The dollar strengthens, oil and the Russian ruble plummet and the euro, yen, and yuan all limp along.
Globally the big picture is slowing growth, with some areas even in contraction, and currency, commodity and political tensions on the rise. The problem appears to be primarily structural and part demographic, but so far the tools to address the pain have been primarily only monetary and, to some degree, tax increases. The results speak for themselves.
Europe
- The European commission reduced its forecasts for eurozone growth for 2014 to 0.8% from a previous forecast of 1.2% and for 2015 reduced the forecast to 1.7% from 1.1%.
- Euro-area PMIs showed that companies have been cutting selling prices by the most since 2010 to spur consumption.
- In the U.K., services PMI fell to 17-month low.
- While the U.S. economy has surpassed its early 2008 output level by about 8%, the output of the 18-country eurozone is still 2% below its 2008 level.
Last week Sweden's central bank cut its repo rate to 0% from 0.25%, exceeding market expectations in an attempt to fight deflation.
Asia
- China's services PMI fell to 52.9 in October, the lowest level in three months, while new order growth for manufacturing felt to a five-month low.
- In a desperate attempt to get its economy going, Japan has taken the biggest double-down in history, with the Bank of Japan launching an asset-buying spree that, according to the Wall Street Journal, will have the BOJ holding assets worth 57% of its GDP, compared with 26% for the U.S. and 21% for the eurozone.
- Don't think Japan's long-time political jousting partner China isn't paying attention to this latest attempt to massively devalue its currency. China won't like Japan having a material exchange rate advantage, which only adds to the reasons China is likely to de-link from the U.S. dollar.
- South Korea's PMI is now in contraction, falling below 50. The same goes for Hong Kong.
- With the fall in oil prices, coupled with Ukraine-driven sanctions, the International Monetary Fund forecasts a non-existent growth rate of 0.2% for Russia's economy. Meanwhile, the nation's currency continues to plummet, despite significant attempts at strengthening it, is currently the worst-performing in the world, while its stock market is one of the worst-performing emerging markets.
Speaking of oil, earlier this week Saudi Arabia lowered the price it charges U.S. customers in order to protect its share of the American market ... and a rather clear shot across the bow of the American Shale Boom. Today, oil hit new lows yet again. We are getting very close to the price at which these sources become money-losers, somewhere between $75 and $77 per barrel according to research by Goldman Sachs and Morgan Stanley. A material hit to these companies will not only hurt the U.S. energy sector, but also the ancillary beneficiaries such as regional housing and even the high-yield bond market.
Energy companies today represent more than 15% of the Barclays U.S. Corporate High-Yield Bond index, from 4.6% in 2005. We have to wonder what falling oil prices mean for alternative energy solutions. In the past, drops in oil have tended to cause a lull in alternative energy interest and that could weigh on companies like First Solar (FSLR), Capstone Turbine Holdings (CPST), Otter Tail (OTTR), NextEra Energy (NEE) and others, not to mention the First Trust ISE Global Wind Energy ETF (FAN).
While the U.S. economy has been stronger than much of the rest of the world, falling oil prices and slowing global growth will have an impact, exacerbating the struggles the nation already faces.
- The trade deficit will reduce the estimate for 3Q GDP to 3% from 3.5%, which shouldn't be surprising if you consider that about 20% of U.S. exports go to Europe. About half of the overseas profits from U.S. multinational firms originate in Europe, according to Dartmouth economist Matthew Slaughter.
- Continued underemployment of the workforce is a headwind to productivity, which means weaker growth. How many baristas have Master's degrees? A survey of 1,000 workers who graduated from college in 2013 or 2014 released last May by Accenture reported that 46% claimed they were in a job that didn't require their degree, a 5% increase from the prior year's survey. The Federal Reserve reported earlier this year that 44% of working recent grads were deemed underemployed in 2012. This hurts the nation not only today, with the productivity of the underemployed far below what it could be, but will continue to hurt us into the future as these people are not being challenged and gaining skills that will improve their productivity in the years to come.
- This morning we learned that total loan application volume fell 2.6% last week with a 6% drop in refinance applications. Purchase applications are up, but still almost 13% below last year's level, according to the chief economist for Mortgage Bankers Association, with the caveat that growth in the purchase market is at the high end, with continued weakness at the entry level.
- We also learned today that the pace of growth in the service sector dropped more than expected with the Institute for Supply Management's service sector PMI falling from 58.6 in September to 57.1 in October vs expectations of 58.
The trend we've mentioned numerous times in this weekly to boost earnings through share buybacks continues to move full steam ahead, with IBM (IBM) adding $5 billion to its buyback plan after shares hit a three-year low on Oct. 21, having already repurchased $19 billion in the past four quarters. This doesn't look to us like a good way to get EPS growth. On the other hand, Apple (APPL) issued $3.5 billion in 8-12 year bonds in euros on Tuesday, including share buybacks and dividend payments amongst the use of proceeds. With the U.S. tax penalties for repatriation of cash earned outside the US, this looks to us like a cheaper way to put some of those enormous cash balances in the hands of shareholders in a tax-efficient manner.
So what's an investor to do?
For those who are comfortable with shorter-term plays and follow Baron von Rothschild's advice to buy when there is blood in the streets, the Russian Micex Index has been hammered, with many of its stocks trading at a fraction of book value with dividend yields more than 5%. Plus, Russia's low national debt puts it in a much better position to weather economic storms than much of the rest of the world.
For those who can handle the volatility, Market Vectors Russia ETF (RSX) can be a way to buy into relatively cheap equities with a decent dividend yield. (Make sure not to purchase this in a tax-exempt account as the Russian government imposes a 15% withholdings tax on dividends and distributions, which can be recaptured by U.S. investors through a tax credit for taxable accounts.) RSX could do well if we get a short-term bounce in oil prices and a brief reprieve in the appreciating dollar theme.
RSX could get hurt with further oil price declines, but one airline will benefit above all the rest. American Airlines Group (AAL) is the only airline that no longer hedges its jet fuel costs. In addition, Hawkins is an all-too-frequent-flyer, racking up the miles between the west coast, east coast and across the Atlantic. She's been a long-time member of AAL's frequent flyer program, but has often sought to fly with their partners rather than endure their outdated and cardboard-seat-cushioned planes. With the airline's recent plane rejuvenation program, that's all changed and she's actively looking for ways to incorporate the airline into her plans. We suspect she isn't alone.
For those who want to work with the appreciating dollar and relative U.S. economic strength theme, iShares 20+ Year Treasury Bond (TLT) is an excellent choice. As the dollar strengthens and global growth continues to slow, the massive U.S. dollar carry trade will be unwound that could materially depress interest rates in the U.S. while driving up demand for the dollar.
