Brennaman's Four Points for the Week August 18, 2014

Brennaman's Four Points for the Week

1.       Market Performance –Not a bad week If We Were in the Late 1990’s – Last week was not a bad week or a good week depending upon your inclinations.  A little volatility because of the Ukraine situation and the continued ISIS situation in Iraq.  But in the grand scheme of the market history it was a normal week. Some have described week’s market returns as tepid.   The broad markets were up 1.29% for the S&P 500 and 2.15% for the NASDAQ.  One percent return in one week is considered tepid?  In the late 90’s and even into the first decade of the century a 1% move was good – for a month!  Now we are crying that the market is failing and the worst is yet to come.  I remember early in my career when we had a 20 point move on the DOW Jones Industrial Index and we were ecstatic (if it was upward).  Now it is tepid and we are morose.  I feel last week is indicative of what we are going to see for the foreseeable future; low volatility, the market moving on real company news and sudden moves as a result of national or global events.  Just like the good ol’ times.  So what are the equity markets telling us?  The markets as a whole are a great prognosticator (or discounter) of the economic future.  The current market conditions reinforce the belief that investments in the equity markets are worth the risk, the FED is going to stay on the sidelines even after the Bond Buy-Back program ends in Oct and that better economic times are closer than they were just six months ago.  An old adage is particularly true in this case in that market prices almost always lead economic fundamentals.

2.       Agriculture – Good News & Bad News – The U. S. Department of Agriculture has repeatedly upgraded the forecast for corn, wheat and soy bean production this year as a result of mild temperatures and more normal rainfall (still low levels in many states).  Corn production alone is likely to break records in 2014 in terms of total production and yield per acre.  Very good news indeed.  Now the bad news.  Speculation on possible bumper crops has circulated for over six months driving down the price of corn per ton by nearly 30%.  The potential loss of earnings has had ripple effects as farmers (large and small) may defer new equipment purchases in the coming year.  Stocks of note that could be affected include John Deere and Caterpillar.  The impact on Deere is the largest with the return year-to-date of -5.8% (whereas the S&P 500 is up 5.8%).  However, if the sanctions remain in place against Russia, the nations of the EU will probably absorb much of the excess and the remaining grain will go a long way to replenish feed stocks for the U.S. beef, pork and poultry industries.  The resulting good news may be lower prices for these areas next year.

3.       Ukraine – Success on the Ground May Spell Further Trouble – The situation in Ukraine appears to be getting a bit more favorable for the government in Kiev as the Russian Separatists strongholds continue to weaken.  While Russia continues to support them it appears that the attempts to resupply them with arms is being interdicted by the Ukrainian Army at the border.  The developments late in the week with Russian military formations crossing or cruising the Ukrainian frontier and being repulsed caused the market jitters all over the world especial in the European and U.S. Markets.  The longer view is this situation needs to be resolved in a manner favorable to the European Union (EU).  Delayed or cancelled natural gas deliveries to the EU will most likely hinder the growth of the collective economy and could push the continent into a recession once again despite the extraordinary measures taken by the EU Central Bank.

4.       Chinese Economy – Growth Continues to Slow – The Chinese economy continues to slow as the central government continues to struggle with large numbers of unemployment, scarce resources and lower demand for their goods in overseas markets.  Many of these markets are experiencing slower growth as well and consumer demand is not on a strong upward curve (U.S. and the EU).  Chinese manufacturing levels are the lowest levels seen in a decade and affect all sectors; leading to layoffs, plant idling and a reallocation of government assets.  This trend is not new and has been evident going back well into 2013.  What does it mean?  While the U.S. is a significant importer of Chinese goods they are also important consumers of our natural resources (steel, coal, wood, etc.).  A slowdown in their economy will definitely impact our economic well-being as well.  Indeed we live in a global, mutually reliant economy.

“I was really too honest a man to be a politician…and live” Socrates

Have a good week and enjoy the waning days of Summer but alas, Autumn too is wonderful.

