CWS Market Review – December 12, 2014

“Successful investing is anticipating the anticipations of others.” – J.M. Keynes

Before I get into this week’s issue, I want to remind you that I’ll be unveiling the 2015 Buy List in next week’s CWS Market Review. As always, I’ll be adding five new stocks and removing five current ones.

For tracking purposes, the “buy prices” of each stock will be the closing prices on December 31, 2014. The exchanges will be closed on New Year’s Day, so the new Buy List will go into effect on Friday, January 2. Once the Buy List is set, it’s locked and sealed. I won’t be able to make any changes until next December.

Now let’s look at the market’s latest doings. Last Friday, the Dow came within inches of cracking 18,000 for the first time in history. But the market followed up by dropping the next three days. It could have been a fourth as the indexes dropped quickly going into Thursday’s close, but we held on to modest gains.

The major development continues to be the remarkable decline in the price of oil. What started out as a modest pullback has turned into a full-fledged rout. I’m ready to say it out loud: “OPEC is dead!” On Thursday, oil dropped below $60 per barrel for the first time in five years. I don’t think people are surprised that oil has fallen, but nobody expected it to fall this much this quickly. Less than six months ago, oil was going for $107 per barrel.

What makes the falloff in crude so important is that much of the world economy had been based on oil’s being worth around 80% more than it currently is. I’m not exaggerating when I say that the math of the entire world economy has shifted. In this week’s issue, we’ll look at what the fallout is. We’ll also take a look at the recent news from eBay ($EBAY), and we’ll preview next week’s earnings report from Oracle ($ORCL). But first, let’s take a closer look at last week’s jobs report and what it means for investors.

The Economy Created 321,000 Jobs Last Month

Last Friday, the Labor Department reported that the U.S. economy created 321,000 net new jobs last month. That was well above expectations, and it was one of the best jobs reports in years. The unemployment rate is now down to 5.8%. I was pleased to finally see some real improvements in “discouraged workers” (folks who had left the workforce entirely). There’s also some evidence to indicate that wages might be growing as well.

What’s the impact of an improving jobs market on the stock market? There are several factors at work. For one, it helps consumer stocks. More people with more jobs being paid higher wages means more shoppers. Since the beginning of August, retail stocks have done twice as well as the rest of the market. On Thursday, the Commerce Department reported that retail sales rose 0.7% in November. That’s the best report in eight months. (By the way, ignore any discussion of the impact of Black Friday. It’s really not that important.)

The retail sales report for October was good as well. Clearly, cheaper fuel prices are helping the gains here, and this portends a strong holiday shopping season. On our Buy List, Ross Stores ($ROST) hit another new high on Thursday.

An improving jobs market is also good for financial stocks. Obviously, more people working means a lower default rate. On a relative-strength basis, financial stocks have been doing very well this month. Wells Fargo ($WFC), our favorite big bank, is close to a new 52-week high. The better jobs market also has a major impact on homebuilding stocks. The homebuilders had been lagging the broader market since early 2013. Only in the last two months have they resumed leading the market. I think this trend will continue. Mortgage rates are still holding below 4%.

Speaking of mortgage rates, the recent behavior of the bond market has been interesting. Bond traders were largely unimpressed with last week’s jobs report. Yields ticked up for a bit, but the yield on the 10-year is back below 2.2%. Interestingly, the yield on shorter-ranging debt is starting to creep higher. The yield on the one-year Treasury has doubled in the past few weeks. Of course, by doubling, I mean going from 0.1% to 0.2%. Still, the one-, two- and three-year Treasuries are all near three-year highs, while longer-term yields have trended lower. This means that the yield curve is getting narrower.

One of my favorite economic indicators to watch is the spread between the two- and ten-year Treasuries. Whenever the 2/10 spread turns flat or negative, the odds that a recession will soon follow are quite high. Since the beginning of this year, the 2/10 spread has narrowed by more than 100 basis points. (One basis point is bond-nerd shorthand for 0.01%.) The 2/10 spread is now down to 157 basis points, which is still quite wide, so I doubt we’re in immediate danger of a recession. The 2/10 spread hasn’t dipped below 120 basis points in nearly seven years.

To me, this indicates that bond traders truly expect the Fed to raise interest rates sometime next year. This is also why the dollar has been rallying. As long as the yield curve remains relatively wide, stocks are the best place to be. But this won’t last forever. To borrow from Churchill, the narrowing of the spread isn’t the beginning of the end for stocks, but it is the end of the beginning. Now let’s look at the stunning drop in oil.

OPEC is Dead

On Thursday, the price of West Texas Intermediate Crude dropped below $60 per barrel for the first time since July 2009. This is the biggest fall since the financial crisis. The difference this time is that it’s not about demand—it’s about supply and demand.

