Sunday, November 29, 2015

Paper on Monetary Policy During Financial Crisis on Second Tab!

Hey guys, over Thanksgiving break, I wrote a little paper on some of the ways Ben Bernanke communicated with the market in order to try and fight the financial crisis. He called it "open mouth operations" a very catchy name that is referenced in my paper. If you would like to read it, go to the second tab on the website! Also, commenting is available for anyone who wishes to share their opinion.


Monday, November 23, 2015

Thanksgiving Markets

Trading resumes on the last full week of November with one of the biggest retail days in sight. After Thanksgiving feasts in the United States, consumer, both online and off, will spend copious amounts of money trying to capitalize on their favorite stores' sales. Like a proverbial"run of the bulls" at Pamplona, hordes of people will wake up early just to partake in the opening of the most robust season of spending in the world, the road to Christmas. Just like those charging bulls in Pamplona, investors will tend to trade in an uptrend as many sectors feel a boost of demand. While prospects for consumption are sure to increase going into December, trading sentiment is currently dragged down by bearish energy shares. Therefore, we should see a lot of flat movement as buying and selling in the overall market will be about equal. individual industries might experience different trends, but broad-based gains and losses should cancel any clear trend through the rest of November and possibly December. Today's trading represents the equilibrium that I am predicting. Earlier in the session the S&P 500 spiked up and down but look to end at a loss of about -0.15%. European and Asian major market indices close similarly with a tiny swab of sellers forcing parsed gains. The Russell 2000 gained 0.64% today representing the benefits of the Christmas season to smaller firms. Because they have smaller cash flows and may obtain a majority of their revenue through consumer consumption, smaller bullish periods as such have more of a positive effect on their price. On top of that, new product releases tend to occur during the densest shopping segment of the year which could predict upgraded revenue streams and new popularity among consumers. With the jolting nature of trading, the volatility index, VIX, grew by 1.49% to warn of the potential for more whipsaws in pricing. Even though there was an increase today, the index continues to trade near 52-weeks low with most investors feeling relatively stable when trading equities. One area that I'd expect to be leading gains in the quarter is the consumer goods sector with emphasis on retail and other similar industries. In Monday's trading, these trends already showed the potential to develop with gains just under 1% for both the S&P Retail Select Industry and the S&P Leisure Time Select Industry on the day. During the same time, Oil and Gas Production and Exploration and Mining and Metals Select Sectors both traded down over -2%. Look for these two industries to lag through the end of the year even though these losses are confined to today's observations. The commodity decline continues to pervade forms in these areas with deflationary pressures in mind as interest rates could be hiked.

These are just a few glimpses of the markets today. There is a whole lot out there that wasn't discussed, but I leave the post abbreviated today and probably through the week, As I have returned home for Thanksgiving, I have decided to hold posting for this week and focus on family, college assignments that I need to finish up at the end of the semester. Check out my StockTwits and Twitter pages for posts on comments I'd like to make throughout the week. Otherwise, enjoy Thanksgiving and have a great week with family. These are the breaks that are so important to replenishing clarity and inspiration to thoughts in every kind of thinking. Cherish them.

In the near future, I will be working on a little statistical study of the numerical correlation between price and supply in Henry Hub Natural Gas and WTI futures trading. It will be very exciting!

Thursday, November 19, 2015

How Low Can Oil Go?

Today, investors trade off of gains in Wednesday from the release of the FOMC meeting minutes that supported rate hikes in December. As a result, the S&P 500 gained 1.35% at the signal of stronger economic growth as well as the conveying the belief that rate hikes are the right move. Some of the more hawkish Fed members already voiced regrets of not raising rates earlier and the tide seems to be turning in their favor. In my opinion, the major delay of rate hikes this year has splotched Janet Yellen's credibility as a central banker who can rule on the middle ground. Her decisions demonstrate her dovish tendencies in FOMC meetings which may have appeared desirable coming out of the financial crisis with a sizable unemployment but not during stabilization periods of the business cycle. While most lost faith in the free market system during 2008, it remains the single most effective pricing mechanism for the value of goods and the value of capital. The Fed cannot facilitate limitless growth. Moving into Thursday's trading, muted movement caps off gains earlier this week as a bullish trend trails off with lower volume throughout the market. Despite opening higher, the S&P 500 trades around 0.00%  at midday with small bearish undertones. The NASDAQ is trading slightly higher at 0.16% as tech companies have their rallies muted as well. European and Asian stocks show a little more bounce on Thursday with the Euro STOXX 50 up 0.50%, the China Shanghai Composite up 1.36%, and Nikkei 225 gaining 1.07% on the day. Global stocks in these markets are most likely responding to a call for more European stimulus which will trickle into major importers that are in the Asian countries. MSCI Emerging Market Standard indices are just slightly negative with losses of -0.13%. Gains from the emerging European nations counter the losses in the rest of the developing world. Looking at yield spreads over Treasuries, one can observe the effect of the last FOMC meeting and the minutes just released. European 10-year bonds have dropped 13.85 basis points below the Treasury 10-year in November alone. Currently, only two countries in Europe have higher 10-year yields, Greece and Portugal, who have both experienced financial pressures over their debt in the recent past. Stimulus programs from Draghi will continue to dilute the yields in Europe making U.S. bonds look appealing due to their higher yields. Dissection of the markets will reveal lagging securities in the industrials and energy sectors which have been the notable industries dictating overall movement in almost every trading session. Leading losses in energy is the mid-sized Chesapeake Energy Corporation with a decrease of -9.83%. The company headquartered in Oklahoma with assets across the U.S. has been ravaged by the supply glut with YTD losses of -72.36% compared to the S&P Oil and Gas Exploration and Production Index which has YTD losses of -22.54%. With the energy losses, the healthcare services industry is also weighing on stocks with Tenet Healthcare Corporation leading those drops trading -8.26% lower. On the other side of the markets, the consumer non-durable and transportation industries lead gainers with stocks there jumping just over 1%. The biggest gainers on the day were Keurig Green Mountain at 18.17% and the J. M. Smuckers Company at 7.21%, both of off positive earnings surprises that have been the story of gains in October and the beginning of November. The gains from these consumer non-durable firms reflect the bullish trend elicited by growth in U.S. retail sales. October retail sales grew very slightly, but it represented the efforts of the economy to reverse the effects of the global slowdown. Higher numbers were expected as many retailers and consumer non-durable companies had positive earnings surprises at the end of Q3 and lead the bullish trend we've seen in the last month and a half.