 Steve

Brennaman’s Four Points for the Week August 11, 2014

1.      Equity Market Correction Did not materialize – Just A Return to Volatility – The market last week opened with a bang then settled into a simmering morass of fear, uncertainty and doubt.  The combined news from the Middle East (Israel, Gaza and Iraq) and the continued threat from Russia / Ukraine threatened to upset the already tepid trading levels in U.S. Markets.  Bottom line is by Friday the market as measured by the S&P 500 was essentially flat for the week and still positive for the year (5.8%).  Earnings this past week were a broad mix of surprises and disappointments.  In the Mega-Cap space Citigroup continues to underperform due to their settlement with the U.S. Justice Department slammed their earnings, resulting in net income per share of only $0.03.  Without the settlement the income would have been $1.24 beating estimates handily.  Therefore the stock was up on the announcement.  It makes you wonder what will make a stock’s price go down if legal troubles and low income does not do it.

2.      Economic Situation – No Big Change But Things Are Moving in the Right Direction – We are still trying to come to grips with the 2d quarter GDP growth of 4% after the dismal showing in the 1^st quarter of (-2.1%).  No doubt we will see a downward revision of the 2d Qtr. number but that is to be expected.  We are seeing improvement in many key leading and lagging indicators that indicate that the slow recovery is gaining momentum.  Unemployment is holding at 6.2%, capacity utilization rate is approaching historical levels and office space utilization is improving in key urban markets.  Not everything is coming up roses as we are still observing employment participation rates moving in the opposite direction as we would expect in a recovery.  We feel part of this movement is a two decade plus improvement in production efficiency through technology and an increased focus on lean operations in all industries.  Also an area of concern is the weak level of wage growth and the high level of long-term unemployed population in the country.  If the economy continues on this course and inflation remains within the FED’s target area (2%), the FED will stay on the sidelines after they stop the bond-buy-back program in October.  I keep saying it:  Do Not Fight the FED!

3.      Agriculture – As If A Continuing Draught Was Not Enough; Putin Decides on a Hunger Strike For Russia –   The simmering situation in Eastern Ukraine took on another look last week as Vladimir Putin decided to strike back at the coalition against Russia’s actions in the eastern half of the Ukraine.  He announced late last week that he was banning for one year all imports from the U.S., The European Union and several other players for their part in placing sanctions on Russian exports and imports.  While this will cause a significant price drop in many agricultural commodity categories, especially in the EU, who does this really hurt?  Russia cannot produce enough food for the population as it is (imports on average 40% of all food categories).  This is one of the reasons that the eastern half of Ukraine sis important to Russia as it is a significant source of agricultural products for export to Russia and other countries (It is important to remember that during the Soviet era Ukraine provided greater than 40% of the agricultural production for the Soviet Union – Putin remembers).  At the beginning of this week Putin may be pulling back from the brink of invading Ukraine but as the Ukrainian Army makes headway in reasserting control will Putin stay on the sidelines?  Not a bet I am willing to take.

4.      HealthCare in America – Law of Unintended Consequences – Every action has an equal and opposite action (Newton’s Third Law of Motion) or as I like to paraphrase it there is always an unintended consequence to an action taken by an individual or in this case the Federal Government.  As time marches by we see different turns in the unfolding of the Affordable Care Act implementation.  The latest installment (too numerous to list) involves unexpected profits.  Yes, profits (and costs to insurers) that were unforeseen.  Namely, hospitals and other providers have seen a dramatic spike in requests for service across the board in terms of demographics and services needed.  Increased surgeries (elective and emergent), the fulfillment of delayed care as previously uninsured / underinsured seek treatment as well as other care (maternity and geriatric).  Who are the beneficiaries?  Hospitals, urgent care providers and local physicians are bearing the “brunt” of the increased activity and reaping gains.  Who is footing the bill?  Insurance accompanies participating in the healthcare exchanges and the U.S. Government (you and me).  I am not complaining, as a renovation in our health care system was and is still needed, but the real unintended consequence will be higher premium rates in 2015 and beyond as the cost structure has to be balanced.  So, will the Affordable Care Act actually produce affordable healthcare?  Capitalism will win out and the heavy hand of the government will intervene.  Hence the law of unintended consequences.

