THE DAILY EDGE (12 December 2016): Earnings Watch

Oil Soars as More Producers Agree to Join Output Cuts Oil prices surged by more than 4% after more oil-producing nations agreed to slash production, a move aimed balancing the oversupplied oil market.

(…) Over the weekend, a group of heavyweight producers outside of the Organization of the Petroleum Exporting Countries, including Russia, agreed to scale back their output by 558,000 barrels a day. The move would come on top of the cut of 1.2 million barrels a dayagreed to by OPEC in late November. The total reduction represents almost 2% of the global supply. (…)

The bulk of the cuts—300,000 barrels a day—have been pledged by Russia, which produces more crude oil than any other country. Other output reductions are promised by 10 other countries, including Oman, Azerbaijan and Sudan.

Bernstein Research noted that some of the non-OPEC supply cuts would come from natural decline but that most would come from self-imposed cuts.

The market got an extra boost of confidence on reports that Saudi Arabia indicated that, if necessary, the kingdom may be willing to take a deeper cut than the 486,000-barrel cut it had agreed in the November meeting. (…)

“Last week the U.S. oil rig count rose by 21 rigs to 498 which was the biggest one week gain since July 2015”, noted SEB Markets in a recent report. (…)

• Goldman Says Saudis Wrong to Rule Out U.S. Shale Oil Rebound

• Saudi Minister Jolts Oil Market in Whatever It Takes Moment

• OPEC Has a Deal, But Will Members Cheat?

(…) The Organization for the Petroleum Exporting Countries has a history of failing to enforce its own production limits, according to numerous energy analysts and former OPEC officials. The cartel’s agreements usually spell out exactly how many barrels a day each member must cut. But ensuring that everyone abides by these quotas has been supported only by a fragile honor system, with OPEC having no official mechanism for punishing members that stray from their pledges. (…)

In 17 production cuts since 1982, OPEC members have reduced output by an average of just 60% of their commitments, according to Goldman Sachs. OPEC exceeded its quota by an average of 883,000 barrels a day on average from 2000 to 2008, according to Morgan Stanley. (…)

• 10-Year Treasury Yield Above 2.5% as Oil’s Rise Spurs Bond Selloff

Protectionist Impulse Poses Threat to Global Growth, Warns BIS Mounting public and political skepticism toward free trade poses a threat to economic growth, according to the Bank for International Settlements in a cautionary reminder of the risks facing the global economy.

(…) “Looking further ahead, the most worrying signs relate to the risk of greater protectionism. Those signs have been multiplying in recent years, and prospects have darkened considerably with the most recent political events,” said Claudio Borio, chief economist of the BIS, a Switzerland-based consortium of central banks.

“There would be no winners, only losers. Lower global growth, and possibly higher inflation, would benefit no one,” he said in comments accompanying the release of the BIS’s quarterly review. (…)

OTHER HEADWINDS: Housing and Autos

Next, is the big two of household spending: cars and houses. Both are obviously harmed by a significant pop in the cost of money and each is displaying signs of late-cycle fatigue. Auto lenders are already dealing with a rapid rise in dud loans (delinquencies on sub-prime loans are the highest since 2010). To keep things moving—and delay loss recognition—they are increasingly resorting to rolling the debt incurred on prior purchases into the next transaction. The result often is negative equity on the new vehicle. There is also a looming mountain of metal coming off lease over the next two years, threatening to inundate the used car market. Meanwhile, housing was looking winded even before the affects of the recent big leap by mortgage rates. (David Hay, Chief Investment Officer, Evergreen/Gavekal)

Windy in China as well:

• World’s Largest Car Market Ready for Pile Up

(…) China’s passenger-car sales rose 17% in November to another record-high. It’s made China the fastest-growing market again both for local and foreign makers. But the strong demand may be less about a love for cars, and more a love for deals. A tax cut on car purchases is set to expire in December. The impending end of the tax has brought forward months of demand and consumers aren’t taking chances, locking in deals.