As market technicals begin to slow down after an upturn in October, both crude oil benchmarks have slowed down into trading in a tight range about $5 wide. On the day, Brent crude gained just 0.25% while WTI dipped into the $30s after a -0.37% left the price at $40.61. This is one of the lowest prices since it finished its "summer plunge" in August. This chart shows WTI price from the end of Q2 to the beginning of Q4. Concerning overall trends, three periods can be extracted and analyzed as clear technical trends that analysts have scrutinized over the 2015 year. The first trend, starting in the summer and ending at the close of August, saw trading dip to the high 30's where a clear bearish trend is extrapolated. Here, momentum and reversals built up in favor of a rebound by the end of Q3. Curiously, major gains paired with the popping of the Chinese stock bubble where global demand appeared in peril. Most investors trading bullishly at the end of August responded to technicals that signaled a reversal. RSI showed that the contracts were oversold, and the Chaikin Money Flow graph reveals a reduction in shorts that broke the weakness of supply and spurred buying into long-term positions and the realizations of shorts. That marks the beginning of the third technical period where trading enters consolidation and the formation of a small head and shoulders formations. The period is relatively short but was distinctly different than the summer trend. Volume levels around then drifted at bullish levels, but demand faltered and never become even slightly overbought (RSI around midway). The MACD line showed no major reversal with 4 or 5 crossover points within 2 months. The resistance and support levels between the dotted blue lines show the trading range that most investors were confident would settle trading into the end of the year. Unfortunately, waning demand and an acceleration of selling move the WTI benchmark into its third ongoing phase. After breaking out from the head and shoulder support, the spot price threatens to drop into sub-$40 territory. CMF shows a consistent increasing of bears suggesting that the trend hasn't tapered off into consolidation yet. RSI shows no evidence of  significant momentum in the other direction either. I suspect that trading will be a bit more bearish in the coming weeks as broad weakness will hit the market will soft losses. Another interesting thing to notice is the type of broad activity in the markets that moved in the background during each of the periods. Over the first period in the summer, U.S. and global stocks traded mostly bullish and flat with the August correction a notable event during that timeline. In period two, the bullish rebound helped energy stocks jump to new highs for the last half of the year. When equities took leaps and bounds in October, WTI was caught in a consolidation phase with muted gains even though demand recovered significantly;y through better economic statistics and positive earnings surprises. The start of November and the new third period defined here paired with equities tending to trade lower than the month before. Month-to-date losses for the S&P 500 amount to -0.23% with threats of more selling as rate hikes are likely. It's not a clear relationship, but a connection may be worth exploring for prediction purposes. On the other hand, I might add that WTI price cannot go much lower as even bottoms around $35 look dangerous to oil and gas revenue streams. If the trend develops like a bearish head and shoulders, there should be some kind of retracement of the height of the head which is measured at approximately $6.73. So going forward consider these Fibonacci retracements. Are they plausible? Is there enough momentum?

Height of head: $6.73
  • 38.2% = $2.57    Low: $40.45
  • 50% = $3.37       Low: $39.65 
  • 61.8% = $4.16    Low: $38.86
  • 100% = $6.73     Low: $36.29

Wednesday, November 18, 2015

Oil Shares Lead a Market Supporting Solidarity

The biggest story of the weekend, which has already begun to pour into the following week, was the terrorist attacks in Paris along with the manhunts and retaliations that followed. Most people understand the political ramifications of the ISIS attacks but aren't often as privy to the consequences in the markets. This is exactly the premise of successful terrorism, that the target experiences detrimental changes in political, social, and economic structures which either hinders growth or disrupts the ability to strike back. In this case, ISIS sought to limit the political will to conduct an air campaign in Iraq and Syria. The results? Well, let's say they came out in favor of solidarity.

The S&P 500 of the United States actually grew 1.51% over the past two days with Monday's movement more intense than today's flat movement. Small cap stocks remained solid as well despite bearish movement last week and the attacks in Paris. Gains of 0.73% were sustained even though a correction today forced a tiny correction. Overall, U.S. markets looked generally healthy with investors appearing to support Paris "solidarity" and "unity" in the face of needless slaughter. Threats of possible terrorist activity in the U.S. were absent in market psychology with traders resuming trends and sentiment that were seen last week. But somehow, I feel that Monday gains after the minute of silence scheduled before the opening bell were a response of determination and hope that we will not let this horrible act move us. Economic sanity remained. European shows of strength were even stronger with the DJ Europe index increasing 1.82%.

Provided by FactSet
If this graph doesn't encapsulate the beauty of strength in the face of evil, then look closer. Yes, the DJ Europe index grew 1.82% through today's trading session which was impressive enough, but three of the most affected countries almost all doubled those gains over the same period. The Germany DAX sprung up 3.26% and the Belgium BEL 40 jumped 2.98% as dozens of counterterrorism raids made tangible the Islamic State network in those nations. Beating them still was the resilient markets of France exploding to 3.82% growth in two days, more than doubled the European index indicated. For any ISIS supporter hoping to observe economic chaos that they thought would ensue, those hopes were obliterated by Central European investors who supported their country with the bullish sentiment. These numbers directly contrast the effects of the 9/11 terrorist attacks in the United States which caused a panicky trading atmosphere that induced a minor recession coming out of the tech boom. Although most of the gains have been blamed on proposals for new stimulus from the ECB and Draghi, I can't help but claim that there is a greater cause in the trading today, and ironically, it would make more sense and less be less irrational than trading around terrorism usually is. Looking at 9/11 investing sentiment particularly, the horde of buyers and sellers erratically projected a future of chaos because of one major terrorist attack in New York. Any economist or financial analyst would agree that group psychology overcame fundamental valuations when traders systematically undervalued stocks irrationally. But that is the overall goal of terrorism, to incite paranoia in every branch of a particular society. Today, if anything, rational behavior overrode panic as economic chaos was set aside for a "business as usual" approach. On the other hand, many investors believe that the ECB will respond to solidarity with easier policy. Something that Draghi should be wary of doing, especially with higher probabilities of Fed rate hikes which could create an unstable global marketplace. 

Stocks and indices are indeed predicting something other than "business as usual" as military campaigns are accelerated because of the attacks. Shares of energy firms and some energy commodities are experiencing bullish undertones as ISIS policy talk pervades the necessary media coverage of political events such as G20, NATO conversations, and internal agenda discussions in the U.S. the leading member of a global coalition against the Islamic State. As discussed in my previous article, airstrikes against key oil outposts of ISIS were deployed on Monday with hopes of choking financial streams fueling the terrorist network. These attacks changed the resistance's course from "containment" to "destruction." With that, investors must begin to consider, and adopt into their subsequent trading strategies, the possibility of a more aggressive plan in Iraq and Syria with discussions of a ground force presence put on the table by French officials and a few other Western leaders outside of France. Just like the Fed futures contract's movement with the prediction of rate hikes, oil and gas firms and energy commodities react to the increased probability of a reduction in petroleum supply during periods of conflict in the Middle East.

Provided by FactSet
As one can observe in the graph above, the 9/11 terrorist attacks had short-term bullish implications for WTI price and oil and gas companies. Here, we can see BP, Exxon-Mobil, and the WTI benchmark outperform the S&P 500 coming out of the attacks as panic reached not only New York but the markets as well. A month later, XOM and BP had both rebounded and gained more percentage points than the S&P 500 with gains in the coming months as ground force involvement was discussed. WTI price fell in that same month but would late gain in the intermediate term as OPEC fanned the flames of supply endangerment. Even though the Paris attacks evoked different sentiment surrounding general stock performance, I do think that there are some bullish upsides to energy shares, appearing similarly to 9/11 short-term trading trends, as more aggressive ISIS tactics are introduced into the debate. Just after the attacks, shares of BP and Exxon are up 3.85% and 2.38% respectively while WTI gains amounted to 2.45% on Monday (with pared losses today). The energy sector outperformed the major market average, but don't count on those increases to be sustained unless the discussions of accelerated aggression elicit some tangible change.

Monday, November 16, 2015

Islamic State's Oil: An Attempt at Legitimacy

Just three days after horrific attacks in Paris that leave over 120 dead on a Friday night, military responses intensify as France and coalition-lead forces have revenge on their minds. Consequently, dozens of air raids over some of the Islamic State strongholds occurred early today.Among the targets, spread over lands in Syria and Iraq, French bombers leveled the unofficial capital of the terrorist organization in Raqqa. While many military bases and industrial structures were successfully hit, a news website associated with ISIS reported that there were no casualties from the attacks although that is most likely not the case. These attacks introduced the conflict to more aggressive plans from Western forces that include President Obama's "amplification: of air campaigns as well as special operations that will be employed strategically in order to continue towards the objective of containing the Islamic State and the organization's desire to increase the amount of terrorist attacks in Europe and the United States. For that reason, coalition air forces teamed up to destroy key financial targets that provide revenue streams to terrorist activities of the Islamic State. These targets consisted of major oil fields that have been taken over by ISIS ground forces. After being overrun, the Islamic State makes these wells operational by staffing them with petroleum engineers and workers that vary out the production processes. According to the group's so-called "finance ministry," reports have counted about 275 engineers and 1,107 workers operating on 253 wells that have been taken over with around 160 deemed operational.