 “It is the highest impertinence and presumption, therefore, in kings and ministers to pretend to watch over the economy of private people, and to restrain their expense. They are themselves, always, and without any exception, the greatest spendthrifts in the society.”  Adam Smith

Have a good week and watch for children as school starts this week everywhere.

Steve

Brennaman’s Four Points for the Week August 4, 2014

Brennaman’s Four Points for the Week

1.      Equity Market Correction? – Does Not Appear So – I had to rewrite this section as the markets opened positive this morning, starting with large cap and spreading to mid and small.  The drop we experienced last week was dramatic in many aspects.  True to form the old adage buy on rumor and sell on fact took hold as the economic numbers came in strong as a surprise to most observers.  Couple the GDP growth number of 4% (annualized for the quarter) with good job numbers along with the average investor looking for reasons not to remain exposed; the market tanked.  It is almost as if it is a self-fulfilling prophesy after all the market Bears have been announcing the end was near.  Is this the beginning of a correction?  I can only say that the conditions are ripe for a correction with market valuations in the high range and bull sentiment rising (until this past Thursday).  But the prospect that easy money from the FED will be here for at least the next 7-8 months and the U.S. economy is not recovering at a faster pace, I still think there are gains to capture in the equity market with the right asset allocation.  How well do you sleep with your risk profile?

 2.      Economic Situation – Nothing Has Really Changed– The 2d quarter GDP growth of 4% is staggering in the light of what we saw in the 1^st quarter of -2.1% (revised upward from   -2.9%.  I believe the 2d qtr. growth rate is an anomaly as was the weather induced 1^st quarter.  Much of the production was deferred until the 2d quarter as demand picked up and inventories built as the 1^st quarter ended.  Pent up demand while still weak across the board, still drove manufacturers to bring on new employees, open dormant lines and continued the move to normalcy.  However, wage growth is still anemic and unemployment edged up as many long-term unemployed reentered the job search.  The FED did not disappoint in that they reduced bond purchases by $10B and reaffirmed that the program will end sometime in the Fall.  In their announcement last week the FED gave no indication or hints as to when they will raise interest rates going forward.  Still, our best guess in late 2d quarter 2015 or later.  Inflation will drive this number with the unemployment rate a definite influencer.  Better to listen to what the FED says they will do rather than prognosticate.  Remember:  Do Not Fight The FED!

3.      The Middle East – Putin Has Got To Love It –   The confrontation between Hamas and Israel in the Gaza strip has diverted much of the media’s attention away from the Ukraine and the economic sanctions imposed on the oligarchs in Russia, as ineffective as the may be at the current time.  Vladimir Putin continues to parlay his influence in the Western hemisphere with yet another trip to South America, meeting with the Brazilian leadership, hoping to build economic relations within the region as he and Russian companies continue to seek out new markets for the goods they produce.  President Obama stating that Russia “doesn’t make anything” (Reuters and the Economist magazine) further illustrates relations between the U.S. and Russia are seeking new lows.  The crises in Ukraine and the Middle East threaten to overshadow our national security and economic interests at home and abroad.  China no doubt is watching.

