Archive for December, 2015

• Oil and Stocks Part Ways
  Eddy Elfenbein, December 16th, 2015 at 10:46 pm

  Since late-October, stocks and oil have been somewhat correlated. But today, on the day of the Fed meeting, there was a big divergence. Stocks did well while oil did not.

  Here’s the chart:

  

  What does it mean? That’s hard to say. Odd relationships can last for a few weeks before breaking up. I suspect that as oil starts to fall, it’s good for stocks. But if it falls too far too fast, then maybe it can harm the economy.

• Yellen on Natural Rates
  Eddy Elfenbein, December 16th, 2015 at 5:33 pm

  This is from Janet Yellen’s press conference:

  This expectation is consistent with the view that the neutral nominal federal funds rate–defined as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy were operating near potential–is currently low by historical standards and is likely to rise only gradually over time. One indication that the neutral funds rate is unusually low is that U.S. economic growth has been only moderate in recent years despite the very low level of the federal funds rate and the Federal Reserve’s very large holdings of longerterm securities. Had the neutral rate been running closer to its longer-run level, these policy actions would have been expected to foster a much more rapid economic expansion.

  The marked decline in the neutral federal funds rate may be partially attributable to a range of persistent economic headwinds that have weighed on aggregate demand. Following the financial crisis, these headwinds included tighter underwriting standards and limited access to credit for some borrowers, deleveraging by many households to reduce debt burdens, contractionary fiscal policy, weak growth abroad coupled with a significant appreciation of the dollar, slower productivity and labor force growth, and elevated uncertainty about the economic outlook. Although the restraint imposed by many of these factors has declined noticeably over the past few years, some of these effects have remained significant. As these effects abate, the neutral federal funds rate should gradually move higher over time.

  This view is implicitly reflected in participants’ projections of appropriate monetary policy. The median projection for the federal funds rate rises gradually to nearly 1-1/2 percent in late 2016 and 2-1/2 percent in late 2017. As the factors restraining economic growth continue to fade over time, the median rate rises to 3-1/4 percent by the end of 2018, close to its longer-run normal level. Compared with the projections made in September, a number of participants lowered somewhat their paths for the federal funds rate, although changes to the median path are fairly minor.

  I think this is very important and I’ll try to explain why. Prior to the recession, it was assumed that the natural rate was about 2% in real terms, meaning after inflation.

  That means that the Fed’s job is pretty simple: bring the Fed funds rate below 2% to get the economy going, and then bring it above 2% when the economy is running hot. As such, the trend of real Fed funds should oscillate between about 0% on the low end and 4% or so on the high end. Check out this chart:

  After the recession hit, all that went out the window. The Fed believes that the natural rate tanked and probably went negative. I think that’s right.

  Now the “sine wave” of real rates may fluctuate between, say, -2% and +2%. According to today’s blue dots, the Fed expects the real Fed funds rate (the blue line in the chart above) to be -0.9% at the end of this year. It will rise to -0.2% at the end of 2016, and to +0.5% by the end of 2017. The Fed believes the long-rate rate is 1.4% which we can assume is the Fed’s guess for the natural rate. I think that’s too high.

  To me, what the new numbers are isn’t exactly important. It’s that we live in a new economic world. The old rules no longer apply.

• Oracle Earns 63 Cents per Share
  Eddy Elfenbein, December 16th, 2015 at 4:40 pm

  Oracle (ORCL) just reported fiscal Q2 earnings of 63 cents per share, three cents more than Wall Street’s consensus. Revenue fell 6% to $9.0 billion, but adjusted for currency, revenue was flat.

  “We’re very pleased with our non-GAAP EPS of $0.63, beating the mid-point of guidance by 4 cents despite a stronger than expected currency headwind,” said Oracle CEO, Safra Catz. “We grew our SaaS and PaaS revenue 38% in constant dollars this past quarter, and we expect that revenue growth rate to accelerate to nearly 50% in Q3 and close to 60% in Q4. This rapid increase in our cloud revenue will help drive our SaaS and PaaS cloud gross margins from 43% in Q2 to approaching 60% in Q4 and drive significant EPS growth in Q4.”

  “It was a very strong growth quarter for our cloud business, with SaaS and PaaS bookings up 75% in constant currency and billings up 68% in U.S. dollars,” said Oracle CEO, Mark Hurd. “We did 100 Fusion HCM deals and over 300 Fusion ERP deals in the quarter. We now have more than 1,500 ERP customers in the cloud — that’s at least ten times more ERP customers than Workday.”

  “We are still on-target to sell and book more than $1.5 billion of new SaaS and PaaS business this fiscal year,” said Oracle Executive Chairman and CTO Larry Ellison. “That is considerably more SaaS and PaaS new business than any other cloud services provider including salesforce.com.”

  The shares are up 2.2% in after-hours.

  Update: Oracle is now down in the after-hours market. On the conference call, the company gave fiscal Q3 guidance of 63 to 66 cents per share. For Q4, they gave guidance of 83 to 86 cents per share.

• The Bond Market’s Reaction
  Eddy Elfenbein, December 16th, 2015 at 3:12 pm

  So far, the market’s reaction is pretty muted. The two-year yield looks to close above 1% for the first time in several years.