As an economic force, the Islamic State has provided no credence to its ability to bully financially even though they have crippled crude oil production from two of the (potentially) most productive Middle Eastern states. Iraq and Syria have suffered from the encroachment of the radical organization, and their forces have been pushed back forcing to concede land and these valuable oil resources. Iraq may feel more troubled by this loss because of its recent increase in production that has become endangered by Islamic State threats. Syria, on the other hand, has experienced a consistent decrease in its production as the civil war and ISIS conflicts continue to brew. While these nations have been hurt be conceding land and oil, the Islamic State has managed to add almost $50 million a month to its coffers with successful expansion supporting the rampant smuggling of petroleum in the region. Military officials estimate that purchases from smugglers moving oil around the region have been buying the oil for a cheap $35 a barrel with some purchases ranging as low as $10 a barrel. These prices sharply undercut the marketplace and could have potential supply and demand effects if these industrial capacities were to grow. Current approximations of ISIS production land around 40,000-50,000 barrels a day, with about 30,000 from Syria and 10,000-20,000 from Iraq. Below are some very rough estimations of the potential selling prices per barrel based on an upper and lower bound described above. These numbers are based on the presumption that IS will seek to get the most out of its oil sales as well as the necessity to stay below market prices of just over $40 in order to incentivized buying from a stigmatized source.

Once again, these guesses are very rough and are based on estimations themselves, but I think they may provide insight into the possibilities of oil realization for the Islamic State. With these numbers, a projected average price per sale of barrel rests at $24.25 a barrel. This guess takes into account that at least 50% of oil production is being sold in the range from $25-35. Lower prices are considered and counted so heavily because buyers are in the position to negotiate as ISIS is a dangerous entity with which to do business. Using this average price, one can calculate an amount of production which could represent that of the current Islamic State (before air strikes). Many articles propose revenues of $40-50 million a month for a total of $450-500 million a year, very similar to a moderately sized U.S. oil and gas production firm. My calculations will take ISIS's reports of $46.7 million of revenue for September. Using this statistic, estimations of $30 million for the first three months, $38 million for the next three, and an average of $45 million for the last six months as a potential revenue stream for 2015 (once again, given that air strikes did not change anything). In the end, my estimates are $39.5 million a month with a yearly total of $474 million, a very rough number reflecting what has been read in various articles as well as considerations to the organization's growth. These calculations provide us with a yearly production of 19.55 million barrels and a daily count of about 53,500 a day which top the upper approximations that I have observed in various publications. Even with errors of 5,000 barrels on either side, Islamic State remains at about 50,000 barrels with the likely potential to produce more by operating currently inactive wells. Stepping back and looking at the current market conditions, does ISIS cheap oil play into the supply and demand equation? Not exactly, but it could imply something else. Think about it this way. Every barrel that is produced by a friendly or neutral Arab country is accounted for and sold on the market or processed domestically (for the most part), but oil fields that are taken over by the expanding forces of ISIS are labelled as a target with intent to cripple their finances. As oil production is taken over, it is automatically assigned a higher probability of being destroyed. For example, if ISIS were to launch an enormous ground offensive and occupy all of Iraqi oil infrastructure, crude prices would skyrocket, not because supply has suddenly vanished, but because the coalition forces are now out to destroy it. Market psychology played beautifully into the hands of paranoid doomsday oil economists during the invasion of Kuwait and the Iraqi wars even though small amounts of production were likely to be affected. We have already seen this effect in today's trading session as energy shares lead gains. From a military standpoint, I think bombing ISIS's oilfields is one of the best strategies at this point with too much opposition to a "boots on the ground" approach.  Petroleum products account for about 65%. according to WSJ, of Islamic State revenue at this point, and the group shows no desire to relax this strategy of attaining wealth. With the crippling of financial flows, the economic devastation will effectively discredit the organization as a productive unit operating towards their ultimate goals. One can already observe the desperation to seem "legitimate" with the establishment of a "finance ministry" and the desire to infiltrate and adopt a sustainable financial system. The Islamic State is more advanced than al-Qaeda in that it wants to become a viable force with more than just haphazard terrorist attacks seeking to inspire fear. They want to build a network. Because of this interesting new nation-terrorist group hybrid, the Western world should consider this new type of threat and how to deal with it. Even though it seeks to be legitimate, the Islamic State will not create any market disturbances in the global economy because of successful financial undermining through the bombing of oil fields. These strategies should be commended and continued until the capacity to produce oil in ISIS territory is either disabled or destroyed completely. On top of that, smugglers and demand for the oil should be quarantined and subsequently choked off until no oil in that region will be able to find a home. Turkey has already started to crack down on smuggling with thousands of cases combatted and resolved. There is no doubt, though, that an Islamic State with oil is bad news. With Iraqi production reaching almost 3.5 million barrels a day in 2014, the radical group has plenty of capacity to attack and reallocate. These economic threats of ISIS legitimacy should be resolved and, ultimately, extirpated.


Saturday, November 14, 2015

Volatility and Trading Ranges: Energy and Commodities

Once again, the busy trading week ends with decisive movement to take into the doldrums of Saturday and Sunday. Investors are left with a particularly bad taste in their mouth after stocks turn bearish on them. Across the globe, we are seeing a systematic loss hit securities that may or may not have been at speculated highs. Let's look at a chart.

Provided by FactSet

Here, we have three of the major national indexes plotted over the past three months, from the correction in August to trading now. Most of the trading that is represented by the graphs is in October, the month with the largest bullish gains so far this year. As can be seen, equity growth during that month surged up to pre-correction heights (except for the Shanghai Composite Index). The S&P 500 reached a new high. in fact, just 0.87% higher than pre-correction levels, and the Euro STOXX 50 capped at just under that point. Even though the Chinese stock market only gained to about 90% of their previous price, they saw the highest gains of 22.35% over the past three months. Investors in that market can attribute the accelerated growth to the tendencies of cyclicality where the largest dips give way to the largest gains in the future. The causes of the losses differed across the three indexes as well. The Shanghai Composite's equities fell after an asset bubble popped and sparked a national sell off. Meanwhile, the S&P 500 and Euro STOXX 50 responded to a recession-like force that crippled manufacturing and industrial growth in the world's exporting nation. Indexes and assessments measuring the performances of these sectors were not only weak in China, but the U.S., Europe, and just about anywhere else as well. We all know this though. This is just about ancient history. Instead, today we're talking about another bearish trend developing this week. The blue line denotes the beginning of this week which featured flat movement at the opening on Monday. For the week, Shanghai Composite losses amounted to -2.18%, Euro STOXX 50 to -1.69%, and S&P 500 losses to -2.67%. The week signaled a technical reversal from a resistance level that had been established last August. Now, equities will begin to bounce down as Dow Industrial futures already traded 75 points lower after Friday's close. On top of that, terrorist attacks on the same day have shaken global stability and will no doubt add to economic uncertainty. The French economy has already experienced some of the possible repercussion of the Parisian terrorist attacks as retailers closed down Friday night and Saturday in order to recovery from the tragedy. European stocks also have a high probability of entering a new trading week on fragile investor confidence that has already seen the start of a bearish trend.

So what of these trends in 2015? I hope it is not just me when I think of how unnecessarily volatile stock market movements have been. The S&P and Dow have been trading in very large ranges. The difference between YTD highs and lows in the DJIA is over 10% of its current level. These changes haven't been gradual either. Many investors will remember days where 100-200 points were shed off of the Dow at a time, and these trends haven't been restricted to U.S. major market indexes. The Shanghai Composite is a good example of a particularly volatile entity this year as it careened into recession, and many sectors heavily affected by the slowdown showed increased volatility as well. These wide trading ranges add towards the uncertainty that contributes to volatility and have become a good indicator in hindsight.