4.      Earnings Season – Earnings Have Exceeded Expectations – Earnings reports are in from 359 of the 500 companies in the S&P 500 with 236 exceeding analysts’ expectations while 74 firms missing estimates.  Surprisingly, Financials led the charge followed by Industrials and Technology companies.  A dichotomy is the Financials sector had the most companies to disappoint, 13 while Consumer Discretionary followed up with 12 losers.  What does it mean?  Not much really.  Considering that 66% of companies (236) that have reported through July 31 exceeded expectations is a good indication that we are indeed still recovering from the Great Recession.  While only 20% (74) missed expectations the quality of earnings in too many cases is clearly evident that we still have a journey ahead of us in terms of growth and productivity.  Still, there is still light at the end of the tunnel (could be an oncoming train) so the next week of announcements may tell us the next junction ahead for us.  Of course, it can be said that the Earrings per Share (EPS) numbers we are seeing are somewhat inflated due to share-buy-back efforts by many of the large cap names in the index.  Nonetheless, by the measure of quarterly earnings in comparison with year-over-year earnings we are experiencing the results that may embolden the Federal Reserve next year.  Time will tell if this lagging economic indicator will hold sway and be verified by more forward looking data.  Earnings to look for this week are concentrated in the Energy and Utility sectors.  Look for strong earnings from Duke Energy, Transocean and EOG Resources. 

"Success is never final, failure is never fatal.  It is courage that counts.” John Wooden

Have a good week even if the market is not pretty.

 

Brennaman’s Four Points for the Week

Brennaman’s Four Points for the Week

1.                   FED Watch – Quantitative Easing III (QE III) Ending in October – What is next?  The Fed will likely announce this week that they are going to continue tapering the bond buyback program to $25B in July (from $35B in June) down from the $85B at the start of QEIII in 2012.  Inflation is tame at 1.9%, running below the 2% target for well over 25 months; with unemployment at 6.1% and improving (albeit at a snail’s pace).  Anemic economic growth as measured by the GDP remains the point of interest this week as the preliminary numbers for the 2d quarter should be released Wednesday.  Nonetheless, barring a negative number (not expected) the FED will end QE III in October and the real issue becomes when do they begin raising short term rates.  Our best guess is still 2d quarter 2015 or later. 

 2.                   Ukraine Watch – Appeasement tin the Works? – I hate to delve into politics (not really) but the situation in Ukraine continues to be unsettling on many fronts.  Let’s face it, Putin has done a very good job of positioning Russia in terms of controlling the situation in Ukraine.  He (and Gazprom) supply 40% of the energy (natural gas) consumed by the economies in the European Union (European Commission news release May 2014) with some countries approaching 60%+.  So what can be done?  European Union Energy Commissioner Guenther Oettinger has hinted that restricting technology related to energy development may be in the offing but has stopped well short of saying there will be sanctions on Russian exports to the Continent.  Economic sanctions on Russian exports and imports to Russia are likely to hurt the EU more (and the average Russian citizen) in the short run than hinder the policy of Putin and his foreign policy in Ukraine.  Russia is a major partner with the EU and the loss of trading could well plunge them (EU) into a recession; and a cold winter.  Worst case is the core of the EU, France and Germany, seeks self-service over remedying the situation in Ukraine.  Shades of Europe in the 1930’s.  Likewise can Putin afford failure in Ukraine?

3.                   The Bull Market – Earnings Announcements Are Taking Some Wind Out of the Sails – Apple, Amazon, and Visa were among the many companies announcing 2d quarter earnings this past week.  Apple provided fuel for an upward broader market movement but Amazon disappointed with another quarter of losses even with strong top-line growth.  Visa as well as General Motors and Starbucks missed earnings.  Anecdotally, these results and others could indicate that that the consumer is still reticent to return to pre-recession spending levels as they continue to deleverage and restore savings/investment accounts.  The wealth effect expected after five years of good market returns has not emerged on Main Street.  Despite the disappointing earnings news, the markets were basically flat for the week; trading activity was low maintaining a low level of price volatility, while the yield on the U.S. Treasury 10-year bond remains at 2.47% where it began the week.  So the Bull Market? – The number of days since the last correction of 15% or more stands at 678.  The average since 1929 is 752 days.  Historical trivia at its best.

