, but the outlooks portrayed by the banks were less encouraging.

Despite the strong rally we saw in the equity markets at the end of last week the fixed income market was not as adversely affected as one would have expected, giving up a relatively small piece of the gains from two weeks ago:

Fixed Income Change
Long (20+ years) -0.33%
Middle (7-10 years) -0.11%
Short (less than 1 year) 0.03%
TIPS -0.26%

The 10-year US government bond closed out the week last week with a yield of 2.05 percent after briefly dipping back below 1.95 percent during the wild trading on Wednesday. TIPS (Treasury Inflation Protected Securities) continue to be a poor investment choice in the fixed income markets as inflation, as measured by the CPI, is nowhere to be found in the US economy. Currency trading volume was light last week as traders took Monday off for a holiday here in the US. Overall, the US dollar advanced 0.66 percent against a basket of international currencies. The best performing currency last week of the major currencies was the Canadian dollar, which gained 2.71 percent against the value of the US dollar. The worst performing currency of the major currencies last week was the Japanese Yen, as it declined by 1.51 percent against the value of the US dollar. The strength of the Canadian dollar was due to the increase in the price of oil as the Canadian economy is largely dependent on the oil and mining industry.

Commodities were all positive over the course of the previous week, a feat that has not been replicated for several months looking back in the data:

Metals Change Commodities Change
Gold 0.88% Oil 5.46%
Silver 1.06% Livestock 4.03%
Copper 3.02% Grains 1.01%
Agriculture 0.80%

The overall Goldman Sachs Commodity Index gained 3.75 percent last week, thanks to a broad based increase in commodity prices. Oil reversed a multi-week slide last week, gaining 5.46 percent and turning in its best performance of the year thus far. The major metals were all higher last week with Gold gaining 0.88 percent for the week, while Silver increased 1.06 percent and Copper went up 3.02 percent. There was nothing that fundamentally changed for any of the commodities in terms of supply or demand, so much of the gain is attributed to just being a relief rally. Soft commodities were positive last week with Livestock gaining 4.03 percent, while Grains gained 1.01 percent and Agriculture overall moved higher by 0.80 percent.

The global markets were very mixed last week with about 40 percent of the markets booking losses, while the other 60 percent saw gains. The best performing index last week was found in Sweden and was the Stockholm based OMX 30 Index, which turned in a gain of 4.3 percent for the week. The worst performing index last week was found in the Philippines and was the PSE Index, which turned in a loss of 3.7 percent for the week.

The VIX was very volatile last week, seeing new 2016 highs during the middle of the week and ending the week in a steep decline on Friday. Overall, for the week the VIX declined by 17.32 percent. The swings in the VIX thus far in 2016 have been large and it looks like they will continue as we move forward into 2016. The current reading of 22.34 implies that a move of 6.45 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

For the shortened trading week ending on 1/22/2016, returns in my hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model 0.58 % -3.86 % 0.21 %
Aggressive Benchmark 0.86 % -7.10 % -11.82 %
Growth Model 0.44 % -3.15 % 0.04 %
Growth Benchmark 0.68  % -5.54 % -9.21  %
Moderate Model 0.25 % -2.02 % 0.62 %
Moderate Benchmark 0.49 % -3.98 % -6.58 %
Income Model 0.19 % -1.09 % 1.46 %
Income Benchmark 0.25 % -1.98 % -3.25 %
S&P 500 1.41 % -6.70 % -7.57 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

I made only one change over the course of the previous week in my models and that was to adjust my hedging position early on during the week to protect against further declines in the broad markets should they be on the horizon. Earnings season starts in earnest this week for my individual equity holdings with McDonalds being the first up before the market opens on Monday. During earnings season the individual stocks I own can move a lot in one direction or another, but in aggregate they should be relatively tame compared to the overall markets.

 

Economic News: Last week was a boring week for economic news releases as all but one release came in very close to market expectations. There were no releases that significantly missed or beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 1/20/2016 CPI December 2015 -0.10% 0.00%
Neutral 1/20/2016 Core CPI December 2015 0.10% 0.20%
Neutral 1/20/2016 Housing Starts December 2015 1149K 1197K
Neutral 1/20/2016 Building Permits December 2015 1232K 1200K
Neutral 1/21/2016 Initial Claims Previous Week 293K 280K
Neutral 1/21/2016 Continuing Claims Previous Week 2208K 2260K
Neutral 1/21/2016 Philadelphia Fed January 2016 -3.5 -4
Neutral 1/22/2016 Existing Home Sales December 2015 5.46M 5.12M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started off on Wednesday with the Consumer Price Index (CPI), which posted a loss of one tenth of a percent for the month of December, almost entirely due to the falling prices of gasoline. Looking at core CPI, prices were shown to have increased by one tenth of a percent, which was slightly slower than was expected, but expectations were so close to zero anyway that it did not make much of a difference to the markets. Two housing related figures were released and sent mixed messages as housing starts came in lower than expected, while building permits came in better than expected during the month of December. On Thursday the standard weekly unemployment related figures were released with both initial and continuing jobless claims coming in slightly higher than expected, but close enough that the markets chose to focus on the equity rally on that day and ignore the unemployment figures. The Philadelphia Fed index fell into the same boat as the unemployment figures on Thursday as the market overlooked yet another negative post for manufacturing in the East coast and cheered on the equity rally instead.