Both from FactSet

The graph and the chart demonstrate the wide ranges of trading in sectors that were most hurt by a worldwide manufacturing slowdown. Commodities and the energy sector experienced the largest gaps with ranges over 20% and 30% compared to average prices. Last year, they were just about 10% less wide. As has been said before, this volatility is attributed to low oil prices that have rallied and fell through the early parts of the year as well as in the summer. Ranges of trading in WTI might even be wider, and they have certainly been a key driver in commodity and energy volatility. Moving to industrials and consumer good sectors, wide ranges can be observed as well. Though not as volatile as the first two sectors, these industries have shown considerable uncertainty when trading under the global slowdown sparked by the popping of a Chinese asset-bubble. Demand from emerging markets that rely on cheap and open access to raw and manufactured goods were damaged by an exit of significant amounts of investor capital. Combined with a stronger dollar, these contracting macroeconomic factors have created a strong bullish presence in these sectors that was particularly evident in quarter three. Large trading gaps may not seem significant in terms of technical trading, but I think they can provide a way to appropriate an ideal price target in trading. The idea of "regressing towards the mean" is quintessential to statistical observations that can be applied to market analysis Taking into account highs and lows in trading as resistance and support levels, one should be able to estimate an intermediate-term price target. This calculation would treat highs and lows as short-term periods of over-buying or over-selling as they are often corrected (just like in August and October). While buying and selling during trends does no good for valuation, instead a proper price is most likely wedged in a tight range in the middle. True valuations may not help technically, but they can assist in fundamental analysis where proper share prices are relevant. These values can found in the average price column and are subject to change as prices change over time. Going into the end of the year, these four sectors will be particularly sensitive to their valuations as companies are reconsidered in periods before and after interest rate hikes as well as the speeding up of the world economy. By those numbers, gains in October may be in danger of falling to bears who are seeking to protect their money from the uncertainty in trends.

Thinking of Paris

Tonight, just across the Atlantic Ocean, the night of Friday the 13th has been painted with terror. In five different spots around Paris, either gunman or explosions sought to kill and destroy the everyday life that only terrorists would desire to end. Crowds of spectators at an international soccer exhibition were evacuated to safety after two explosions alerted the local authorities to converge upon the street in search of the attackers. Just miles away gunman walking down Parisian streets, entering various popular Friday night locations, and killing dozens of civilians were neutralized after the massacre ensued. Immediately after, emergency relief personnel flooded the scenes with firefighters, policemen, and eventually French military units assisting survivors, both injured and uninjured. The death count is estimated to be between 80-100 with higher estimates at 120. French President Fran├žois Hollande declared an official state of emergency as well as closed borders as his government begins the healing process with hopes of finding and prosecuting all perpetrators. Foreign nations united against the Islamic State are issuing statements of support and words vowing revenge on the speculated offenders, but ISIS has yet to confirm their involvement.

As we go into the weekend, let our thoughts be with those in Paris as well as our prayers for their recovery and communal emotional outpouring. Nations across the globe have already spoken out against the atrocities in France with condemnations against blatant inhumane acts of terror. Coutrries with differences have come together over these terrorist attacks because at the base of it all, humanity was attacked. I can't think of a single person on the globe who feels safer after hearing this news. American authorities have already increased alertness and safety protocols in order to protect their civilians. European countries, France's neighbors, have taken steps to secure their capitals as well. At the same time, all countries against the threat of Islamic extremism (the most likely actors behind the attacks) have vowed to contain and eliminate the problem endangering innocent human beings across the globe. The Islamic State has done nothing but applaud the horrible events. Many people may go back to the January terrorist attacks on "Charlie" and the incredible global support that was offered up as a result. A response to these significantly worse tragedies should be more resolute. Governments and military forces should take a harder look at how they can advance the fight against ISIS. Its domestice conflicts have just become a global threat to human security, just as the 9/11 plane crashes had intensified feelings towards al-Qaeda militants. For this reason, we need to take the chance to increase the safety of the world population who have newfound doubts about their ability to stay away from terrorist threats. The globalized flows of thousands, even millions of people a day allow evil men to plan and execute their worst on anyone they so choose. Those gunman were not concealed, they strolled down crowded streets of Parisians wielding AK-47s with no intention of emerging alive. These are the conflicts we face today, not those of severe economic crises or nations declaring war upon one another, but of the random possibility of being slaughtered by an unknown soldier that has made it his cause to kill innocent people. So with this, and many incidencts before, we are not innocent. We have become a part of the global struggle for safety, and it is necessary for us to realize that. The night of November the 13th in Paris will forever live in global infamy, but the next days, weeks, and months will be marked by the formation of a united front against the broad threats of terrorism in all forms. We are not nationals looking to maintain our country's security anymore, but international citizens that seek to make the world a better, safer place for the neighbor next to us.

God Bless Paris.

Jacob Hess

Friday, November 13, 2015

Welcome New Political Commentary!

Hello and welcome to a great and glorious expansion to the Black Gold Disease family. While I never thought I'd get into the M&A business (I am just a blog after all), there will be the addition of another stream of analytic writing connected to this website. As I focus on finance and energy articles, this other blog will provide political commentary for those who wish to read comments about current political events. I will continue to author posts on this page, and nothing will change here, but just above the moving ticker, a tab will be created to create a link to the new political blog. Currently, it is named "Politics" (not a very clever name), but it will be adjusted as the author begins to settle in. The new resident analyst will be John Learn, a good friend of mine that wants to pursue a career in political science and a fellow writer who loves to speak his mind. I hope that you will click on the new tab as his stream begins to take shape. From time to time, we hope to co-author some articles together, so as the finance topics continue, please be (at the very least) tolerable of some diverse topics, as you often have already been. All in all, I hope that our writing and this website and all of its content serves as a successful knowledge base that promotes intellectualism and a good, critical thinking mind. Thank you for all readers who have continued to digest my ideas. You all have been a great inspiration for my dedication! Both John and I hope that we continue to entertain those visiting as well as the audience that we have the potential to reach.

Happy reading,
Jacob Hess

Thursday, November 12, 2015

Rejecting Keystone: The Importance of Incentives in Environmental Policy

Today, we're going to dive into the ugly world of U.S. petroleum imports, a long debated topic often stuck in the political rifts that continues to plague this country's reputation. Particularly recently, the passing of Keystone XL Pipeline bill onto Obama's desk has reignited the conversation over domestic oil product, the environmental effects of fossil fuel consumption, and energy independence in the United States. In the end, there hasn't really been an astute analysis of the subject with regards to all three topics, instead, the proposed pipeline is often dismissed as an old platitude of the rifts between climate change and energy policy, and no one seems to find a middle ground. Just a little while after the bill was passed to President Obama, his veto power killed the hope of it passing with little political and economic repercussion evident. What really did the Keystone Pipeline Project mean for the United States? The proposal had such a long appearance in Congress, and its nuances changed with the simultaneous shifts in both energy and climate agendas. I seek, in this article, to sift through the implications and re-analyze the potentials that this project could have provided with an emphasis on energy markets and policy and environmental externalities.

From Politico
In 2005, a Canadian company that specializes in the transportation infrastructure that moves crude products coming from the tar sands region, requested permission to build a pipeline from Alberta, Canada to Steele City, Oklahoma, TransCanada sought to build this line in order to bring more of the tar sand crude to the market based in Cushing, Oklahoma. At the time, high oil prices and increasing fossil fuel demand created a strong movement to support the proposal. Conversely, environmental opposition grew against the bill which was submitted to Congress for the rights to build on the land requested. There was no political shade pulled over the deal, but a clear divide was evident from the beginning of the controversial proposal. The bill was rejected twice in voting, but it was never totally stricken down as vote tallies were marginal (November 2014 vote was 59 for, 41 against, one short of passing). The main issue debated during the earlier attempts of passing was over the environmental effects of bitumin, the heavy, viscous substance that the tar sands produced. Climate change activists claimed that production and consumption of the heavy form of crude oil were more harmful to the environment than typical crude oil consumption. It is also worth noting that bitumin's heavy status was preferable to most U.S. refineries who were used to processing the heavy, sour Arab oil that is typically imported. Fast forward to late 2015 and the bill is placed in Obama's hands where the debate reemerged on the political scene once more. Even though we know that Obama killed the bill completely with his veto power, let's look at what the Keystone Pipeline could have done if it had been passed.