4.                   Bond Yields – Do They Indicate Lower Confidence in the Direction of the Equity Markets? – We are in 20^th quarter of the economic recovery (National Bureau of Economic Research - NBER) that started in 2010 and the average length of expansions since WW II is 20 quarters.  So, are the low bond yields telling us to beware of investing in the equity markets?  As usual I tell clients to be diversified across the board and to look for risk and be prepared.  But I do not think the bond yields are telling us to head for the exits away from the equity markets.  Yields are where they are for many factors not the smallest of which is that central banks in developed nations continue to feed liquidity into the markets to stimulate economic growth.  Geopolitical risks and strife have put pressure on yields as well as investors seeking safety with available cash (still high levels after the market decline and recession).  Finally, low inflation (domestically and abroad) coupled with anemic economic production (GDP) is also adding to lower yields in nearly all bond markets (Russia is at 8%).  Until the Federal Reserve (among other central banks) sees inflation as a threat and GDP growth is healthier than at present, yields here and abroad will be muted.

“History doesn't repeat itself, but it does rhyme.”   Mark Twain

“Those who cannot remember the past are condemned to repeat it.”  George Santayana

Brennaman's Four Points For The Week May 12, 2014

Brennaman’s Four Points for the Week

 

1.       Russia and the Ukraine (continued) - The sanctions the West has imposed on Russia (Vladimir Putin) are questionable in their effectiveness and leads me to believe they are symbolic in the short run.  Over the weekend the deepening crisis in the Ukraine punctuated by the elections in eastern Ukraine for independent sovereignty (surprise – they voted 90%+ for independence) has pushed world oil prices back above $108 per barrel on fears that the supply to the EU would be disrupted.  This will have little effect on U.S. oil in the short run but if the supply is disrupted there or in the Middle East then we will see a spike in price in all things petroleum.  Some good news is that we are seeing natural gas inventories increasing at a faster rate than we have seen in the past and we should not have a shortage come the next heating season.  Natural gas prices continue to fall which helps to offset the effects somewhat of the rising crude prices.

2.       GDP Growth – Will it Go South? - The Gross Domestic Product (GDP) growth rate number is already being whispered as having contracted in the first quarter.  As you recall the number we expected was in the 2%+ range but we observed a number of .1%; with economists blaming the ill effects of a brutal winter across much of the United States.  Some economists are now saying the economy actually contracted by as much as ½% or more.  Definitely bears watching as the month progresses and we await the revised numbers.

3.       Shifting Our View to Southeast Asia. - China and her neighbors are still trying to get along in terms of fishing, oil exploration and in general freedom of the seas.  Again I pose the question – “Why do we care?”  It is clear and simple that free movement on the seas anywhere on earth is vital to economic growth and of course our national self-interest and national security.  As you recall, China has essentially claimed the entire South China Sea as their sovereign waters.  This action has been met with condemnation from nearly all the countries in the region since this action by China closes off access to deep sea commercial fishing and navigation routes if unilaterally enforced by the Chinese.  The growing Chinese naval presence in the region threatens to thwart free commerce and create an air of tension that could push the area into deeper conflict.  Any conflict would shut off the free movement of goods to and from China.  Not to mention the impact on Taiwan.  A disruption would impact our economy in a negative way.

4.       Existing Home Sales - The sale of existing homes is increasing in some markets, mostly in homes appealing to affluent buyers (dare we say “sellers’ market”?).  The areas are not located in any one area but seem to be in high growth states that are seeing lower unemployment and population growth.  Historically low mortgage rates are adding to the picture, especially in the price ranges not associated with “starter homes” (varies from “Location to Location to Location”).  Perhaps we are seeing a slow beginning to a better housing market as the spring and summer selling seasons go into full swing. 

Next week I will discuss investment themes we seeing emerge (or sustained) for the next 12-36 months. 

 

Have a good week.

Brennaman’s Four Points for the Week

I started writing these for my friends and clients.  I thought I would share these items each week with a wider audience.  Please let me know what you think.

