I hope you had a good Easter break.
As an aside, have you ever wondered why the world’s two biggest Christian religious celebrations occur when they do?
Christmas celebrates the birth of Christ. It also celebrates the rebirth of the sun (as opposed to the birth of the Son) because, in the northern hemisphere, the days start to get longer from this point.
Easter celebrates the death of Christ. But while we seem to know the precise date of his birth, we are not so sure of the date of his death. As a result, Easter Sunday always follows the first full moon after the Spring Equinox (northern hemisphere).
That’s why Easter falls in March or April. While the sun always crosses the equator at the same time (19, 20, or 21 March), the following full moon is variable. Hence Easter’s changing dates.
The timing of both Christmas and Easter tells you that we used to worship the Sun (and the moon and the stars) before we worshipped the Son.
Now, you could argue the world bows at the altar of money…or debt. They’re really one and the same thing.
The largest debt temple in the world, the US, isn’t seeing the fruits of its devotion.
Yesterday, household spending data released by the US Commerce Department showed personal consumption expenditures rose just 0.1% in February.
Revisions to January spending data also showed growth of just 0.1%. As personal consumption spending is the largest contributor to economic growth, this suggests that economic activity in the US will be weak during the first quarter.
This could be partly due to payback from a stronger than expected final quarter of 2015. Recent data revisions showed that fourth quarter economic growth in the US was 1.4% (annualised), up from earlier estimates of 1%.
That was largely thanks to better than expected consumer spending. In the current quarter, it seems, the consumer is pulling its head in.
That could prove a problem if the trend continues. That’s because, as a Bloomberg article points out, corporate profits suffered a big decline in the fourth quarter — and corporate profitability is a good leading indicator for the overall economy:
‘Corporate profits plunged 11.5 percent in the fourth quarter from the year-ago period, the biggest drop since a 31 percent collapse at the end of 2008 during the height of the financial crisis. For 2015 as a whole, pretax earnings fell 3.1 percent, the most in seven years, according to the Commerce Department.
‘That’s “bad news,” said Nariman Behravesh, chief economist for IHS Inc. in Lexington, Massachusetts. History shows that when earnings fall, the economy often follows them downward into recession as profit-starved companies cut back on hiring and investment.’
The article goes on to point out that much of the profit decline related to the woes of the oil sector; as a result, it wasn’t broad based. But clearly the energy sector has a big impact on the US economy.
What’s interesting is that a falling oil price is not showing up in improving profitability elsewhere. I’m sure some sectors benefit from lower energy costs, but the net, or aggregate, result is negative for the US economy.
Speaking of oil, the recent price surge is more about short sellers getting out of their positions than new buyers coming in to push prices higher. When a short seller bets on falling prices, they borrow stock, or the underlying security, and sell it. To get out of the trade, they need to buy the security back.
It is this need to buy back positions and exit the trade that is behind oil’s latest price surge. From Bloomberg again:
‘As crude has soared more than 50 percent since Feb. 11, the number of bets on increased prices has barely budged. Instead, the upward pressure on prices appears to have come from traders cashing out of bearish wagers at an unprecedented pace.
‘The liquidation of short positions during the last seven weeks covered by data from the U.S. Commodity Futures Trading Commission was the largest on record.’
To me, this is a sign of the oil market nearing a bottom. There may be one more capitulation low in the coming months but, if that does happen, I think it would be THE bottom.
While many people interpret a short covering rally as a ‘false’ rally, it often indicates that a bottom is close. Think about it. What is it that pushes prices down to their lows?
It’s usually short sellers, trying to profit from weak fundamentals, making money on falling prices. This trade builds its own momentum, and prices overshoot the fundamentals on the way down — in the same way they do on the way up.
But increased short selling actually provides fuel for the next rally. Short sellers are in for a good time — not a ‘long time’. It costs money to hold onto a short position; so, when prices turn, everyone tries to get out at once.
Keep an eye on the oil price from here. If it corrects lower again, but makes a higher low than it made in February (which was just over $27), that will be bullish. If it breaks that low briefly, and then bounces back, that will also be bullish.
If it plays out this way, I think 2017 should be a good year for oil related stocks.
But I’m not so keen on the banks. Updates on bad debts from both ANZ Bank [ASX:ANZ] and Westpac [ASX:WBC] on Thursday only served to cast a pall over the market. Not that they were all that bad (actually, ANZ’s announcement was pretty average), but they show that the bad debt cycle has turned.
This is important for bank profitability. Each year, banks make a provision for loans that won’t get repaid. These provisions detract from profits. At the low point of the cycle, low provisions boost profitability.
Thanks to low interest rates, we have been at the low point of the cycle for a few years now. But the cycle is turning, as the Financial Review reports:
‘The median bad debt charge for Australian banks has historically been about 0.34 percentage points of all loans, but the banks have been reporting much lower rates, in the teens and single digits, according to Credit Suisse.
‘Earlier this year National Australia Bank reported its lowest bad debt charge since 1980, an incredibly small $84 million expense for a bank with almost $1 trillion of assets.’
That sounds like the bottom of the cycle to me.
Sell banks and buy oil. If you have a two-year plus time horizon, it might not be a bad trade.
For The Daily Reckoning