 

This week is an important week for economic news releases as there are a number of releases that could impact the overall market, in addition to a meeting of the Fed’s FOMC. The four releases that could impact the overall markets the most are highlighted below in green:

 

Date Release Release Range Market Expectation
1/26/2016 Case-Shiller 20-city Index November 2015 5.80%
1/26/2016 Consumer Confidence January 2016 96.8
1/27/2016 New Home Sales December 2015 506K
1/28/2016 Initial Claims Previous Week 285K
1/28/2016 Continuing Claims Previous Week 2230K
1/28/2016 Durable Orders December 2015 -0.50%
1/28/2016 Durable Goods -ex transportation December 2015 -0.10%
1/28/2016 Pending Home Sales December 2015 0.80%
1/29/2016 GDP-Advanced Estimate Q4 2015 0.90%
1/29/2016 Chicago PMI January 2016 45
1/29/2016 University of Michigan Consumer Sentiment Index January 2016 93.2

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start off on Tuesday with the release of the Case-Shiller 20-City home price index, which is expected to show a gain of 5.8 percent for the US housing market on a year over year basis through the end of November. This data is so stale that it is highly unlikely that it will move the market at all. Consumer Confidence released later during the day on Tuesday does have the potential to move the market as expectations are for a slight uptick, despite a decline in spending being seen in January and continued weakness out of the manufacturing sector. On Wednesday the new home sales figure for the month of December is set to be released with expectations that 506,000 units were sold during the month, which is a pretty strong number given the fact that it is the dead of winter in many parts of the US. On Thursday the standard weekly unemployment related figures are set to be released with both initial and continuing jobless claims expected to be slightly lower than they were two weeks ago. Released at the same time as the jobs data on Thursday is the Durable goods orders for the month of December, which are expected to show a decline of 0.5 percent overall, while falling only 0.1 percent when looking at durable goods excluding transportation. On Friday the big release of the week is set to be released, that being the advanced estimate of GDP for the fourth quarter of 2015 here in the US. Expectations are for a gain of 0.9 percent during the quarter, which is much slower than the 2.0 percent we saw for the final reading from the third quarter of 2015. If we see this GDP number significantly miss expectations either to the upside or down the markets will likely react in a big way. The US economy seems to have been stalling out over the past few months and quarters and if this is confirmed in the GDP estimate it could be negative for the overall markets. Released at the same time on Friday, but likely overshadowed, is the Chicago PMI, which is expected to post a reading under 50 for the third consecutive month. Remember, a number under 50 on this release signifies a contraction in manufacturing in the greater Chicago region. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of January (final estimate), which is expected to show a slight uptick from the mid-month estimate that came out two weeks ago. Wednesday is also going to be a big day this week because that is the concluding day for the latest FOMC meeting in Washington DC, assuming they have the snow cleared enough for the members to get to the meeting. There is almost no expectation that the FOMC will raise interest rates, but the market will be watching and listening very closely to any changes in the language of the release to see if the recent market volatility has had any impact on the Fed’s thinking about when it may increase interest rates again.

 

Fun fact of the weekLow oil prices, but this price is a little bit crazy!

 

Last week Bloomberg ran an article about an oil refinery, Flint Hills Resources, that was offering to buy North Dakota Sour crude oil at a price of $1.50 per barrel, a major discount to the WTI spot price that is commonly quoted in the media. The North Dakota Sour crude oil is one of the lowest quality crude oils around and the price was quoted so low because of limited pipeline capacity from the Bakken and pipeline operators wanting to push more valuable oil through their pipes. I don’t know of any wells up in the Bakken that can afford to pump oil when they are only getting $1.50 per barrel.

 

Source: www.bloomberg.com http://www.bloomberg.com/news/articles/2016-01-18/the-north-dakota-crude-oil-that-s-worth-less-than-nothing

For a PDF version of the below commentary please click here Weekly Letter 1-18-2016

Commentary at a glance:

– The rout in the global financial markets continued last week.

– Retail sales missed expectations for the month of December.

– Fourth quarter earnings season is now officially under way.

– Fears over China slowing down even further scared many investors around the world.

– Economic news last week came in way below market expectations.

 

Market Wrap-Up: Following a very rough start to 2016 two weeks ago, the global financial markets were unable to turn things around last week, resulting in two weeks in a row of declines to start the new year. Unlike the straight downward move seen in the first week of the year, last week saw choppy trading that looked like it could potentially turn positive after such a strong performance on Thursday. The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The charts this week include the closest levels of support to the downside (drawn with red horizontal lines). For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 1-18-16

The Dow (upper right pane above) is clearly the index showing the best technical strength, when looking at how far above its lower support levels it is currently trading. The S&P 500 (upper left pane above) is in the middle, trading right at the first of two support levels, and the NASDAQ is clearly behind as it has broken down below its lower support level for the first time in the last five months. At this point, it becomes very difficult and, for the most part, pointless to try to guess where the next support level will be for the NASDAQ as one would have to go back more than a year and draw support levels on very stale, dated price points. When looking at the three major indexes, it is hard to not think that we should be due for some sort of bounce as discount buyers should be stepping into the markets and buying at some point near here. The small cap Russell 2000 index has now fallen by more than 20 percent since its previous high point, which means the index has technically moved into a bear market. When indexes start to move into technical bear markets they do one of two things: they either quickly move significantly lower or they stabilize and move sideways. Very rarely do they turn around and move up as fast as they moved down. One of two items currently affecting the markets could provide enough reason for the markets to push off from the current levels in a sideways manner: fourth quarter earnings and oil.

 

National News: Aside from focusing on the decline we have seen here in the US to start 2016, the national financial media last week focused on fourth quarter earnings, manufacturing and the US consumer. Last week was the official start to the fourth quarter 2015 earnings season as Alcoa kicked things off by reporting on Monday after the market close. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Alcoa 33% Fastenal -3% PNC Financial 4%
BlackRock -1% IHS 6% SUPERVALU 0%
Citigroup 2% Intel 17% U.S. Bancorp 0%
CSX 4% JPMorgan Chase 7% Wells Fargo 1%

 

Some of the major banks reported their earnings last week and, on the whole, they turned in performance that was very close to expectations. All of the CEOs that spoke on their quarterly earnings call spoke of fears about China, a strong US dollar and a general lack of inflation as major headwinds for the US economy in 2016. Alcoa, always signaling the official start to earnings season, turned in a solid quarter of performance, but saw its stock fall nearly 9 percent the following day on fears over slowing demand for aluminum. Intel was in the same boat later in the week as the company posted strong figures, but its outlook for 2016 was poor enough to warrant the stock opening the next day and declining by more than 9 percent. This seems to be one of the themes coming to light so far with the small number of companies that have released earnings. If their release is not outstanding, the stock will likely be pushed significantly lower. This presents some interesting buying opportunities as temporary downward pressure lowers the stock price far more than it would have declined in a rational market environment.