Besides the environmental effects, the construction of the pipeline would provide various economic benefits for both the United States and Canada. In fact, the oil trade would be considered a very healthy progression of free trade under NAFTA, and one that would help U.S. energy policy as well. In a Forbes article from 2014, the author cites that the pipeline would add approximately 444,000 jobs with 43,000 of those being permanent. On top of that, government fees would generate revenue of about $521 billion in the next twenty years. That does not sound like a bad deal for an economy with over $16 trillion worth of debt. On top of that, the oil and gas industry would benefit from lower transportation costs as more pipelines are opened to pump to refineries.These benefits looked especially enticing to energy firms, consumers, and investors who were looking for cheaper oil prices and lower revenue. But remember, those were the times before fracking had boosted domestic production to over 9 million barrels a day and unemployment had hit its natural level of 5%. In fact, something like the Keystone Pipeline Project, had it been passed, would have had a negative impact on the oil and gas market today. There's no doubt that the pumping of a new 700,000 to 800,000 barrels a day would have diluted WTI price further.When looking at the condition of energy firms with respect to current price trends, these production additions would have elongated the supply glut and caused most oil and gas companies to face higher probabilities of default. Yes, jobs could have been added with the need to keep up and maintain the pipeline, but most likely at the cost of oil majors shedding some of their workforces too. Another strong argument supporting this proposal is the hope of a waning need to depend on OPEC oil as the new Canadian influx could replace those imports. Many people might wonder why imports are so high, but they fail to understand that U.S. refineries are not capable of effectively processing WTI oil, they are built to refine heavier crude from the Arab states. Had the pipeline been built, Canadian tar sand oil could replace that need for heavy oil as the bitumin substance produces the kind of crude oil that U.S. refineries are set to process. Along with that, the U.S. energy sector gains a trading partner that is much closer and more stable than the Middle East nations which are ridden with conflict. These points were once strong but are quickly overshadowed by 2015 import data.

From EIA

Above is annual data plotted over the past twenty years with an emphasis on data from 2005 to 2015. In the year that the Keystone bill was proposed, U.S. imports from OPEC measured about 2 billion barrels a month. Because of that many economists and politicians complained of how dependent the great U.S. superpower was on OPEC production. For the past half of a century, gas prices were subject to the whims of prices that were negotiated far away from U.S. consumers, and for that reason, they saw gas prices as an uncontrollable force that would have to be tolerated as long as the United States depended on oil from oil exporting nations. From Venezuela to Saudi Arabia, the very life support of the largest economy was bought, sold, and transported to the large oil majors that owned most of the downstream operations (and still do). The Keystone pipeline was Canada's play into our extensive demand which was inelastic when it came to most fossil fuels. This year, though, when the bill was placed on the desk of President Obama, monthly production statistics were on track to post an annual total of just 1 billion barrels imported from OPEC, about 60% lower than a peak in 2008 and 50% lower than numbers in 2005. This data shows the clear demise of OPEC's hold over the United States because of the frenetic spread of the fracking revolution. Allowing the creation of the Keystone pipeline would be an ineffective way of combatting U.S. energy independence because it is happening on its own (Canada's import share is slowly growing as well). Because of the lack of economic support for the implementation of the pipeline, those who wanted to see the bill pass have let it go. In fact, TransCanada had actually asked for a delay of the proposal before Obama made a decision over the bill. Instead of improving infrastructure for oil and gas firms, energy investment should focus on converting refineries to light, sweet crude refiners so that upstream and downstream operations can be combined into providing energy cheaply, efficiently, and with a healthy flow of revenue. Many consumers and even politicians want to see oil prices as low as they can be, but that is not healthy for a domestic energy industry who needs a stable level of prices to grow. The U.S. government would never let corn farmers go out of business if they produced so much corn that prices choked revenue growth. Why should the same be done to the energy industry? In conclusion, the failure of the Keystone pipeline was a win for the energy sector and avoided unhealthy and irrelevant economic benefits that are currently being overshadowed by growth in production and exploration operations.

With the striking down of the Keystone bill, many climate change activists praised the President for a small victory against the oil and gas industry which has been notoriously against environmental impetuses imposed by the government and activist groups. President Obama, who has often quoted his desire to be a politician to change things before he leaves, used this rejection to fuel the movement for more green policies in both domestic and foreign settings. As he meets with the United Nations over international climate change policy, this "victory" will be used to validate his green credentials. Coupled with his initiative to phase out coal consumption (due to its extremely dirty nature), Mr. Barack Obama has made it clear that no carbon emission will go unnoticed by him. On the other hand, a WSJ reporter made an interesting comment about how the Keystone pipeline could have been used as an example of how carbon emissions could be penalized with new credits and taxes imposed on the guidelines of those using the pipeline. The suggestion was an interesting use of an incentive structure that could be used to push firms towards greener operations in the future. President Obama and other climate change enthusiasts want to eventually see fossil fuel use phased into an alternate cleaner fuel to which  transportation and electrical infrastructure can convert, and oil and gas companies want to maximize profits using these "dirty" fossil fuels and typical cost optimization incentivizes an apathetic attitude towards the environment. The golden question is how to do politicians create a proper incentive system where green operations are encouraged? Using the Keystone pipeline as an example, those using the pipeline would have to pay a carbon tax to offset the negative externalities which would create incentives to find cleaner ways to transport oil. While the tax won't force all oil to be transported by Teslas, it should spark firms to increase R&D spending on cleaner and more effective solutions. The problem is, in most cases, the oil and gas firm can just pass those costs on to the consumers through price increases. Nevertheless, the opportunity to establish such measures was there but passed up. Although, the failure of the Keystone pipeline was overall a good thing considering weak economic benefits and the avoidance of appropriate environmental externalities. On the other hand, President Obama could have taken an opportunity to show the desire to cooperate with energy firms who often seem alienated by a "radical" approach to forming environmental guidelines. Canadian officials reported that the administration never even made attempts to negotiate over the environmental terms which appeared to set this bill up for failure from the beginning. Politically and economically, the incoming President will have the prickly job of incentivizing cleaner business operations in every sector including that of energy producers. For that reason, energy and climate policy will become key issues going forward into the presidential race, the political mentality of our future congressional leaders, and how business and markets optimize their profits.

Tuesday, November 10, 2015

Oil's Reaction to Fed Rate Hikes

Let's talk about oil, and let's talk about rate hikes. Let's talk about how afraid energy investors are of the stricter monetary policy that has come to destroy their beloved (and lucrative) oil and gas stock that can't operate effectively with such low commodity prices. Many oil companies who are struggling to continue cutting costs are experiencing a cash drought that doesn't show any hints of amelioration. Price-to-earning valuations are continually getting more expensive, but not because of an ineffective cost structure but waning revenue and cash flow. The only way to be evaluated as an inexpensive stock, for the near future, is cutting costs, and we have seen that firms are doing that with OPEC and the EIA projecting significant investment cost cuts by the next year. Some oil majors like BP and Shell have abandoned discovery projects in the arctic region and some Asian states, something that is not advantageous as the global economy tries to escape a slowdown and the largest central bank prepares for tighter monetary policy. Barring bottom line concerns, most energy companies are fixated upon boosting their top line revenue levels with hedging and raising prices where they can. That means downstream prices (the price at the pump) might see more increases than are expected at low oil prices because consumers in the fuel market have little bargaining power over price with an inelastic demand curve. Drivers will always be driving so gas will always be needed, even if the price of gas is $4/gallon. Although, we do know that lower gas prices stimulate more consumption, so firms still do have an incentive to keep consumer prices lower in order for that driver to fill up those extra tanks. Nevertheless, despite downstream profits, many smaller producing and distributing companies are accepting very large levels of debt for their operations in hopes of surviving through the end of the glut. They are less likely to cut major operations off because they make up such a large amount of the revenue streams. Now, we are at this point where a majority of investors and executives think that borrowing will get more expensive within the end of the year, so let's look at investor's opinions when trading oil and gas related securities.