Brennaman’s Four Points for the Week 

1.       The Gross Domestic Product (GDP) numbers that we observed last week were at first glance quite disappointing.  With the numbers approaching 0 at .1% growth for the 1^st qtr. of the year, many prognosticators were blaming the weather, the crisis in Ukraine and a general malaise that is generally associated with our slow recovery.  I agree that all three are evident in the low numbers but the drop from 2.6 in the 4^th qtr. of 2013 conveys a certain reluctance on businesses to stretch for growth when the overall environment is uncertain as to taxes, market growth both domestically and foreign, and the U.S. consumer still unwilling or unable to resume outsized spending while still deleveraging from high levels of debt.  Perhaps the revised GDP numbers at the end of this month will shed additional light.

2.       As a contrast to the dismal GDP growth rate, we witnessed a dramatic increase in new job creation for the month of April, driving the unemployment rate down to 6.3 from 6.7%.  This is a good directional movement and much a needed boost to consumer sentiment.  The fly in the ointment if you will is that nearly as many people (mostly older, long term unemployed) continue to leave the job market (actively searching for work or take lower paying jobs to fill the breach).  The pie in the sky numbers that we are adding new jobs at a rate not seen since the peak in  2008 (pre-recession) belies the fact that wage levels are still significantly lower than 5 years ago and the labor participation rates continue to decline.  This last is driven in part by the long-term unemployed dropping form the workforce but also by the fact there are not enough new jobs for recent high school and college graduates.  The number of new jobs that need to be created to fill this gap is closer to a number of 425K each month.  The Federal open Market Committee (FOMC) still sees the need for quantitative easing and remains committed to keeping interest rates low through the end of 2015.  We shall see.  Inflation is lurking.

3.       There appears to be an increase in corporate governance emerging.  Berkshire, General Motors and Pfizer are among the companies with shareholders and boards questioning the leadership actions taken by CEO’s in the conduct of their companies’ business.  Surprisingly enough there is still not a widespread discussion of the salaries these individuals are making even though their operational results are faltering.

4.       Ponder now the question as to when we should buy bonds versus staying with dividend paying stocks?  I am still in the camp that we are still waiting for the rising interest rate cycle to begin (“Waiting for Godot?”).  For the client with a time horizon of 5-7 years the S&P dividend yield is 2.06 versus the yield on the 5 year U.S. Treasury bond of 1.68%, stock dividends can be compelling.  The decision is a question of the level of risk the investor is willing to take not just how much yield she/he is getting for the move.  I think it is a discussion worth having with my clients.

 

Why Should We Care About The Ukraine?

Last week a client asked me why shoudl we care what happens in Ukraine. Aside from teh fact that we are a worl leader and should care what happens elsewhere in teh world, I decided to give a brief answer to him so we cold move on to other issues. Mainly eyh performance oif hjis portfolio over teh last 2 years.

Here is my response.

Why do we care? Forget Russian hegemony and imperialist desires of Putin we need to visit what really happens if things go south in a big way.

1. The European Union (EU) economy is and has been fragile for decades. Their ever growing dependency on natural gas from Russia and satellite countries highlights a weak point that Putin is sure to exploit if he has to do so. If the flow of natural gas is disrupted or stopped altogether the economies of the EU could grind to a halt. The EU as a whole is a huge trading partner for the United States and the repercussions would surely be felt in our own economy.

2. Russia is the number 3 (behind the Philippines and Indonesia) producer of nickel a key component in the making of modern steel. The U.S. does not even crack the top 15 in the world since we have limited deposits. The current world supply is constrained because of events in Indonesia (another article) so Russia has the goods that the world needs, at least the EU. See comments about the economy in number 1. Russia also has other deposits of minerals that are needed with the same possible effect.

3. A dominant Russia can have adverse effects ranging far beyond the Ukraine. The former Soviet bloc nations are unsure as to whether they are next in line if Ukraine is “reabsorbed”. These uncertainties restrict development of new markets for U.S. and EU goods. Our economy depends on the free flow of goods all over the world and adding areas of instability is another road block to future growth.

4. Finally, we see Russia as a competitor in the world market and if they are willing (and able) to subvert the government and free will of Ukraine, can we trust them in the market place to be a stable business partner? That is the real question

Have a good week and I look forward to hearing from you.

Steve