 

According to Factset Research, we have seen 30 (6 percent) of the S&P 500 companies release their results for the fourth quarter of 2015. Of the 30 that have released, 81 percent have met or beaten earnings estimates, while 19 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 47 percent of the companies have beaten estimates, while 53 percent have fallen short. Among the companies that have reported earnings thus far, the major theme companies are seeing seems to be weakness in demand. While many companies are looking good in terms of beating earnings per share expectations, the forecasts and outlooks given so far have not been encouraging. The management of various companies see 2016 as a year that will be very difficult.

 

This week is the second week of earnings season for the fourth quarter of 2015. We are starting to really get the ball rolling in terms of the number of companies releasing their results. In the table below, the companies that have the greatest potential to move the markets are highlighted in green:

 

American Express Goldman Sachs Precision Castparts
Bank of America IBM Southwest Airlines
Bank of New York J B Hunt Transport Starbucks
Charles Schwab Johnson Controls Travelers
Cree Kansas City Southern Union Pacific
Delta Air Lines Kinder Morgan United Airlines
eBay Morgan Stanley UnitedHealth
General Electric Netflix Verizon

 

Financials will likely continue to take a good portion of the spotlight this week as Bank of America, Bank of New York, Morgan Stanley and Goldman Sachs all release their earnings figures. Much like the other banks that released last week, we will likely hear similar concerns about the global economy as a back drop to a pretty good fourth quarter. American Express will be very closely watched this week as the company typically has a pretty good idea about the spending habits of consumers given the large number of AMEX credit cards in use every day. Netflix, one of the best performing stocks of 2015, will likely receive a bit of attention this week as it releases its fourth quarter numbers. As always, the number of new subscribers will likely push the stock either higher or lower. Starbucks is the final company that will receive the spotlight this week as the company is a good indicator of consumer spending, as its products are relatively cheap and normally in high demand when consumers are confident about their financial future. One thing that may start to be seen in the earnings results of some companies over the next few weeks is the slowdown in manufacturing that we have been seeing for the past few months.

 

Last week the latest figure for the Empire Manufacturing index, an index that measures the manufacturing and business activity for the greater New York City area, came out last week with the lowest reading we have seen since March of 2009. The chart to the right shows the index on a monthly basis going back to late 2008. A reading above zero indicates that manufacturing and business activity picked up during the month when compared to the previous month. You can see that we have now had seven months of contractions with January being the worst slow down of the seven. While other regions have been slowing down as well, the slowdown is the most pronounced in New York during this time period.

Empire manfacturing 1-18-16

While manufacturing has been slowing down, consumer spending and retail sales have either been decelerating or reversing and turning negative. One of the driving factors to the decline seen on Friday by the indexes was the fact that the December retail sales figures were released and showed that both overall sales and sales excluding auto sales declined during the month of December. December is typically a month that retailers count on being strong with all of the holiday shopping that is occurring, but December of 2015 looks like it was a poor month for retail sales. This will likely be seen in the quarter results that retailers post over the next few weeks. We have already seen the largest private employer, Wal-Mart, take action by announcing the closure of several stores and a slowdown in expansion that will last throughout 2016.

 

International News: International news last week focused on the same two topics it has been focusing on for the past few weeks—declining oil prices and continuing weakness being shown in China. Last week oil continued to slide, as it has been doing now for more than 18 months. The chart to the right shows the decline in Brent Crude oil prices oil 1-18-16going back to 2014. As you can see, we closed out last week below $29 per barrel, the lowest point for a barrel of Brent crude oil over the past 11 years. As oil prices decline there is more and more pressure building against governments around the world that count on oil exports to fund their economies. This could result in further pain for the global economy. The countries most at risk are Venezuela, Brazil, Iran and Russia as they have some of the highest costs to get the oil out of the ground and to market. Combined with high amounts of government spending and budgets that are dependent on higher oil prices, oil prices remaining low or pushing lower could present some very difficult situations for these countries. One head wind for the price of oil moving upward is Iran and some of the decade’s old sanctions that are finally being lifted, allowing Iranian oil to flow into the international market at a rate of about 500,000 barrels per day. It is something oil traders have anticipated for a long time, but now that it is happening they still seem to be surprised and are having to adjust their positions to account for greater supply being on the market. This low price oil situation does not look like it will change any time in the near future, barring a war breaking out in the Middle East that raises uncertainty in the oil market enough to overcome the massive global over-supply of oil.

 

China is the focus of other major international financial headlines from the past week as the country continues to show weakness in its economy. GDP for China in 2016 is now expected to run at the slowest pace since the 1990s and the Chinese government desperately wants to turn around the economy before it slows down even more. So far in 2016 the government in China has failed to quell a sharp correction in its financial markets, even as it has stopped some institutions from selling their positions. Individual investors in China are starting to lose faith in China’s financial markets; something the government cannot afford to have happen at this point in its transition from an export driven economy to an internal consumption economy. Much like the uncertainty in the price of oil we will likely see continued weakness and uncertainty out of China for a significant period of time as it tries to sort through its financial mess.

 

Market Statistics: Global financial markets made it two weeks in a row of declines last week as continued weakness in oil prices and concerns about the future growth of China dominated the financial media:

 

Index Change Volume
Dow -1.81% Above Average
S&P 500 -2.17% Above Average
NASDAQ -3.34% Above Average

 

Last week was the second week in a row of volume being above average. It is concerning that the volume when the markets have moved lower over the past two weeks has been significantly higher than the volume seen when the markets have moved higher. A significant portion of the volume has been in the energy sector as investors continue to flee from their positions on fear of oil prices continuing to push lower.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Utilities 0.47% Oil & Gas Exploration -7.55%
Medical Devices -0.89% Global Real Estate -7.29%
Gold -1.41% Commodities -6.48%
Consumer Staples -1.53% Biotechnology -5.96%
Insurance -1.58% Broker Dealers -5.33%

All five of the sectors that turned in the best performance last week could easily be labeled as defensive sectors of the markets. Utilities is historically the most defensive sector of the markets and typically a place where individual investors invest money when they are looking for consistent dividend payments. Investors may be heading into the sector as a proxy for fixed income positions, which have been paying very little in terms of interest while at the same time taking on a higher level of interest rate risk than is typically experienced when interest rates are at a normal level. Gold and Consumer Staples are two stalwart defensive sectors of the markets. On the downside last week, it was not surprising to see Oil and Gas Exploration at the top of the list as the sector just can’t seem to catch a break over the past 18 months. Commodities also made the bottom five list last week as weak demand from China continues to cause uncertainty in the global commodity markets.