Provided by FactSet
If chart is too small, click here 

First up is something a little broad. We've got a 10-day, 15-min chart that reaches right back to the end of the October Fed meeting on the 28th. Against the market average, the Energy Select Sector SPDR Fund (XLE) outperformed the market despite volatility in the oil markets. In fact, a jump of almost 2% showed elation over another month of low rates even though a stern consideration of December hikes was delivered. October 26th trading session opened 2.43% higher for the energy ETFm while the S&P 500 only saw gains of 0.77% on the day. At its peak after probabilities of rate hikes increased, the SPDR Energy Fund was over 9.05% from its start on October 28th, a seemingly healthy reaction with bulls supporting S&P growth of 2.25% with significant volume, especially at the opening of the November 3rd session. From the peak, we see energy stocks declining faster than the market average with losses at -4.50% (compared to market losses of about -2%). Overall, energy stocks are showing more volatility on a weekly and sometimes daily basis. There is definitely more uncertainty surrounding those stocks concerning both fundamental valuation and technical strength. In the overall market, the S&P 500 ADX indicator reveals more downside volume as shown by the peaks indicated which trump the upside peaks in the rectangle. For that reason, look for a bearish trend to dominate S&P Energy trading with the persistence of general downside pressure absent an upside force strong enough to buy into gains.

Provided by FactSet
If chart is too small, click here

Up next, we're going to look at the most popular ETF fund following crude oil future contracts, iPath S&P Crude Oil Total Return (OIL). On the day the Fed preserved low rates, OIL jumped almost five percent as it was complimented by bullish production data that week as well. Before a peak on November 3rd, we can observe two major buying periods that made the ETF outperform the market average tremendously. The ADX line shows significant demand forces behind both of the identified buying periods, but the blue ADX line never topped its previous high, a generally bearish indicator. Looking at the contrived trendlines from the volume pressures, a downward sloping line can be drawn for bullish volume and an upward slope for the bearish volume. The main ADX (blue) line shows selling forces just recently overcoming buying forces and causing the sell-offs seen after a peak of 8.31% gains from the Fed's meeting to now. Two major selling periods can be observed on November 4th and November 6th where both sessions opened with an OIL plunge and not capped with a recovery. Various downside trendlines show OIL price dropping below the level at which it started (Oct 28) and continue losses of -7.95%. Technicals haven't weakened without reason. Valuation of the oil markets has been shifted down with rate hikes brought into the picture as well as the persistence of deflationary pressures on the world's energy demand. Larger buying sessions (cashing in of short sells) may signal that investors have found an appropriate price to trade at, so keep an eye on the volume of any attempted rebounds. Otherwise, sell and short a little while longer.

Provided by FactSet
If chart is too small, click here

Finally, we'll talk about some large oil companies who are currently performing better than the market average and are just now coming down to pre-FOMC meeting levels after probabilities for rate hikes in the near future have risen significantly. Once again, we see a steady rise on price from just after October 28th to peaks on November 3rd. There seems to be a bit of technical weakness across energy stocks developed on that day despite flat movement from the S&P 500. Bullish volume reaches its highest here as well and never emerges to this level for the next 5 sessions. The arrows show a repeated, general pattern where bullish volume is decelerating and bearish volume is accelerating. We're seeing higher highs during selling sessions with the main (blue) ADX line strongly bearish. These volume statistics are for Exxon-Mobil, but can be considered similar to other oil majors. Plotted on the chart are Exxon-Mobil, Shell, and Halliburton, each with similar directional patterns. Trendlines have been drawn in the in the respective color, and all move in a bearish direction (just like previous trendlines). Nevertheless, we've seen, over the past three sessions, bounces off those trendlines into flat movement as opposed to bearish losses. Currently, there should be some consolidation as bearish mentalities build up in the face of rate hikes similar to the movement of the major market index. Despite cooling down in energy technicals, oil and gas firms should hope that valuation does not catch up to companies fraught with debt and facing default because of low energy prices. Price-to-earnings data backs up the fact that the energy sector is becoming more expensive, especially with a stronger dollar. At the beginning of quarter four, this sector led a bullish surge which garnered strength from a crude oil recovery and technical rebounds after a horrible third quarter. Looking forward, expect softer returns from the sector as well as sideways running into the December Fed meeting.

Sunday, November 8, 2015

A Case for Raising Rates: Unemployment and Inflation in 2015

On Friday, the trading day was dominated by the revelation of a key economic indicator which primarily drove the movement of equities at the end of the week. Many might be confused as to why mediocre gains populated securities during Friday's session with the S&P 500 losing just 0.03% and the Dow gaining a small 0.38%, but the monetary implications of the data speak for themselves. Before the session even started, reports of nonfarm payrolls came out and stunned investors and economists who had relatively lower expectations. With a consensus estimate of 180,000 jobs created in October, the bullish month destroyed another lagging estimate with 271,000 jobs created in those 30 days, the most in all of 2015. On top of that, hourly earnings grew 0.4% after a September of no growth and a consensus of just 0.2%. Both of these economic indicators were beaten be almost double the estimate that was given based on the current scope of the economy and the track record of the previous months (which were lackluster in comparison to what some people though 2015 could be). Typically, surprise gains of this magnitude would support gains of at least a percentage points as the economy appears to be returning to full health with unemployment at 5% exactly, the point in the business cycle know as the natural level of unemployment. Whether it accurately reflects a voracious change in demand for workers, one cannot be sure, but the Fed has determined that though surging employment gains are not sustainable, they can be interpreted as a signal that wounds have healed. Markets respond appropriately with higher long-term yields in the bond market, and the Fed Fund future probability of a 25 basis point increase in December increases to almost 40% (calculations have .125% rate now with .375% with hike). For that reason, gains were pared on Friday's session in preparation for the Fed to accelerate their strategy of slowly winding down from easy monetary policy.

By now, we've been able to observe three monetary trends developing in 2015 concerning inflation, unemployment, and the Fed's rate hikes (or the absence of them). All have shaped how the markets trade between periods of change in their respective indicating figure, and all remain inevitably interconnected. One of the most famous theoretical (and often applicable) economic correlations is between the inflation rate and the amount unemployed, Many famous economists have taken part in the debate surrounding the connection with Keynesians and Monetarists joining on either side. Big names like Milton Friedman and Paul Samuelson, both Nobel prize winners in economics, have explicitly dedicated some of their time exploring the strength and sometimes existence of this apparent correlation. In order to develop the theoretical framework behind these ideas, William Phillips, an economist from New Zealand, wrote a paper describing what is now known as the Phillip's curve, an inverse relationship between unemployment and inflation (a picture can be seen here). This became an even more controversial issue as the U.S. economy entered periods of high inflation then stagflation in two straight decades, the 1970's and the 1980's. This attracted a lot of economic thinkers to the problem which were mentioned above, and they debated complications like market expectations and long-term versus short-term correlations. Fast forward to this year, and once again, the relationship between inflation and unemployment emerges at the center of the rate hike debate.

