Opinions Eric NuttallA Comment -- General Comments From an ExpertA CommentaryN/AAug 25, 2015
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Leverage and credit expansion
Leverage is often blamed for the 1987 stock market crash, about 38 years ago. Rising use of borrowed money, such as margin debt in equities or high loan-to-value ratios in real estate, amplifies gains during bull phases and magnifies losses afterward. Easy credit or relaxed lending standards frequently accompany bubbles. Currently, there is a lot of concern about margin debt. According to the U.S. Financial Industry Regulatory Authority (FINRA), margin debt is at about US$1.1 trillion. Sure, it is a big number, and is at a record. It represents two per cent of total S&P 500 market value, and is up 35 per cent in the past year. But again, it may not be as bad as it sounds. The S&P 500 is up about 15 per cent in the past year so some margin expansion is expected. Lower interest rates also help investors manage their debt exposure. And, two per cent of the S&P 500 does not sound like a lot, considering expected earnings growth forecasts in the 10 per cent or more range for next year. Still, margin debt is certainly something to watch, and may be a sign of future troubles.
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Watching for US Treasury announcements this week on quarterly refinancing needs. Appears requirements will be less than originally planned for. Upcoming US Fed meeting will also be indicative of US economy. If US Fed starts to issue more bonds than expected, not a good sign for markets (need to raise capital is bad). Widely expected that US Fed will keep rates flat, and appears rate cuts are on the horizon. Reduction of US Fed balance sheet will also be interesting to watch. Upcoming earnings from big tech companies will be defining on direction of markets (could break momentum of markets).
Best place to get growth in portfolio that is not tech oriented is ETF called PAVE. Offers investors an option to get infrastructure spending exposure. As globalization reduces, more spending will occur "at home" in North America. Bricks & mortal syple business' also provide traditional cash flows. Not a cheap valuation, but would recommend buying on share price weakness. PAVE ETF also pays a nice dividend yield for defensive investors.
Case for Owning Equities Over the Long Term:
This might make the prophets of doom quiver a bit. We ran a Bloomberg screen this week, using Jan. 9’s closing market prices, on every stock in North America. The market at that time had been open for a grand total of six trading days, yet we found 21 stocks that were up more than 20 per cent this year, ranging from a high of 106 per cent for Athena Bitcoin Global to 20.6 per cent for Structure Therapeutics Inc. Since we are on the topic of pie-in-the-sky news, how about annualizing those returns? Wow, that would be something.
For our screen, we only used companies with a market capitalization of more than $100 million. The two companies noted above are more than $1 billion each. If we take off our market cap restriction, we get even more early winners.
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Garner predicts a surprising but sharp uptick in grain prices though agriculture has been hated. Tech has made farmers more efficient. New production came online after the grain shortage following Russia's initial invasion of Ukraine. But demand from China has softened. However, the bears/pessimists have sold by now until we're now seeing a floor/bottom. Garner predicts corn rally to $5.50. Don't buy wheat now, only on dips. He expects wheat to rally with corn. Wheat's chart shows an inverse head-and-shoulders, so wheat is pointing up and could rebound to the neckline of $6.60; a breakout could touch $7.60. Soybeans could see short-term weakness, but a breakout past $13 could see the price reach $14, and can bottom at $11-11.80.
Historically it is a good sign that U.S. markets keep hitting record highs after 18 months of not making new highs. Also we are in an election year after a negative mid-term (presidential) market. This is good too, historically. There has been 5 new net term highs in January which predicts well for the rest of the year. A number of global markets have woken up after 15 years, including Japan after 30 years. There is a substantial improvement of the breadth of the market and in putting new money to work. Along these lines there could be a fair bit of money coming back into Canadian stocks. Also there are a lot of Canadian companies not just focused on the Canadian domestic economy, especially in industrials. Latin America and parts of Asia are interesting - not just the U.S. U.S. earnings are improving after a contraction - could be up 15% by the 4th quarter. There are corporations and individuals with high cash rates.
Energy. The implosion we have had rivals the great recession, and in fact is worse. In some cases names are trading at all-time lows. Negativity in the energy sector is unparalleled and is really historic. There are 3 reasons he feels people are so bearish on oil. 1.) We are told demand is very weak and there is a fear of Chinese demand falling. 2.) We are awash in oil with Iranian oil hitting the market and US production still up. 3.) The forward Strip with oil below $50 is all the way out to 2017. You can see why people are being far too negative. 1.) Demand today is at record amounts. Year-over-year growth rate is as strong as it has been since coming out of the great recession, so we consume more barrels today than we ever have in history. 2.) We know Chinese demand is weak, but he would love to see the data points that people actually have, because the numbers he has shows record oil imports into China and record gasoline consumption in China. Their demand has been flat lining for 3 years, so it is not a new story. If you remove China, emerging economic oil demand has been growing by 1 million barrels per day, each year for the past decade. At current oil prices, it is impossible for US production to grow and we are months away from it being down year-over-year. Even at $45-$55, US oil production could be down by half a million barrels per day by next year. The worst case of Iran is about 800 hundred thousand barrels a day to come onto the market. That represents 6 months of demand. For the past 5 years, outside of OPEC and the US, production has been falling while the average oil price has been over $100. There are companies that can theoretically still drill wells that have a positive rate of return, and yet are still going bankrupt. This is because the amount of cash flow most companies generate is not enough to offset their decline. 3.) The oil Strip tells us we should be negative. He believes we have to go to 2017 until oil is over $50. Looking historically at the predictive capability of Strip, the R squared is less than 1%. That means that one time out of 100 the Strip is actually accurate.
The valuation of these energy companies is unparalleled. You can get so much value for free, because everybody is so pessimistic. It is a waiting game of maybe 1-2 quarters. If he can buy stocks that are trading at 5X cash flow where he is getting possible reserves, their dividend, of which many are sustainable when we get a rally, stocks can go up by 50%-100%. He personally thinks we will recover to around $55-$60 at some point next year.