As one would expect with the equity markets moving lower for the second week in a row, the fixed income market here in the US had a pretty good week, gaining across the board except for TIPS:

Fixed Income Change
Long (20+ years) 1.94%
Middle (7-10 years) 0.78%
Short (less than 1 year) 0.03%
TIPS -0.14%

Last week, demand for fixed income investments in the US was very high, meaning that prices were increasing while yields were moving lower. At one point during the week last week we saw the 10-year US treasury bond trade below a two percent yield, which is a lower rate of return than prior to the Fed increasing rates back in December. Currency trading volume was average last week as traders continued to weigh the slowdown in China and the new reserve currency status of the Chinese Yuan. Overall, the US dollar advanced 0.51 percent against a basket of international currencies. The best performing currency last week of the major currencies was the Chinese Yuan, which gained 2.08 percent against the value of the US dollar. The worst performing currency of the major currencies last week was the Canadian dollar, as it declined by 2.67 percent against the value of the US dollar. Much of the weakness seen in the Canadian dollar was due to the continued fall in the price of oil, with some of the common Canadian oil blends trading at less than $10 per barrel.

Commodities were mixed over the course of the previous week:

Metals Change Commodities Change
Gold -1.51% Oil -10.31%
Silver -0.45% Livestock -1.91%
Copper -3.86% Grains 1.12%
Agriculture -0.79%

The overall Goldman Sachs Commodity Index declined 6.48 percent last week, thanks almost entirely to the decrease in the price of oil. Oil accelerated its slide last week, falling more than 10 percent for the second week in a row with oil closing out the week under $30 per barrel. As oil has now pushed down below $30 per barrel it is hard to see where the next level of support will be. One of the potential factors upcoming that could impact the price of oil is the Iranian oil that will be coming to market for the first time in many years as the international sanctions are starting to be lifted. The major metals were all lower last week with Gold falling 1.51 percent for the week, while Silver declined 0.45 percent and Copper moved down 3.86 percent over fears of China slowing down. Soft commodities were mixed last week with Livestock falling 1.91 percent, while Grains gained 1.12 percent and Agriculture overall moved lower by 0.79 percent.

There was only one major global index that turned in a positive return last week and it was found in Mexico. The best performing index last week was the Mexican Bolsa Index, which turned in a gain of 1.4 percent for the week. Much of the gain occurred after the announcement that El Chapo had been recaptured by Mexican special forces after a shoot out at the home he was hiding in. The worst performing index last week was found in China and was the Shanghai based SE Composite Index, which turned in a loss of 9.0 percent for the week, making the two week slide for the Chinese markets nearly 20 percent to start 2016.

The VIX was surprisingly tame last week, gaining only 0.04 percent last week when looking on a point to point basis between the last two weeks. This small gain, however, did not tell the story last week as the VIX had a bit of a wild ride, falling during the equity advance on Thursday, only to spike upward after the large declines seen on Friday. The swings in the VIX thus far in 2016 have been large and it looks like they will continue as we move further into 2016. The current reading of 27.02 implies that a move of 7.80 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 1/15/2016, returns in my hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model -1.35 % -4.41 % -0.37 %
Aggressive Benchmark -2.47 % -7.89 % -12.58 %
Growth Model -1.10 % -3.57 % -0.40 %
Growth Benchmark -1.92  % -6.18 % -9.82  %
Moderate Model -0.74 % -2.26 % 0.36 %
Moderate Benchmark -1.37 % -4.44 % -7.03 %
Income Model -0.45 % -1.28 % 1.27 %
Income Benchmark -0.68 % -2.23 % -3.49 %
S&P 500 -2.17 % -8.00 % -8.86 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

Very defensively positioned at the start of the week, my models performed relatively well last week when compared to the S&P 500. I only made a single change in my models over the course of the previous week and that change was to sell my partial position in Profunds Large Cap Growth Fund (LGPIX) after the fund started to exhibit more volatility than it had in previously volatile times for the markets. At this point, I am heavy in cash and cash-like positions and am maintaining my hedging positions to offset some of the risk I am taking with my stock positions. I continue to evaluate a number of potential investments, but with the volatility we have been seeing so far this year, I am deciding to err on the side of caution before stepping into any new positions.

 

Economic News: Last week held some key economic news releases that came in very weak. In aggregate, it was one of the worst weeks for economic news releases that we have had in a very long time. There were three releases that significantly missed market expectations (highlighted in red below) and no releases that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 1/14/2016 Initial Claims Previous Week 284K 275K
Neutral 1/14/2016 Continuing Claims Previous Week 2263K 2220K
Negative 1/15/2016 Retail Sales December 2015 -0.10% 0.10%
Negative 1/15/2016 Retail Sales ex-auto December 2015 -0.10% 0.30%
Slightly Negative 1/15/2016 PPI December 2015 -0.20% -0.10%
Neutral 1/15/2016 Core PPI December 2015 0.10% 0.10%
Negative 1/15/2016 Empire Manufacturing January 2016 -19.4 -3.5
Slightly Positive 1/15/2016 University of Michigan Consumer Sentiment Index January 2016 93.3 92.6

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week the economic news releases didn’t start until Thursday when the standard weekly unemployment related figures were released, with both figures coming in close to, but slightly higher than, expectations. On Friday, nearly all of the major releases of the week pointed toward weakness in the US economy. Retail sales for the month of December were released first with overall retail sales posting a decline on a monthly basis of 0.1 percent, while retail sales excluding auto sales also declined by 0.1 percent. This may not seem concerning with the figure being so close to zero, but remember that December is the month that many retailers count on for making their entire year. From these numbers, the holiday shopping season was not good at all as retailers had to slash prices to entice shoppers to make purchases. Later during the day on Friday the Producer Price Index (PPI) for the month of December was released and showed that prices at the overall producer level continued to see declines, while core PPI posted a very slight increase. The Empire manufacturing index for the month of January was also released on Friday and missed expectations by the widest margin that I could find looking back into the history of this release. The markets had been expecting the index to show a -3.5 reading, which means that manufacturing in the greater New York City area contracted during the month of December, but did so at a slow pace. The print for the index was -19.4, which means the region saw the fastest contraction in manufacturing that it has seen since the Great Recession back in 2008 and early 2009. This figure caught the markets completely by surprise and was one of the catalysts for the large declines we saw here in the US markets on Friday. Wrapping up the week last week was the release of the University of Michigan’s Consumer Sentiment Index for the month of January (first estimate) with the print coming in at 93.3, versus expectations of 92.6, which means it was close enough for the market to not pay much attention to the release. It is interesting to see confidence moving higher, while many other consumer related figures are pointing toward weakness, such as retail sales and consumer spending.