Data from FactSet,

The graph above shows the movements of both U.S. unemployment and inflation rate over the past ten years on a monthly basis. The unemployment rate moved very little with the exception of the financial crisis and the recession afterward in 2008 and 2009, but inflation rate was a lot more volatile and continues to move erratically despite the emergence of relative trends. In the period leading up to the financial crisis, 2005 to the beginning of 2008, inflation became a monetary concern as housing prices were increasing rapidly and cash flow in the overall economy sped up after the dot-com bubble burst. The Fed raised rates in this period, and unemployment remained below 5% which was the apparent trade-off of higher inflation for more jobs, a confirmation of the Phillip's curve in the short run (2-3 years). After 2008, the recession reversed the pattern to low levels of inflation with high unemployment (although the loss of jobs was mainly caused by the crisis). As the Fed pursued an expansionary monetary policy, market expectations caused the Phillips curve to shift over, forcing the Fed to accept accelerated inflation for a recovery. This effect can be seen in the picture linked to the blog in an earlier paragraph. The curve shifting to the right makes unemployment gains move slower relative to inflation gains. Starting from the lowest point in July of 2009, one can observe the effect of market psychology preparing for expansionary policy as well as quantitative easing weakening the dollar substantially. This period supports the idea of an "expectations-augmented Phillips curve" that shifts when considering the expectations of the market. As the economy progresses further into the post-crisis period of expansionary policy where interests rates continue to float around 0.25% (down from 5.25% in 2008), the Phillips curve starts to become an ineffective representation of the trade-off that could happen. By 2012 and 2013, it appeared as if the Fed had been able to reach their target of 2% inflation, deemed healthy for the continuation of the recovery of unemployment and the support of the bull market rebound, but inflation began to taper off into deflationary pressures even though unemployment still slowly dropped to 6% and continued lower. This year, we find ourselves fighting negative inflation with unemployment still shrinking to 5% and possibly lower. Milton Friedman would call this an exhaustion of the Phillips curve trade-off which breaks down in the long run; instead, the relationship reverts to a point called the "non-accelerating inflation rate of unemployment" where market expectations cause the curve to transform into a vertical line. At this point theoretically, expansionary policy becomes moot, and increases in inflation will not be coupled with equally progressive employment. From 2013 to the present, the economy is seeing the correlating relationship reversed because of long-run expansionary monetary policy, as Friedman cited. Although this time, inflation and unemployment are going down together instead of increasing together like in the 1980's. There should be a widespread realization that the relation has broken down, and the Fed should respond accordingly with a change in monetary policy which will, in turn, change the market expectations with a leftward shift of the curve.

Data from FactSet

Adding to the theoretical framework of the Phillips curve is the New Keynesians with their ideas of aggregate demand changes (which is sometimes associated with Stiglitz). Their addition was the notion that a positive relation existed between inflation and the level of demand in the economy, and they asserted the strict short-term application of the trade-off as well. A model like this might reflect what is going on the economy now and why inflation and unemployment are moving in the ways that they are. The second chart shows the relationship between the unemployment rate and the GSCI basket of commodities which measures the performance of almost all the commodities over time. For our little study here, the commodity basket represents demand change because of price sensitivity to global scarcity (as seen in the oil glut). After years of stable prices, commodity prices drop significantly starting midway through 2014, mostly caused by a major drop in crude oil prices. Demand for commodities becomes a serious problem in the summer of 2015 as it edges on deflationary problems and causes a reduction in global trade accounts, hurting emerging markets. For this reason, consumer and producer prices became volatile and eventually cheaper as buyers pulled back. With this deceleration of demand, the global economy should see a deceleration in inflation, which has happened, but at the same time, there should be a deceleration in hiring, right? Wrong. The Phillips curve has already broken down because the expansionary monetary policy has already been exhausted. Market expectations have already changed because of the conclusion the markets have made: it is time for stricter policy. And just like we said earlier, the curve will be (theoretically) shifted to the left where the current level of unemployment is associated with less inflation. Perhaps this is where the Fed went wrong, inflation could not be stimulated to the 2% target that was set because (1) the long-turn Phillips curve had transformed to the NAIRU, and (2) the markets have already adjusted the curve because of their expectations for stricter monetary policy. That leaves this question to be asked: when should they have increased interest rates? That question is not answered easily, but it does elicit answers that should have been considered earlier. If the expansionary policy established in reaction to the crisis was for reducing unemployment, the reversal of the trade-off should have been recognized earlier. Perhaps the Fed was scared into expansionary policy for too long because of the frightening consequences of the crisis, or perhaps the Fed acted too dovish when supporting the recovery. A sudden correction August might not have happened if monetary policy had been cooled down earlier. Adjustments could have happened over time, and acute changes in inflation levels (and aggregate demand levels) would have been more gradual had market expectations of stricter policy been recognized earlier. If the December rate hike does not occur, the economy could see more corrections after more overheating off of loose policy. In the case that rate hikes do occur, we can see this relationship readjust into a healthier cyclical correlation that can reduce volatility and support growth. Then when needed, policymakers can take advantage of the short-run trade-off the Phillips curve offers during periods of decrepit economic growth.

Thursday, November 5, 2015

Markets Pared Before Jobs Report

Metaphors, in my opinion, can add a lot to the ideas surrounding the stock market and its movements. Often times, they can paint pictures more insightful than those of simple numbers, but at the same time, their themes may be over or understated. For that reason, history sees a lot of finance commentators burned on their choice of words. None was put under more scrutiny than Ben Bernanke as the Fed chairman during the financial crisis of 2008 where debates over one word were not uncommon. So I will attempt to take on the same responsibility as I use the images that I think of to describe my ideas about current market conditions. Over the past three trading sessions, we've seen pared losses looking to cap out market gains. No major losses plague any security except for extenuating circumstances. I liken it to a glass of water that's been filled to the brim. When it reaches its inevitable point of full capacity, the drinker ofter takes a small sip to quell that chances of overflowing. That sip takes not much more than a tiny amount off the top and does little to quench the thirst of our drinker. After a few moments now wanting more water, our drinker will reach for another larger glass, move the water into the new glass, and continue to fill until full once again. Many analysts have brought into question the momentum behind the rally, but positive earnings surprises in the tech sector and elsewhere have helped maintain demand in the system. Investors continue their thirst for equities and do not see the prices as an overvaluation except for a small crowd of bulls that snubs the rallies most of the time. Most of the gains, though seem very expensive as a strong dollar and low inflation keep them costly to foreign investors. The commodities market, as well, has experienced a relatively bullish recovery in the latter part of this year despite trade deficits hurting emerging markets revenue streams, and in turn, damaging prospects for demand growth in the future.

Here, the chart shows the stabilization of the GSCI Emerging Markets index after the bullish October. Although losing girth just before November on high volume, retracements of almost 100% followed shortly. For now, it appears trading is stuck in a price channel with hopes of it developing to a continuation pattern and doubling gains. Moving closely with it is the basket index of commodities, CRB Reuters-Jefferies Index, charted in black. They seem to move really close to each other until October when emerging markets outperform the basket. In my opinion, the underperformance of commodities in relation to emerging markets is what's hurting the chances for a rally for EEM. Energy prices and most other industrial commodities are hindering inflation which can be healthy for developing countries looking to buy into foreign economies as well as trading with them. Today, the chief economist of the IMF has touted the potential pain of stagflation growth in advanced economies. Referring to data put out by IMF, he cites current inflation as at the same levels of 2009, when a post-crisis recession spurred unemployment to 10% in the United States. Inflation has slowed from its 2.7% peak in 2011 to 0.3% that is predicted for the end of the year (2009 inflation was 0.2%). Worried politicians voice their concerns for stagnate wage growth even though unemployment levels are basically at full capacity (U.S. jobs report to come out tomorrow). Frustrated central bankers and state economists have no choice but to point to controversial monetary solutions like open market operations and quantitative easing. As the Fed continues to evaluate growth for December rate raises, flat movement at market highs populate sessions between the two meetings. The S&P 500 and Dow Jones Industrials pare losses to -0.35% and -0.28% for the day. The Euro STOXX 50 and England's FTSE 100 move blandly at -0.10% and 0.46% over the day as well. Most emerging markets' indexes gain and lose under 1% as whipsaw movement often ruptures accumulated gains or losses over a small amount of time: India loses -0.27%, Brazil loses -0.80%, and Turkey gains 0.83% after a day. Many foreign economists and investors are waiting for the Fed's decision on interest rates in December, now rated at a 60% probability, to see where emerging market sentiment will go.

