- Weekly market focus
- Can markets show some stability this week?
- Zero chance for a Fed rate hike this week but FOMC may adopt more conciliatory language
- Q4 earnings season reaches peak week
Weekly market focus — The markets this week will focus on (1) whether oil prices have at least temporarily bottomed, (2) whether the Shanghai Composite index can hold its tentative upward rebound or whether it falls further to take out its 2-year low posted in early-Jan, (3) whether the FOMC at its Tue/Wed meeting adopts a less hawkish view in its post-meeting statement due to the turmoil seen in the last few weeks, (4) the Treasury’s sale of $105 billion of T-notes this week, and (5) the peak week for Q4 earnings reports.
Can markets show some stability this week? — The big question is whether the markets this week will settle down after the volatile start to the year. The extraordinarily large size of the +13.2% upward rebound in March crude oil prices last Thursday and Friday may indicate that the crude oil market has at least put in a medium-term low. The oil market may have adjusted sufficiently lower to account for the incoming flood of Iranian oil. If oil prices can stop dropping, that would provide some stability for the U.S. stock market, assuming there isn’t a renewed drop in the Chinese yuan and/or Chinese stock market.
However, there is still much uncertainty about how quickly Iranian oil will come into the markets and whether oil prices have sufficiently discounted the extent to which Iranian oil will worsen the world’s oil glut. The market consensus is that Iran will be able to boost production by 100,000 bpd almost immediately and by 500,000 bpd within 6 months. However, oil prices could easily fall to new lows if Iran quickly dumps its massive supply of oil in floating tankers into the market and if it is successful in its attempt to ramp up production by 500,000 bpd within a matter of weeks.
The oil markets also need to assess the extent to which the plunge in oil prices seen since November is successful in shutting down oil production by high-cost producers and helping to curb supplies. Major oil companies have been announcing cost-cutting layoffs and further cutbacks in exploration. In addition, Baker Hughes last Friday reported that the number of active U.S. oil rigs fell by 5 rigs to a 5-3/4 year low of 510 rigs. However, U.S. oil production has so far fallen by only -3.9% to 9.235 million bpd from the 43-year high of 9.610 million bpd posted in October despite the 68% plunge in the number of U.S. oil wells to 510 rigs from the peak of 1,609 rigs in Oct 2014. Nevertheless, increased financial pressure on U.S. oil producers due to the renewed drop in oil prices seen since November is likely to result in progressively lower U.S. oil production as the year wears on.
Zero chance for a Fed rate hike this week but FOMC may adopt more conciliatory language — The chances that the FOMC will raise interest rates another notch at its meeting this Tue/Wed are virtually zero. The federal funds futures market is discounting the chances at only about 8%. The FOMC just implemented its first rate hike to a mid-point funds target of 0.375% in December and the markets have since been very volatile because of turmoil in China, the plunge in oil prices, and uncertainty about how tighter Fed liquidity will affect the markets going forward. Given this turmoil, the FOMC will not spring a surprise rate hike on the global markets that could cause a stock market meltdown.
In fact, the federal funds futures market is now discounting only one 25 bp rate hike this year by December. This stands in contrast to expectations before the January turmoil emerged for two 25 bp rate hikes in 2016.
The plunge in the U.S. stock market has not only reduced American household wealth but has also raised questions about how stable the American economy really is against the backdrop of weak growth across much of the rest of the world. Moreover, the plunge in oil prices seen so far this year has driven inflation expectations even lower, virtually ensuring that the Fed can’t hope to meet its 2% inflation target within even the next two years. The 10-year breakeven inflation expectations rate, which measures the difference between nominal and TIPS 10-year T-notes, fell to a 6-3/4 year low of 1.29% last Friday. Some members of the FOMC were already worried about low inflation before their December rate hike and those worries within the FOMC can only have grown after January’s plunge in oil prices and commodity prices in general.
Q4 earnings season reaches peak week — This will be the peak week for Q4 earnings with 132 of the S&P 500 companies scheduled to report. Notable reports include McDonalds and Halliburton on Monday; Apple, AT&T, and Capital One on Tuesday; Facebook, PayPal, and eBay on Wednesday; Amazon, Microsoft, Visa, Caterpillar, Ford, PulteGroup on Thursday; and MasterCard, Honeywell, Chevron and Phillips 66 on Friday.
Of the 73 reporting SPX companies, 73% have beaten earnings expectations, according to Thomson I/B/E/S, better than the long-term average of 63% and the 4-quarter average of 69%. However, only 47% of reporting SPX companies have beaten revenue expectations, below the long-term average of 60% and the 4-quarter average of 48%.
The market consensus is for Q4 SPX earnings to fall by -4.3% y/y, worse than expectations of +1.1 on Oct 1 when Q4 began, according to Thomson I/B/E/S. However, earnings growth is then expected to improve in 2016 with SPX earnings growth of -0.6% in Q1, +2.0% in Q2, +6.6% in Q3, and +13.3% in Q4. On a calendar year basis, the consensus is for SPX earnings growth to improve to +5.9% in 2016 from unchanged in 2015.