 

This week, much like last week, has all of the economic news releases packed into the back half of the week. The three releases that could impact the overall markets are highlighted below in green:

 

Date Release Release Range Market Expectation
1/20/2016 CPI December 2015 0.00%
1/20/2016 Core CPI December 2015 0.20%
1/20/2016 Housing Starts December 2015 1197K
1/20/2016 Building Permits December 2015 1200K
1/21/2016 Initial Claims Previous Week 280K
1/21/2016 Continuing Claims Previous Week 2260K
1/21/2016 Philadelphia Fed January 2016 -4
1/22/2016 Existing Home Sales December 2015 5.12M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts off on Wednesday with the release of the Consumer Price Index (CPI) for the month of December, which is expected to show a zero reading overall and a gain of 0.2 percent when looking at core CPI. The main aspect of the CPI that is keeping it so low is the falling price of oil and, in turn, the falling price of gasoline. As long as oil continues on the path it has been on for the past 18 months it will be very difficult to get any inflation in either the CPI or the PPI. Housing starts and building permits for the month of December are also set to be released on Wednesday, with both figures expected to be higher than 1.1 million units. As always, housing starts are a more important figure than building permits when looking at the health of the US housing market. On Thursday the standard weekly unemployment related figures are set to be released, with both figures expected to come in close to the figure from two weeks ago. The Philadelphia Fed Index is also released on Thursday and, after such a dismal report out of the Empire index last week, it would not be surprising to see this index miss expectations in a big way to the downside. This week wraps up on Friday with the release of the existing home sales figure for the month of December, which is expected to show 5.12 million homes being sold during the month, an increase of about 400,000 units when compared to November’s reading. Maybe everyone figured out the new loan paperwork, which was blamed for the poor reading in November, and pushed ahead and purchased homes in December.

 

Fun fact of the weekWhat does a barrel of oil turn into?

 

One barrel of oil accounts for about 19.15 gallons of gasoline, 9.21 gallons of diesel, 3.82 gallons of jet fuel, 1.75 gallons of heating oil and about 7.3 gallons for other petrochemical products like tar, asphalt, bitumen, etc.

Source: http://www.investinganswers.com

For a PDF version of the below commentary please click here Weekly Letter 1-11-2016

Commentary at a glance:

– Markets last week tumbled on fears over China.

– The first 5 days of trading saw the worst decline for the Dow ever to start a year.

– Fourth quarter earnings season started much the same way third quarter earnings season ended.

– Oil prices continued to push lower.

– Economic news last week came in above market expectations.

 

Market Wrap-Up: “Tumble” and “plunge” were the two most common words in the financial media last week as markets around the globe declined by large amounts to start the 2016 trading year. After two weeks of relative calm around the holidays, investors seemed to be just as scared by China slowing down last week as they were back in the middle of August when China caused the first global 10 percent correction in several years. There were very few spots to hide last week as all of the major sectors pushed lower with gold proving to be one of the best assets to own during the decline. The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The charts this week include the most recent trading range for each of the indexes, a range that has been in place for more than two months. These support (lower lines) and resistance (upper lines) levels are the approximate high and low points reached over the past three months. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 1-11-16

From a technical standpoint, last week was a bad week. Not only did all three of the markets break down at the same time, but they did so in a big way, easily blowing right down through their respective trading ranges (drawn in red above). In terms of technical strength, there is no clear index ahead of the other two this week—they are all pretty bad. One of the few positive developments is the fact that none of the indexes broke through their previous low points set the last times the markets reacted so badly: August and September of 2015. These previous low points mark the next levels of support and the indexes are currently less than 2 percent away from these points. There should be a decent amount of support at these low points if the indexes get to them because they are the levels at which enough buyers jumped in last time to turn the markets around. If the indexes manage to break through these lower support levels, however, we could be in a bit more of a decline because there are just not many technical support levels below these points. As is normally the case, while the equity indexes were pushing lower last week the VIX was moving in the opposite direction, moving higher by nearly 50 percent. With such a large increase, the VIX is now at a level we have not seen since the middle of September when the VIX was coming down from its mid-August spike. With such a large decline over such a short period of time, the markets seem like they are due for a bit of a bounce as any time the markets move too fast one way or the other there is nearly always a little give back before a true trend is formed. A lot has been made in the media about how bad of a start 2016 has been, so I dug into the historical data of the Dow to find out for myself just how bad of a start 2016 has been and what, if anything, such a poor start might forecast for the full year.

 

Looking at historical data, I used the longest running index in the US, that being the Dow Jones Industrial Average, and pulled daily data back to February 16th of 1885. In looking at the historical data, the first 5 trading days of 2016 are in fact the worst start for the index, ever. The table to the right shows the years with the worst first 5 trading days and the cumulative amount the index was down. As you can see, 2016 barely beat out a -5.99 percent decline that occurred in 1896. What happens for the full year after such a stumble at the starting line? The average return of the starts that were down more than 5 percent (there are only the four listed in the table) is a decline of 11.85 percent for the full year. This bodes pretty poorly for the financial markets for 2016. However, when looking at all of the negative starts for the Dow, there are 47 negative starts out of the 130 years of data. The average return on those years is 3.47 percent. If you look at just the top 10 negative starts, the average return for the year is a gain of 1.45 percent. One caveat to the historical data is that the times are very different now than they were for half of the major stumbles to start the year. I would argue that the Dow in 1896 and 1901 is almost nothing like it is at the current time with how trading takes place and how information flows around the world very quickly; so I am not sure that much weight needs to be put on historical data from a time that is so different from now. The main drivers for for 2016 currently are falling oil and China—with both situations looking like they will take an extended period of time to work out.bad starts 1-11-15

 

National News: National news last week was all about the fall the markets took to open 2016 trading—it was a historic decline. Other than the decline in the markets, national headlines impacting the financial markets were mainly focused on politics as President Obama attempted to go at it alone on gun control through executive order, expanding things like background checks. The actions set forth by President Obama, however, had a somewhat opposite effect than he was likely going for as gun sales spiked to some of the highest single day and weekly levels the US has ever seen following the announcement. Instead of ensuring fewer guns on the street, the changes, at least in the short term, have lead to people rushing to buy arms on the fear that they may not be able to do so in the future. This was most directly seen in the firearms companies such as Smith & Wesson and Sturm Ruger. Both Sturm Ruger and S&W were up more than 10 percent over the first two trading days of 2016 leading up to the expected announcement. While everyone was returning to work after the holidays, earnings season for the fourth quarter 2015 commenced.