There are two groups following different psychologies on the market today, and they are using the same information to prove their mindsets. The bulls are trading openly and according to earnings that have come out. They believe that their demand for securities is matched by their counterparts and aren't afraid to commit their capital to an open market that appears less scary after seven years of recovery. The August correction, to them, is a reality but one independent of the prices and valuations that they trade on now. Emerging markets are recovering to them, and the Fed's willingness to raise rates is a signal of strength. Most of the bulls don't focus on inflation statistics but support their sentiment with data behind a strong job market. These traders are focused on sectors like technology, healthcare, and construction which have posted high 1-year gains despite a major contraction in August. Construction and homebuilders point to a recovery in the housing market with home sales and home starts increase from a stronger dollar making imports cheaper. The bears retain a scrutinous mentality when trading in the current bullish trend as they see gains as unsustainable pointing to losses in August after a correction shed value that was previously at this level. Some bears might even be skeptical of a market just seven years out of the worst financial crisis since the Great Depression. They might blame a long period of low interest rates for an over exhaustion of cheap funding and the dismantling of profits in the bond market. While they see interest rates as good, they would predict major contractions like those in August after tighter monetary policy hurts commodities and emerging markets. These bears are the short sellers keeping the bulls at bay, and there seems to be slightly more pressure from them on days that are uneventful. Bearish sentiment has the power of uncertainty on their side, but that doesn't mean more volatility. The measure of volatility index, VIX, has been at its lowest levels for the entire year which fuels confidence. Nevertheless, bears cite deflation risks and the problem of depreciation in commodity prices as endangering cash flow levels. For that reason, bears exist in industries related to commodities like metals, energy, and consumer goods. Even though they lead gains in October, bears believe a reversal in these sectors could lead future losses. They also see revenue and corporate income dropping as funding gets more expensive. It is important to recognize the psychological bearings behind sellers and buyers. Depending on volume and movement when trading is mostly uneventful, investors can determine which market outlook is being supported more. Trading is just making predictions and sharing opinions, and volume is the strength of that opinion. That being said, group psychology can often lead to incorrect assumptions just like 2001 and 2008. Going forward, I'll make sure to address the validity of each market psychology as the market goes forward.

Tuesday, November 3, 2015

Speculation and Energy Devaluation

The month of November opens with the continuation of earnings season and the introduction of a slew of economic statistics to the respective economic environment. Projections of the markets and where they go from here have now assigned a higher probability to a rate raise, the ominous possibility looms larger as strength becomes more evident. I find the process almost paradoxical. Acting a lot like a contrarian indicator, Fed policy change signals send contradicting signals; for example, markets responded with positive movement when the Fed cited a rate delay despite broad-based economic weakness, Traders have a weird way in deciding what is important and what is not, but sometimes they can be wrong, hences, corrections and bubbles exist. According to MarketWatch, suspicions of another tech bubble (first one in 2001-2002) are looming over data that shows tech spending is moving slower than tech equity cash inflow. Nasdaq growth might prove to be a bit overvalued, especially after impressive earnings surprises from Google, Apple, Amazon, and the like have spurred shopping sprees on their stocks. But ideas of a bubble seem 2009-ish, we just had a correction in August, right? With gains from Monday and Tuesday, the Dow Jones Industrial Average and the S&P 500 have already surpassed the peaks before the August corrections. The DJIA is just 0.2% above that level, and SPX has risen to 1.68% above its pre-correction value. What may be even more frightening is the blitzkrieg of bullish trading that has sent these indexes to these values in just two months. The ETF that measures 100 of the top non-financial equities, QQQ, has been traded even higher over its pre-correction level, about 3.50%. Analysis of these charts shows a clear double bottom pattern off of the August low with support from September and October volume that rivals that of August. It might also be worth noting that, when compared to SPX and DJIA, the price of QQQ shows a smaller drop, a larger retracement, and a deviation that could result from accelerated speculation of exchange traded derivatives. When looking at economic growth figures, this acceleration seems a little premature. Over the past two days, international figures measuring the strength of the manufacturing index showed growth with China's PMI index increasing 1.1 points from last month and the Eurozone's up 0.3 points. Despite the growth, both still lag 1.15 points and 0.27 points from their respective June peaks. In translation, contraction has appeared to stop, but the state of industrials have not fully recovered. The story is further told by U.S. factory order data that came out Tuesday. Falling 0.1% below a consensus estimate of -0.9%, factory orders contracted for the second month in a row with September losses of -1.0% improving from a -2.1% contraction in August. These statistics are optimistic, but altogether not supportive of the 100%-plus retracements of August corrections in major indexes.

One of the major stories of the bullish surge seen by the stock market is the recovery of the energy sector and the stabilization of oil prices. Some might even say that the energy industry is driving the large, long retracement of August losses. After underperforming in late August and the month of September, a reversal in October erased the negative performance and has the sector as one of the major talking points this year. The drivers of price movement in the oil and gas industry have been extensive with reacts to weekly supply and production, the occasional demand outlook report, and even general economic statistics that may warn of more (or less) global weakness. With mixed sentiment, the main problem with energy-related securities is how to determine an appropriate price for an industry ridden with uncertainty. Even earnings reports can be confusing with upstream operations returning losses and downstream doing just the opposite. This is especially the case for integrated service firms that shed no true light on the scope and quality of their businesses. For that reason, energy companies are trading based on sentiment and price changes on the commodities market (WTI and Henry Hub natural gas).

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The chart above plots the S&P SPDR Energy Sector Select ETF against the S&P 500 for a comparison of price since 2011. The deviation in mid-2014 as a result of the supply glut sticks out as the main difference in price pattern. Even after that point, the trading patterns have been relatively similar with the exception of a lower energy trading price.On the bottom, quarterly EPS growth has been plotted to show a key valuation number moving with its market price. Before 2015, both securities show a consistent rate of EPS growth as a bullish market, easy monetary policy, and higher energy prices allowed for the expansion of cash flow and earnings growth. By early 2015, energy companies (especially those heavily in fossil fuels) were already starting to devalue with the prospect of lower revenue as their assets were becoming cheaper by the day. Midway through 2015, we see the correction shift both the energy sector and the overall market down in the face of a short-term recession. Quarter three revealed that "recession" to us with S&P EPS contraction of -4.06% for the only time in these five years. The earnings "recession" continued to put pressure on the energy sector with Q3 EPS growth at a new 5-year low of -50.28%, the twelfth fiscal quarter of EPS contraction. Despite the unprecedented EPS contraction, the energy sector has led the retracements in the stock market and build on gains of 14.58% above the 2011 start. As for the possible formation of a bubble, that could be a strong case as fundamental adjustments don't appear to price companies with significant EPS contraction right. It could be that investors are currently trading in a range that they think values these companies well, but questions regarding the future prices maintain a status of unanswerable. Oil and gas companies are expected to default, but which ones and when? Crude oil futures amble along as a security even more difficult to price as they continue to jump around a range below $50. As the global growth scenarios start to become more lucid, energy consumption should paint a more clear picture of what kind of outlook investors can expect. Typically, uncertainty coupled with volatility leads to bad performance (as seen by August), but uncertainty coupled with growth can lead to bubble-like patterns. Investors should watch volume levels to keep track of when a significant reversal might have occurred. Also, watch for similar sectors and other commodities to compare deviations from indexes that tend to move with energy like industrials and consumer goods.