Of course, the tremendous growth of U.S. shale has roiled oil. President Rouhani of Iran said that the drop in oil is a conspiracy against the Muslim world. (I’m not making that up. He really said that.) Apparently no one told the Saudis, because they seem perfectly willing to stand by and watch oil fall.

The fact is that OPEC, for all intents and purposes, is dead. Killed by shale. OPEC simply doesn’t have the pricing power they used to. If a cartel can’t do that, what’s the point? The U.S is rapidly becoming energy-independent. Plus, the U.S. economy is much more efficient than it used to be. Twenty years ago, the U.S. consumed 1,760 barrels of oil for every $1 billion in GDP. Today that’s down to 1,178 barrels. On top of that, China’s economy appears to be slowing, so that’s pinching demand as well. There’s talk that oil could fall as low as $40 per barrel. Wow!

Naturally, the strong dollar is playing a major role as well. The greenback just backed off a two-year high against the euro and a seven-year high against the yen. Bond yields in Europe aren’t just low—they’re absurdly low. The yield on the German 10-year bond got down to 0.68%. With falling oil, there’s now fear that Europe might experience deflation. That would be more ammo for Mario Draghi to start his own QE program. The euro might be headed a lot lower.

The oil bear is weighing heavily on Russia. The ruble is looking more like rubble. Russia estimates that inflation will hit 10% next year. The Russian Fed raised interest rates again this week, but the forex market just laughed at them. I don’t blame them. Despite a lot of talk, the Bank of Russia simply isn’t serious about defending the ruble. The BOR raised rates by 1% to 10.5%. Please. If they’re serious, they would have raised rates by 2% or 3%. That’s what needs to be done.

The impact of lower oil can be seen in so many different areas. Tesla ($TSLA), the headline-grabbing electric-car stock, is 28% off its high from September. Energy stocks as a whole have been getting clobbered. The Energy Sector ETF ($XLE) was over $100 per share in July. This week, the XLE dipped below $75 per share.

My advice: Don’t be fooled into thinking energy stocks are cheap. A lower stock simply means it’s cheaper than where it was, not that it’s cheap in an absolute sense. I’m still leery of most energy stocks. I expect oil to continue to fall. The forces working against oil are just too strong. This is good news for many consumer stocks. Now let’s look at one of our favorite consumer stocks, eBay.

eBay is a Buy up to $60 per Share

Shares of eBay ($EBAY) got a nice bounce on Thursday. Unfortunately, the good news was rather unpleasant news. The Wall Street Journal reported that eBay is considering laying off thousands of workers next year in preparation for their spin-off of PayPal. According to the WSJ, the online-auction house is looking to shed 3,000 positions, which is about 10% of their workforce. The cuts will mainly impact eBay’s marketplace division, which runs and StubHub.

Personally, I’m conflicted about news items such as this. I can’t help but think of the employees who are laid off. However, I have to concede the reality of the situation; eBay is planning to be a stand-alone company, and they need to keep overhead as low as possible. I also realize that the market very much approves of this kind of news. Shares of EBAY jumped 2.7% on Thursday to reach a nine-month high. This week, I’m raising my Buy Below on eBay to $60 per share.

Oracle Earnings Preview

Oracle ($ORCL) is due to report fiscal Q2 earnings on Wednesday, December 17 after the closing bell. I wasn’t exactly thrilled with Oracle’s last earnings report. The company missed earnings by two cents per share (62 cents versus a 64-cent estimate). This was the third quarter in a row in which Oracle missed estimates. But not everything in the report was bad; Oracle’s cloud business is doing quite well. The hardware business, however, continues to be a weak spot.

The biggest news in the last earnings report wasn’t earnings—it was that Larry Ellison said he’s stepping down as CEO. In his place, Mark Hurd and Safra Catz are now co-CEOs. In my opinion, that’s a big mistake. These things sound good on paper, but I’m convinced that any dual CEO scheme is a bad idea. I predict that within two years, there will only be one CEO, and it will probably be Mark Hurd.

Oracle told us to expect Q2 earnings to range between 66 and 70 cents per share. Wall Street expects 69 cents. According to my numbers, that’s about right. Oracle is coming through a difficult period for them, but I think things are turning around. The company should earn at least $3 per share for this fiscal year, which ends in May. That means that Oracle is going for about 13.6 times this year’s earnings. That’s not bad. Plus, I think Oracle may raise its dividend soon. Oracle remains a buy up to $42 per share.

That’s all for now. The Federal Reserve meets again next week. The policy statement will be out on Wednesday afternoon. It will be interesting to hear of any changes in their thinking. We’re also going to get key reports on inflation, industrial production and housing starts. Also, Oracle will report earnings after the close on Wednesday. Don’t forget: Next week, I’ll unveil the Buy List for 2015. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on December 12th, 2014 at 7:09 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.