 

Last week was the unofficial start to the fourth quarter 2015 earnings season as the very early to report companies reported their earnings. The official start to earnings season is this week with Alcoa kicking things off by reporting on Monday after the market close. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Bed Bath & Beyond 0% Helen of Troy 8% Sonic 0%
Constellation Brands 10% KB Home -16% SUPERVALU pushed
Container Store -180% Monsanto 59% Walgreens 6%
Franklin Covey 67% Ruby Tuesday 0% WD-40 4%

 

In looking at the small number of companies that released earnings last week, there was nothing very surprising in the announcements. KB Homes saw a rough quarter as demand for already existing homes during the quarter outweighed demand for newly built homes. This was one of the reasons the home builder sector turned in the worst performance of any sector for the week. WD-40 turned in mediocre returns. As such, there was no clear indication about the future of the US economy when looking into the release to determine if Americans are choosing to repair rather than buy new items.

 

According to Factset Research, we have seen 21 (4.2 percent) of the S&P 500 companies release their results for the fourth quarter of 2015. Of the 21 that have released, 76 percent have met or beaten earnings estimates, while 24 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 33 percent of the companies have beaten estimates, while 67 percent have fallen short. The same major themes seem like they will play out in the fourth quarter earnings season as they have played out for the past few quarters. Falling oil prices, the slowing global economy (thanks in large part to China) and potentially the increasing value of the US dollar are likely to remain the main themes being called out in the releases.

 

This week is the official start to earnings season for the fourth quarter of 2015 when Alcoa announces its earnings. In addition to Alcoa, there are a several other well-known companies that release their fourth quarter results this week. In the table below, the companies that have the greatest potential to move the markets are highlighted in green:

 

Alcoa Fastenal PNC Financial
BlackRock IHS SUPERVALU
Citigroup Intel U.S. Bancorp
CSX JPMorgan Chase Wells Fargo

 

Alcoa is seen as a bellwether company for the overall health of the US economy since it has been around for such a long period of time and its primary product, aluminum, is used in so many industries. Typically, if Alcoa turns in a poor earnings announcement, it will be a difficult earnings season for many companies. If Alcoa turns in strong numbers, the earnings season should perform well. In addition to Alcoa announcing its earnings this week, we have several of the major banks also announcing their results. Citigroup, JP Morgan, US Bank and Wells Fargo all report their earnings for the fourth quarter this week. Foreign currency weakness and uncertainty over China will likely dominate each of these announcements since most of the banks are large multinationals. One of the old-school leaders in technology, Intel, is also set to report earnings this week, potentially showing some insight into the microprocessor and chip market. Demand seems like it should be moving upward for products sold by Intel as high tech gadgets are utilizing more and more microchips to perform increasingly complex functions.

 

International News: International news last week focused on two main players—China and North Korea. The feud between Saudi Arabia and Iran, at least for now, seems to have taken a back seat for the moment as oil has resumed moving lower. China was the main culprit in the declines seen last week as the main Chinese market had a very tough time last week, even making it through a full trading session without hitting trading halts. In fact, the main Chinese markets were halted for the day twice last week after falling by the daily maximum allowed, 7 percent, in a very short period of time. Some of the decline was due to rules expiring in China at the end of last week (at least they were supposed to expire) with the main rule being the ban on selling. Back in August and September when the markets in China were very wild, the government imposed a ban on selling of large stakes in companies by investors. This ban was set to expire on Friday last week. Some of the decline early last week were small investors trying to front run what they thought could be large downward pressure on the markets from sellers selling on Friday, after being barred from doing so for the past few months. After the markets performed so badly to start the week, the Chinese government alleviated those fears by saying that the ban on selling would stay in place past Friday. At the same time, however, there were other announcements being made with data coming out that was pointing toward China being even weaker than first expected with some economists calling for China’s growth rate to be sub 6 percent during 2016. Add in a World Bank report on global growth that lowered overall global GDP growth for 2016 down to 2.9 percent from the 3.3 percent expected back in June. All of these changes coupled with no real upward catalyst anywhere in the world, including the US, led to investors around the world selling and moving toward safety over the course of the first week of trading in 2016. The hard part with China is that the government and investors are stuck at odds, as the government wants to step in to forcibly make things better and investors want the markets in China to be “free” of government meddling. Other news last week that had a noticeable impact on the global markets was a big explosion out of North Korea, even if it was not as large as it should have been.

 

Last week North Korea tested what it said was a Hydrogen bomb for the first time in an underground testing area that the global community had been watching for about 8 months. After the explosion, which was picked up by many agencies around the world that are watching North Korea, the country announced that it had successfully tested a Hydrogen bomb. However, the signature and power released from the blast suggests that it was not a Hydrogen bomb, but rather the same type of small nuke they have set off three previous times. A Hydrogen bomb explosion would have been several times larger than what was seen. What type of nuclear device they set off is not material as the international community quickly jumped on the band wagon condemning the test. Even China, North Korea’s most supportive friend, condemned the test. South Korea immediately started taking actions to show force against North Korea, which included air patrols involving both South Korean and US hardware. It seems this type of proactive action is taken by North Korea every few years as the country becomes more and more irrelevant on the global stage. Its actions throw it onto the global scene in really the only way it can get there. Global markets initially moved lower after the blast was confirmed, but as more details came out about the blast the markets moved upward, largely ignoring the whole episode.