The blow might be cushioned if the tax rate is raised only in stages. State media reported that the state-backed auto association, China Association of Automobile Manufacturers, submitted a proposal to raise the tax to 7.5%. Yet that may not be enough of an incentive, given the extent of buying front loaded over the past year, and sales should slow, nonetheless. (…)

The car industry accounts for 10% of China’s economic activity, according to Credit Suisse, so the stakes of keeping it going are high. But China’s car market is now inundated with cars. And the vehicle population has hit an inflection point of sorts. Car ownership is nearing 20%. Put another way, one in five people now own a car, according to Nomura analysts. Going by the fate of other large car markets, like Japan and South Korea, that is when sales see a significant shift lower. (…)

Making U.S. Stocks Great Again

Good stuff from Barron’s Randall Forsyth with my remarks:

(…) As for fundamentals, the outlook for growth and inflation isn’t likely to shift, given that fiscal policy won’t change until next year at the earliest. The most immediate—and arguably most powerful—effects are likely to be from regulatory changes, which may be effected by executive order or by different guidance from the bureaucrats’ bosses.

For the markets, that means further mediocre global growth, subdued inflation, tamped-down volatility, and continued accommodative monetary policies from central banks around the globe. In other words, more of the same in the near term, much as if Hillary Clinton had won.

Hmmm…for now, markets are betting more on “less subdued” inflation. The Fed is clearly becoming hawkish while the ECB has announced its own tapering.

To be sure, what has changed is psychology. “Animal spirits,” to use Keynes’ hoary cliché, have been aroused, not the least in the stock market, where industrials and financials have gotten the biggest spring in their step. (…)

In another departure from the consensus orthodoxy, Berezin provocatively writes in BCA’s Global Investment Strategy report that, while rising protectionism could have a big negative impact on the global economy, the effects on the U.S. economy would probably be modest. The U.S. remains a relatively closed economy, with exports accounting for only about 12% of gross domestic product. Much of those exports are intermediate goods that are processed or reshipped back to the U.S. or another market. So, Berezin contends, it wouldn’t make sense for China or Mexico to put up barriers to American exports, since it would hurt their jobs.

Moreover, conventional wisdom is wrong that foreign producers can pass on U.S. tariffs to consumers, he continues. And while tariffs are a tax by another name, Trump’s tax cuts would offset the fiscal drag. In any case, tariffs would probably shift sales to domestic producers, with a boost to U.S. employment. Neither would tariffs hurt capital investment; indeed, domestic industries might have to boost spending to move production back onshore.

So, why even bother thinking and talking about that since protectionism seems to be a net positive for the U.S.. But wait, it’s not, after all:

But these short-term economic gains miss the big picture. “Trade agreements are also about politics—they help form the geopolitical glue that holds the global community together,” he writes. “The real reason the 1930 Smoot-Hawley Tariff Act was so disastrous was not because it contributed to the Great Depression, but because it led to a breakdown of international relations among democratic governments at a time fascism was on the rise.”

That protectionism could actually benefit the U.S. at the expense of other countries would likely stoke anger abroad, Berezin continues. China is especially vulnerable, but tariffs would probably also spread to South Korea and Vietnam, leading to a wholesale breakdown in global trade.

Even if Trump’s threats of tariffs on Mexico and China turn out to be negotiating ploys, some increase in trade barriers seems inevitable, even if they’re not explicit. “Trump’s success in browbeating Carrier into keeping its plant open in Indiana is an example of things to come. Corporate America does a lot of business with the government, and the subtle threat of canceled government contracts will make any CEO take notice. Good news for Main Street, perhaps, but definitely bad news for Wall Street,” Berezin concludes.

Meanwhile, S&P 500 profits might not benefit nearly as much as investors expect from promised corporate tax cuts, he adds, given that the effective U.S. rate is about 25% already, well under the statutory 35% rate. As for infrastructure spending, he doubts that there are enough “shovel ready” projects around.

Some even doubt there would be enough people to actually manoeuver the shovels…

THE STOCK RALLY ISN’T JUSTIFIED by faith alone, to be sure. What impresses Doug Ramsey, chief market analyst at the Leuthold Group, has been the uniformity of the market’s positive action, from the overall breadth of the advance to the action of various subgroups. About the only nonparticipant has been utility stocks, the most prominent of the bond proxies, which have trailed with the upsurge in intermediate- and long-term interest rates.

Seasonal tendencies also are on the side of the bulls at this time of year, he adds.

On that, David Rosenberg says that “from the two days prior to Christmas through to the opening week of January, the stock market in the past rallied 80% of the time. That compares to less than 60% the rest of the year.” Since tax rates are widely expected to decline markedly in 2017, taxable sellers are likely to take trading time off till year-end. That is for those who have profitable trades on their books. Losers would be well advised to book their losses this year.

