Sure, it always feels great for the bulls when the futures are ripping. You get all of that juice from overseas. People are feeling that Fed chief Ben Bernanke didn't mean what he said. The dollar is going down, too, which even helps commodities. So let's go buy stocks!
There's only one problem. The travails of individual companies, in dealing with this new environment, are about to come on display -- and the facts, often sadly, do not fit with the story. The stocks that are being swept up by the futures -- the stocks that we might want to buy because of today's snapshot of the dollar, the 10-year U.S. Treasury and the price of oil -- may not fit the patterns people are trying to catch. In fact, they might be performing in the opposite manner from what you would expect.
Take two different companies in two different industries that have had the misfortune to report during periods when the snapshot said, "Buy, buy, buy." I'm talking about Paychex (PAYX) and Nabors Industries (NBR).
Paychex is a terrific payroll-processing company that grows earnings in four ways. First, when more jobs get created, there are more checks to be processed. Second, when more companies get created, there are more company payroll accounts to be processed. Third, the company profits when more products are added to those who take the payroll processing, like 401k processing and advice for tax law changes.
Fourth, and perhaps most important: the float. How much can Paychex make on the $4 billion or so it has to invest between the time it gets the money and the time it delivers the checks? That's the float, and it is a bonanza for companies like Paychex -- unless, that is, interest rates are so low that they can barely make much money at all off that float, meaning they make pretty much what you make right now in your checking account.
Paychex is the perfect microcosm for this moment when it comes to the Fed. It's a catch-22 microcosm, because -- as has been made clear by Wednesday's minutes from the last Federal Open Market Committee meeting -- Ben Bernanke isn't going to raise interest rates through a slowdown in bond-buying until there is more hiring and more business formation.
So think about it: Paychex, right now, isn't getting enough new clients because there's been such horrid business formation and such limited hiring. At the same time, it can't make the big money off the float that investors want. So it has to rely on the third point, ancillary fee work, in order to grow earnings -- and that's not growing fast enough.
So what happened when Paychex reported? All of those people who saw interest rates move up figured instantly that the company was already investing the float and getting a much higher rate than it had in the prior quarter. They were looking for a big gain from the float-income line. There were others who were looking for some job growth because, well, didn't we just hear from the Fed that it might start tapering stimulus because job growth is coming back?
It turns out, though, that the Paychex facts just didn't fit the better-employment/higher-float income story. It was just the opposite, in fact. Client growth was almost nil. The yield curve hadn't changed so much that Paychex could take advantage of the higher rates, so float income was pretty much unchanged from what it was supposed to be. No upside surprise in this market, of course, means nothing less than a downside surprise, and the stock was hammered.
Now consider Nabors. On Wednesday oil broke out above $105 per barrel. Nobody really knows what the heck is going on with oil. Could the strife in Egypt close the Suez Canal, causing traders to freak out and bid the price up in anticipation of that event? Could the drawdown in inventories in the U.S. be so great that we aren't pumping enough? Yet U.S. pumping is now at levels not seen since 1992, and we are clearly on a path to return to the levels of oil we produced in the 1980s. At the same time, we are more efficient in our use of oil, which means we will import less and less each year.
Is this oil move a technical breakout? Is it the kind of breakout that makes people think prices will at last go back to where it they been right before the worldwide economic collapse? Is China about to stimulate? Is oil now just the new commodity coin of the realm? If so, this would mean that big pension and hedge fund managers like to use oil as their chit in the asset allocation of commodities, now that copper, aluminum, iron and the grains are all in glut. Is that the deal, as our friend Dan Dicker has been asserting here?
All I know is that, when crude crossed above $100 and then broke through $105, it seemed like a darned good idea to get long an oil-services company, didn't it? You know that, if orders were being cancelled, those cancellations would get canceled. You know that some oil companies have to be deciding their oil budgets, and they realize if they just drill a little more now, they can pay down debt later.
So the Market Vectors Oil Services ETF (OIH) gets bid up, and then folks snap up individual stocks in the group are that haven't been moving as quickly as others, as the race is on to play the oil breakout.
Then someone invites the Nabors skunk to the party -- Nabors, the giant land driller that has simply disappointed time after time after time. Nabors, which has a kind of "if there is a will to do poorly, it will find a way to do poorly" quality -- and this company sure has that will.
Then Nabors issues a pre-earnings announcement, and it's a real stinker because of the decline in natural gas drilling, owing to the well-known glut. When that happens, all of the air goes right out of the group, and it underperforms the averages despite the surge in oil. It's a total pick-off, to use the baseball analogy, as the whole oil complex had been leaning the wrong way, with traders in disbelief that Nabors could screw up such a fabulous trade.
But don't worry. All is not lost. The hope-hype game springs eternal. Paychex is right back to where it was before it reported, in part because it had a good dividend yield and it looks like Ben Bernanke has put a little pep into the bond-yield-equivalent game. If he isn't taking rates up that much, and we still get a good tax deal on dividends, then why not take the 3.5% Paychex is offering? Why not wait until the float income does go up? It shouldn't be long now, because rates haven't gone back down -- they just stopped going up. Wait for the job growth to kick in because, alas, won't that happen someday?
Who knows? Maybe even Nabors can get it right -- although I think that it's the oils, not the services stocks, that represent the best way to play a rise in oil.
That all brings us to where we are now. We have seen a series of bank downgrades in the last few days on the eve of big bank earnings. I get that. That's the Paychex problem: There isn't enough job growth, plus not enough certificate-deposit repricing -- that's the float -- in order to offset a prospective decline in demand because of higher prices for money. So the very stocks people want to play for the moment -- the banks, the ones that have done so well -- might turn out, in the short-term, like Friday, to be the wrong ones.
Still, never fear: The Paychex-like rebound could be here, at least sooner than you think, so it probably isn't worth selling the banks. But I fear there will be no more bank gain without some pain first -- and, if you own the real wrong ones, like Nabors, there'll just be pain and nothing more.
