Equities and the Economy

No sense sugar coating it. 2016 began abysmally. It was the worst first trading day of the year in 15 year. The Dow lost 276 points, 1.58%, finishing at 17,149, the S&P 500 fell 31, 1.51%, to 2,103 and the Nasdaq closed 104 points lower, 2.09%, and once again under 5,000 at 4,903. That’s the good news. Global markets performed much worse. Germany’s DAX lost more than 4% yesterday. That’s huge and was a big yoke for U.S. equities to carry. Additionally, at one point during the day the Dow was down a whopping 462 points, 2.66%, but fortunately in the last 36 minutes rallied 154 points.

It all started with a lousy Chinese purchasing managers’ report rekindling worries over global growth which infected equities around the world. Making matters worse the domestic economic data wasn’t very good. The Institute of Supply Management reported that its U.S. index of manufacturing activity fell from 48.6 in November to 48.2 in December with economists’ forecasting 49.0. Now this on the surface may not seem like a big deal but there are two things to note. First, it’s below that all important number of 50 separating contraction from expansion, and second, December’s index was the lowest since June 2009. With the Fed raising interest rates making our exports more expensive in relative terms it’s going to be hard for this index to rally.

If that wasn’t enough, more disappointing news came from the Commerce Department which reported yesterday that construction spending decreased 0.4% in November, the first decline in 17 months. Wall Street was expecting a 0.6% increase. Construction has been a bright spot and important in our economy’s recovery so this is a bit disturbing. However, the “glass is half full” side is that Federal government construction was down a huge 7.2% pulling the overall index lower. Let’s see if this was an end of year one-off.

Overnight the major Asian markets closed lower but not materially losing 0.26% to 0.65% and the European markets after starting the day in the red are recovering currently trading close to unchanged to Monday’s closes. Locally, Dow futures are down 22 points but have bounced back nicely from when I came into the office and futures were down triple digits. By the way, keep an eye on the S&P 2,000 level. That’s been an important support level. During yesterday’s carnage that level held fairly well.

Oil

In very early morning trading, and I’m talking about before you woke up, oil prices shot up 4% yesterday on increasing tensions between Middle East powerhouses, and enemies, Saudi Arabia and Iran over the execution of a Shiite cleric by the former. However, sellers sold into the price pop and prices retreated. At the day’s end WTI fell 28¢ to $36.76 and Brent closed about unchanged (-6¢) at $37.22. Fundamentally, the negative manufacturing data out of the U.S. and China certainly didn’t feed the bull argument.

For the near future rallies are going to be tough to sustain. Many, many producers have a greater than desired amount of production unhedged for 2016 and beyond choosing not to hedge at current prices. Any pop in prices will see producers selling/hedging forward production.

This morning WTI is down 49¢. Let’s attribute the lower price to weaker equities.

Courtesy of MDA Information Systems LLC

Natural Gas

The cold weather forecast we saw yesterday morning was built into the market on last Thursday’s price run up and with yesterday’s weather forecast similar to Thursday’s natty prices did nothing closing down 0.3¢ at $2.334. Chatter. This morning natty is giving it up somewhat being down 7.1¢ with the 11-15 day forecast coming in marginally warmer than yesterday’s forecast but still marginally cooler than normal temperatures. The 11-15 time frame may have warmed up a tad but the 6-10 forecast is very cold everywhere in the U.S. except the east and west coastlines. We could see a couple of weeks of really big storage withdrawals beginning with this Thursday’s EIA weekly report. Last week with the cold weather a peak of 2.6 Bcf/d of natural gas supply was frozen off which was made up with gas from storage. Looking forward, the very cold weather coming to the middle part of the country next week (the coldest of the season so far) will result in big draws out of storage. Actually, this is good. Due to the anomalously warm weather in November and December storage levels are materially above normal for this time of year.

Elsewhere

Commodities in general had a lousy year in 2015, and the energy commodities had a horrible year. Looking at the bellwether S&P Goldman Sachs Commodity Index (GSCI), industrial metals fell 24%, grains declined 19% and precious metals 11%. The energy component of the index? It got crushed falling 41%! Nickel, diesel and crude oil has the largest declines of the 16 commodities in the index. Weakness in global economic growth was a big reason for the decline but unique supply side factors affected certain commodities, such as oil. OPEC decision, really Saudi Arabia’s, decision in November 2014 to maintain market share at the expense of price (i.e. not curtail production) sent oil prices into a huge tail spin. Interestingly, gasoline not only had the smallest price decline of all the components of the energy sector but fell less than many nonenergy commodities. This was due to increased gasoline consumption in not only the U.S. but other countries as well. Natural gas makes up 4% of the of the S&P GSCI index and in 2015 prices fell about 22% to the lowest level in 16 years in mid-December due to record high inventory levels due to inordinately mild temperatures. Nickel prices fell hard as activity in China’s manufacturing sector as well as an economic slowdown of many developed and emerging markets.

The point here is this is why it’s important to follow the commodities markets. They give you insight into global demand, and hence equity prices. It also gives you insight on how certain country’s economies are performing. For example, commodity export based countries, such as Australia and Canada, should perform worse than countries lacking commodities, such as Japan, when commodity prices fall.