And then there are those animal spirits, which are indicated in the CNN Fear & Greed Index, which has swung from extreme negativity at election time to giddy euphoria in a month, notes Peter Boockvar, chief investment officer at the Lindsey Group. (…) To which it might be added that laggard hedge funds and other money managers probably are lobbing Hail Mary passes in the rally to make their 2016 numbers.

Ramsey thinks the momentum and positive sentiment could carry the advance for another four to six months. And even such a confirmed contrarian says he has to admit that sometimes the crowd can be on the right side. (…)

This last Barron’s was indeed well laid out:

• Stocks: Beware the Early Days of January

(…) In the stock market, it is already the most wonderful time of the year. While stocks look overbought in the short term, with three of four stocks already stretching above their 50-day averages, the bullish throng won’t thin now—not when selling after Jan. 1 lets you put off paying capital-gains tax until April 2018, when the tax rate just might be lower. Even recent laggards are catching up, a sign that brokers are getting calls to hoover up anything that hasn’t yet shimmied higher. That helped swell to 18.6% the crop of S&P 500 stocks pushing 52-week highs, the highest in two years, notes Bespoke Investment Group. (…)

But here’s the useful part:

Morgan Stanley ’s bull case pegs S&P 500 per-share earnings at $147.30 next year, and the index pushing to 3050, but its bear case puts earnings at $114.40 and the index at 1625. Bank of America Merrill Lynch likens 2017, the Chinese year of the rooster, to “an erratic bird with fat tails.” Its bull case puts the S&P 500 at 2700, its bear case at 1600. (…)

And this warning for those few who might care:

Unlike households, corporations have binged on cheap rates, and net debt to earnings before interest, taxes, depreciation, and amortization among Russell 2000 companies (excluding financials and cash-rich technology names) are near the highest in at least 30 years, notes Merrill Lynch. The percentage of S&P 500 companies using buybacks to shrink outstanding shares year over year recently peaked near 65%, just as it did in 2007, and is starting to slip. Rallying stocks ratchet up expectations for the new administration to deliver and avoid policy missteps. (…)

• U.S. Share Buyback Authorizations Sizzle in November

(…) Stock repurchase authorizations by U.S. companies totaled $83.8 billion in value for the month, according to Birinyi Associates Inc., a 76% rise from November 2015, when they totaled $47.6 billion.

It was the most robust November for share buyback authorizations since 2005, when companies set buyback plans of $88.5 billion, according to Birinyi. (…)

A couple of exceptionally large buybacks contributed to the November spike. (…) CVS Health Corp.’s board, for example, approved a new $15 billion plan while Facebook Inc.’s directors authorized one for $6 billion of its class A common stock. (…)

Even including the robust November figures, though, authorizations for the first 11 months of 2016 trail those for the corresponding period last year by a wide margin, $628.5 billion versus $783.2 billion. The number of buyback authorizations was also lower, 902 versus 1,158.

Last year was an exceptionally robust year for buyback executions, with companies making repurchases of $696.4 billion. That was the highest number since the year before the financial crisis, 2007, when companies executed $761.8 billion in buybacks.

Year-to-date through November the financial sector notched the biggest number of buyback authorizations at 281, or 31% of the total, according to Birinyi. It also authorized the largest amount by value at $141.2 billion, or 23% of the total.

EARNINGS WATCH

From Factset:

In terms of estimate revisions for companies in the S&P 500, analysts have made smaller cuts than average to earnings estimates for Q4 2016 to date. On a per-share basis, estimated earnings for the fourth quarter have fallen by 2.2% since September 30. This percentage decline is smaller than the trailing 5-year average (-3.4%) and the trailing 10-year average (-3.9%) for the first two months of a quarter.

In addition, a smaller percentage of S&P 500 companies have lowered the bar for earnings for Q4 2016 relative to recent averages. Of the 110 companies that have issued EPS guidance for the fourth quarter, 75 have issued negative EPS guidance and 35 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 68%, which is below the 5-year average of 74%.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings growth rate for Q4 2016 is 3.0% today. On September 30, the expected earnings growth rate was 5.2%.

As a result of downward revisions to sales estimates, the estimated sales growth rate for Q4 2016 is 5.0%. On September 30, the expected revenue growth rate was 5.3%.

Pre-announcements are indeed positive so far:

But estimates have really improved in only 3 sectors. Eight sectors are seeing a fairly significant degrading in their Q4 outlook, including the currently popular Industrials. To be closely monitored.