  

• The Fed’s Projections
  Eddy Elfenbein, December 16th, 2015 at 2:22 pm

  Here are the Fed’s projections. This is often referred to as the “blue dots.” Personally, I think the Fed is way off here. They see rates rising much faster than I think is needed. The FOMC members currently project four rate hikes next year, and another four in 2017. I think we’ll see one, or maybe two, next year.

• The Fed Raises Rates
  Eddy Elfenbein, December 16th, 2015 at 2:00 pm

  The Federal Reserve has raised interest rates by 0.25%. The vote was unanimous. Here’s the complete statement:

  Information received since the Federal Open Market Committee met in October suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft. A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down.

  Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.

  The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

  In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

  The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

  Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

• Brief Updates
  Eddy Elfenbein, December 16th, 2015 at 1:17 pm

  The financial world is on pins and needles. Here are a few items I wanted to pass along.

  Jefferies initiated coverage on Hormel Foods (HRL) with a Buy rating. Of course, this comes after the Spam people rallied 50% this year. The stock is close to breaking $80 per share.

  Express Scripts (ESRX) said that they’ll announce their guidance for next year on Tuesday, December 22.

  Oracle’s (ORCL) earnings report will be our final Buy List earnings report for this calendar year.

  The futures market odds for the November 2016 meeting are exactly 50-50 of rates being 0.75% or less, or 1% or more.

• Fed Day Is Here
  Eddy Elfenbein, December 16th, 2015 at 12:03 pm

  Today is the day. After nearly 10 years, the Federal Reserve is set to raise interest rates later today (here’s my post on the last rate hike). The announcement will come at 2 pm. Wall Street and the Fed have almost continuously overestimated the need for interest rates to rise. But this time, it’s real. According to the futures market, however, there’s still some room for doubt.

  I’ll put it as easily as I can. The Fed said it won’t raise rates until X happens. X happened. So that’s why I expect rates to go up.

  Here’s the effective Fed funds rates for the last seven years. It’s averaged 0.128%. That means you’ve made less than 1% combined.

  Bear in mind that rates aren’t going up much. Interest rates will still be below the rate of inflation. In fact, they’ll be below inflation for quite some time. Perhaps two more years.

  The government reported today that industrial production fell 0.6% last month. I think it’s accurate to say that the manufacturing sector has been in a mini-recession for the last several months.

  By the way, it’s one of the biggest myths you hear that “America doesn’t make anything anymore.” That’s flatly untrue. In reality, America is a manufacturing powerhouse. The difference is that fewer people do it.

  Yesterday, the stock market finally delivered back-to-back gains. This is our first two-day winning streak since the beginning of November. That’s one of the longest such cold streaks in history.

  Also, after today’s closing bell, Oracle will report earnings.

• Morning News: December 16, 2015
  Eddy Elfenbein, December 16th, 2015 at 7:06 am

  Thaw in China-Russia Relations Hasn’t Trickled Down

  French Business Grinds to Halt as Services Hit by Terror Attacks

  Why Very Low Interest Rates May Stick Around

  Congress Reaches Fiscal Agreement That Ends U.S. Oil Export Ban

  U.S. Oil Discount to Brent Near 11-Month Low as Exports Awaited

  Fed’s Historic Liftoff and Everything After: Decision Day Guide

  Valeant Pharmaceuticals Slashes Revenue, Earnings Guidance

  What’s Behind Kohl’s 170-Hour Pre-Christmas Shopping Marathon

  Global Payments to Buy Heartland Payment for $4.3 Billion

  Remaking Dow and DuPont for the Activist Shareholders

  Rolls-Royce Culls Executives as East Responds to Profit Drop

  Battered, Apologetic and Still Pitching Their Hedge Funds

  Boeing Says China Postal Airlines Orders Ten 737-800 Converted Freighters

  The Major Difference Between Wall Street and a Casino

  Cullen Roche: The Macro-ization of the Investment Landscape

  Be sure to follow me on Twitter.

• Qualcomm Rejects Split Idea
  Eddy Elfenbein, December 15th, 2015 at 10:24 am

  Qualcomm’s board rejected the idea of breaking itself up. I think that was the wrong decision.

  Qualcomm Inc. rejected calls to split, betting that keeping its chipmaking and patent licensing business together is the best formula for turning around an earnings slump and stock drop.

  Qualcomm also updated the outlook for its fiscal first quarter ending this month, saying it may “modestly” exceed its prior profit forecast.

  Following a review of the “benefits and challenges of the existing structure,” the mobile chipmaker’s board and management decided, as anticipated, not to separate the two arms of the company.

  “We have a focused plan in place that we believe will drive growth and we are off to a good start implementing that plan,” said Chief Executive Officer Steve Mollenkopf. “The strategic benefits and synergies of our model are not replicable through alternative structures.”

  (…)

  Qualcomm’s decision contrasts with other technology companies that have split this year. Hewlett Packard became two entities in November, EBay Inc. split with payments unit PayPal and Yahoo! Inc. is separating itself from its stake in Alibaba Group Holding Ltd. to return the asses to shareholders without incurring taxes.

  The decline in Qualcomm’s stock price has pushed its market value to about $70 billion, compared with a peak of more than $130 billion in 2014, when it surpassed Intel Corp. to become the biggest U.S. publicly traded chip company. Talk of a split was rekindled earlier this year by activist investor Jana Partners LLC, which bought up stock in the company. Jana signed off on the strategic review, which was initiated in July and included a 15 percent employee reduction and a shakeup of the board.

  The stock is up about 2.6% today.