 

Market Statistics: The markets started 2016 with a slump as the global markets pushed lower on renewed fears about the future of the Chinese economy and, with it, the growth rate of the global economy:

 

Index Change Volume
S&P 500 -5.96% Above Average
Dow -6.19% Above Average
NASDAQ -7.26% Above Average

 

Volume picked up on a relative basis a lot last week, when compared to the volume we had seen the previous two weeks, but this was expected as volume around the holidays is typically very light. The first full week of trading typically sees what looks like a spike, but is more just moving back toward normal after such a light period. However, last week the volume was higher than normal as the market pushed noticeably lower. NASDAQ being the worst performing of the three major indexes was not surprising as last week was a “risk-off” week for the markets. Thus, the historically highest beta index declined the most. Typically, during such weeks the Dow should be the best performing of the three indexes, but this was not the case last week as the S&P 500 was the index that declined the least.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Utilities -0.55% Home Construction -10.96%
Global Real Estate -0.94% Biotechnology -10.68%
Residential Real Estate -1.64% Semiconductors -9.45%
Telecommunications -3.27% Broker Dealers -9.18%
Consumer Staples -4.16% Financial Services -8.86%

There were no equity sectors of the markets that turned in positive performance last week as we were in a time that sectors essentially won by losing less. Safe haven asset classes made up all of the top five performing sectors last week with Utilities leading the way, while Real Estate came in second and third. Telecommunications and Consumer Staples rounded out the top five performing sectors, each loosing significantly less than the overall markets. On the negative side, Home Construction and Biotechnology essentially tied for the worst performing sectors, each giving up more than 10 percent during the week. Semiconductors came in third, in what looked like a pure risk-off trade, and then two of the financial sectors rounded out the bottom 5 performing sectors. Financials typically get hit a little harder than most sectors in times of the markets moving significantly lower as investors sell their risky positions.

As one would expect with the equity markets seeing such a dislocation, the fixed income market here in the US had a pretty good week, gaining across the board:

Fixed Income Change
Long (20+ years) 2.31%
Middle (7-10 years) 1.48%
Short (less than 1 year) 0.01%
TIPS 0.65%

Fixed income typically moves in the opposite direction of the equity markets as investors move toward fixed income because of its perceived safety relative to equity positions. When this happens, it drives up the price of the bonds and pushes yields lower. Currency trading volume was heavy last week as many traders came back from time off and adjusted their positions. Overall, the US dollar declined 0.35 percent against a basket of international currencies. The best performing currency last week of the major currencies was the Japanese Yen, which gained 2.28 percent against the value of the US dollar. The worst performing currency of the major currencies last week was the Australian dollar, as it declined by 4.29 percent against the value of the US dollar. Much of the weakness seen in the dollar was due to the weakness being seen in China and fears over the country slowing their orders of basic materials from Australia.

Commodities were mixed over the course of the previous week:

Metals Change Commodities Change
Gold 4.16% Oil -10.91%
Silver 0.83% Livestock -1.71%
Copper -6.33% Grains 0.20%
Agriculture -2.33%

The overall Goldman Sachs Commodity Index declined 5.69 percent last week, thanks almost entirely to the decrease in the price of oil. Oil accelerated its slide last week, falling more than 10 percent in what turned out to be only the second week of the past year that saw a decline of more than 10 percent. Oil does not seem to be able to catch a break as we have now seen it push well below $35 per barrel, which is a level that was supposed to see support, but there turned out to be none. At this point, some of the larger banks and commodity traders are calling for oil to push all of the way down to $25 or below before finding a bottom. The major metals were mixed last week with Gold proving to be a safe haven asset, gaining 4.16 percent for the week, while Silver advanced 0.83 percent and Copper went the opposite direction, falling by 6.33 percent over fears of China slowing down. Soft commodities were also mixed last week with Livestock falling 1.71 percent, while Grains gained 0.20 percent and Agriculture overall moved lower by 2.33 percent.

There were no positive indexes last week, when looking at all of the major global indexes, which is a pretty rare feat for the financial markets. The best performing index last week was found in Indonesia with the Jakarta Composite Index turning in a loss of 1.0 percent for the week. The worst performing index last week was found in China and was the Shanghai based SE Composite Index, which turned in a loss of 10.0 percent for the week, thanks to massive amounts of uncertainty over what the government will do in 2016 to try to make the economy in China grow as well as uncertainty over future trading rules for the financial markets. Both of these fears do not look like they will be alleviated any time soon.

As global equity markets were shaken by fears about China slowing down, the VIX here in the US spiked higher, gaining almost 50 percent over the first five trading days of the year. The weariness we started to see in the VIX at the conclusion of 2015 appears to have been warranted, at least in the short term. With the increase last week, the VIX is at its second highest point in terms of spikes that we have seen over the past year, but still remains well below the spike peak of August when the VIX topped out at 40.74, shortly after China devalued the Yuan. The current reading of 27.01 implies that a move of 7.80 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 1/8/2016, returns in my hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week Since 6/30/2015
Aggressive Model -3.10 % 1.01 %
Aggressive Benchmark -5.56 % -10.36 %
Growth Model -2.49 % 0.72 %
Growth Benchmark -4.34  % -8.05  %
Moderate Model -1.53 % 1.12 %
Moderate Benchmark -3.11 % -5.74 %
Income Model -0.83 % 1.73 %
Income Benchmark -1.56 % -2.83 %
S&P 500 -5.96 % -6.84 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

Last week was a wild week for the markets. I went into the week defensively positioned with hedging positions partially in place and finished the week with fewer positions and a little bit of a larger hedging position in place. Over the course of the week my sell signals tripped on Semiconductors, Electronics, Healthcare and Midcap stocks; the proceeds from the sales went to cash. At this point I am setup for further deterioration in the markets as I should be participating in a relatively small percentage of any further downward moves, while still having some exposure to the markets should they turn around briskly and push higher. Areas of the markets I have been watching for a long time continue to become cheaper; mainly energy as well as oil and gas. At some point these will present great buying opportunities, but the time does not appear to be quite yet.

