Unofficial week 1 in the books….
The unofficial first week of first quarter 2016 earnings is in the books. And what did we learn? Two things: (1) financial companies (XLF) are being hurt by the interest rate and global economic picture and the remainder of 2016 will be challenging for them and (2) the market tends to trade higher if companies beat Wall Street expectations … even if those expectations have been dramatically reduced.
It is one of those odds things about earnings season. The market seems to breathe a sigh of relief if a company can beat the Street estimates, regardless of the level or the change leading into the report. Companies experience reduced sales and earnings per share, but yet they still trade higher. This dynamic has been a head-scratcher for me over the years, but like a lot of things in the market, you simply don’t find the underlying reason.
For the longer term, however, we should be paying attention to the first thing we learned: Interest rates (^TNX) and global economic activity will make this year hard for banks and other financial institutions. If that is true, then that means the market overall will find it hard to achieve meaningful gains as the struggles in the financial sector will eventually be reflected elsewhere. Next week is tech (XLK), with two more big financials, Goldman Sachs (GS) and Morgan Stanley (MS), also coming out. If we hear the same downbeat forecasts, don’t expect the rally to last much longer.
Speaking of interest rates …
I’ve been struck the last few days with all of the commentary on Japan’s failed negative interest rate experiment. Negative interest rates are a last ditch effort by a central bank to stimulate the economy by effectively imposing a tax on the excess reserves that banks hold at the central bank.
Obviously, the central bank is forcing the member banks to lend the reserves to earn a risk adjusted return on the capital. This, in turn, should stimulate a economy as loans create demand deposits, which create activity. Also, consumers should be spending their money as they will obtain greater value by spending instead of saving.
That’s how it should work in theory, but it has broken down and a lack of confidence in Abenomics now pervades. You need two things for this to work: willing borrowers and willing consumers. Unfortunately, both are in short supply at this time in Japan.
The Japanese experiment provides valuable lessons that monetary policy alone cannot solve all of the world’s economic ills. Negative interest rates should stay in the financial laboratory.
Before the big week in earnings, we may have a busy weekend…
All eyes will be on Doha to see if any substantive news comes out of the big oil producer meeting, which includes most OPEC members and a few non-members—namely Russia. I won’t be paying that much attention because I doubt anything real will happen. Even if some earth shattering news does come out, there’s still the likelihood that the parties will renege on the agreement.
Despite my cynicism, the meeting will be important for gauging oil prices (CLK16.NYM). And, as we know, oil prices have been driving equity prices. The current price seems to be in a sweet spot for the Saudis. At $40 to $45 per barrel, the hit to its national budget is not as dramatic. Yet, that is a level which still makes it infeasible for many North American producers to operate, thereby curtailing its major competition. Given this, it seems to me that there is very little incentive for them to change the current state of affairs, so this this weekend's meeting may be a big yawn.
No matter what happens, the prevailing linkage holds: WTI crude above $40 (and especially above the 50-day moving average of $41.45) is good for equities. WTI below $40 is bad.