 

Economic News: The first full week of economic reporting for 2016 held some very nice upside surprises, primarily on the employment front. There were three releases that significantly beat market expectations (highlighted in green below) and one release that significantly missed market expectations (highlighted in red below):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Negative 1/4/2016 ISM Index December 2015 48.2 49
Positive 1/6/2016 ADP Employment Change December 2015 257K 190K
Neutral 1/6/2016 ISM Services December 2015 55.3 56.4
Neutral 1/7/2016 Initial Claims Previous Week 277K 270K
Neutral 1/7/2016 Continuing Claims Previous Week 2230K 2215K
Positive 1/8/2016 Nonfarm Payrolls December 2015 292K 200K
Positive 1/8/2016 Nonfarm Private Payrolls December 2015 275K 194K
Neutral 1/8/2016 Unemployment Rate December 2015 5.00% 5.00%
Slightly Negative 1/8/2016 Consumer Credit November 2015 $13.9B $18.5B

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started off on Monday with the release of the ISM index for the month of December, which came in showing a contraction, but a contraction that was worse than expected. Manufacturing contracting in the US is not a positive sign for the overall future health of the economy as it is typically a leading indicator of what is to come. On Wednesday the ADP employment change figure for the month of December was released and showed that nearly 60,000 more jobs were created during the month than was excepted; a positive precursor for the other employment figures at the end of the week. Also released on Wednesday was the services side of the ISM index, which showed that the services sector expanded during December, but at a slightly slower pace than was expected. On Thursday the standard weekly unemployment related figures were released, with both figures coming in very close to market expectations. On Friday the big releases of the week, those being the employment figures from the US government, were released. Nonfarm public and private payroll figures both blew expectations out of the water with both beating expectations by more than 80,000, or 40 percent. Despite the strong payroll figures, the overall unemployment rate in the US failed to move from the 5 percent level seen in November. Wage growth was also released and showed a slightly contraction, while labor force participation showed an anemic increase of only 0.1 percent. Wrapping up the week on Friday was the release of the Consumer Credit report for the month of November. The report showed that consumer credit expanded by $13.9 billion during November, which is slower than the expected $18.5 billion; but much of the decline was due to tightened lending standards ahead of the Fed interest rate hike and should not be taken as a trend.

 

This is a slow week for economic news releases with only three releases that should have any impact on the markets and all releases crammed into the last two days of trading for the week. The three releases that could impact the overall markets are highlighted below in green:

 

Date Release Release Range Market Expectation
1/14/2016 Initial Claims Previous Week 275K
1/14/2016 Continuing Claims Previous Week 2220K
1/15/2016 Retail Sales December 2015 0.10%
1/15/2016 Retail Sales ex-auto December 2015 0.30%
1/15/2016 PPI December 2015 -0.10%
1/15/2016 Core PPI December 2015 0.10%
1/15/2016 Empire Manufacturing January 2015 -3.5
1/15/2016 University of Michigan Consumer Sentiment Index January 2015 92.6

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts off on Thursday with the release of the standard weekly unemployment related figures, with both initial and continuing jobless claims expected to show no change over the levels seen two weeks ago. On Friday, retail sales for the month of December are set to be released with expectations of very slow growth of 0.1 percent overall and 0.3 percent when excluding auto sales. These are not very high expectations, especially given that much of the month included the holiday shopping season. If we do not see an upside surprise on these numbers it would be very negative for the overall markets. The Producer Price Index (PPI) for the month of December is also set to be released on Friday and prices at the producer level overall are expected to show a decline. The decline will be due to the continually falling price of raw materials and energy, both of which are considered transitory by the Federal Reserve and should have little impact on future interest rate decisions. Later during the day on Friday the Empire Manufacturing index for the month of January is set to be released with expectations of a slower contraction than was seen in December being shown. This, however, is not a positive thing as a contraction still means that manufacturing in the region was still slower than it was in December and it was really slow for that month as well. This is the first release of manufacturing data for the month of January and it should set the tone for all of the other regions and the overall ISM for the month. The market could react to this announcement if it misses by more than a tenth of a percent or so on release day. Wrapping up the week this week is the release of the University of Michigan’s Consumer Sentiment Index for the month of January (first estimate) and it is expected to be unchanged from the reading at the end of December. With the markets performing so poorly at some point this week I am expecting a Fed official to take a microphone and say something about holding off on further rate hikes until we see how this volatility plays out in the markets. This will likely lead to a small relief rally, but it may not be sustainable.

 

Fun fact of the weekDavid Bowie

 

David Bowie, who passed away today at the age of 69 after fighting cancer for 18 months did something no one else had done prior to him. Back in 1997 David Bowie issued his own bonds; they were referred to as “Bowie Bonds” and were bonds that were issued on his future royalty income stream from his music. He netted about $55 million from the bonds and used the proceeds to buy even more of his music catalog from a manager. The bonds paid 7.9 percent and were 10-year bonds. Since that time, other celebrities have issued bonds on their future income streams, but he was the pioneer of the bonds.

 

Source: www.cnn.com http://money.cnn.com/2016/01/11/media/bowie-bonds-royalties/

I saw a lot of media talking about how bad of a start 2016 has been so far for the Dow so I decided to look further into it. I pulled daily data for the Dow back to 1885. Then looked at the first 5 trading days of year year to see what the cumulative return was. I then looked to see what the average for the full year was after negative or a positive start to the year. The numbers are pretty interesting:

Top 20 Worst 5 day starts for the Dow:

2016 -6.19%
1896 -5.99%
1978 -5.61%
2008 -5.09%
1901 -5.08%
1991 -4.72%
1904 -3.97%
1962 -3.03%
1934 -2.96%
1922 -2.44%
1969 -2.38%
1887 -2.23%
1955 -2.17%
1977 -2.14%
1939 -2.08%
1916 -1.83%
1956 -1.77%
2005 -1.66%
1985 -1.64%
2001 -1.53%

So YES 2016 is the worst 5 day start for the Dow EVER!

What happens for the full year after such a rough start?

The average of the four other times that the Dow has started the year by falling more than 5 percent over the course of the first 5 trading days the Dow has turned in a full year average return of -11.85 percent

When looking at all 43 of the negative starts to a year of the 131 years of Dow data the average full year return looks much better with the Dow on average gaining 3.47 percent.

So we really are moving into uncharted waters for the Dow moving forward in 2016. Good active money managers will likely shine bright during what could be a very trying year for investments. Contact me if you would like more information or the data behind the numbers mentioned above.

Peter@callahancapital.com

Follow

Get every new post delivered to your Inbox.