The Quiet Man
"I wonder now, why a man would go to Innisfree?" No, not that quiet man. Often you will hear me credit my dad, who opened for me a retail brokerage account when I was 13 and allowed me to buy and sell equities under his guidance with my newspaper profits. You will also often hear me credit Jim Cramer, as I had watched and listened to Jim long before he ever knew who I was. Jim and I think alike on a lot of issues. There is a third man, a much more private man, who impacted me in a positive way, and my development in the financial industry. That man ran the NYSE trading floor for Credit Suisse First Boston during the gravy days of the 1990s.
He was not a gentle man. One of the very smartest individuals that I have ever known. Many in the industry did not know that this man had once earned the "title." He was very quiet about that. Perhaps that title is why he hired me. I know that he brought it up during the interview.
For whatever the reason, I was better for it. This man demanded an elite level of performance from everyone around him. When I say elite, I mean elite. You have to use the restroom? You run there, you run back. You do not walk. Have to eat? One at a time, and while you work. From 6am to 5pm, you did not goof off, not for one second. I loved working for this guy. In this environment, I could excel.
Highest on his list of demands was decisiveness. "Make a decision, and move on." That still bangs around inside my head, and in still in his voice. Oh, I know, this man would not appreciate it very much if I actually used his name in a morning note meant for public consumption, but sir if you still follow the markets, and if you still follow my stuff... I thank you. Profusely.
I thank you for taking a chance on me all those years ago, for teaching me about capital commitment, for teaching me about investment banking, and for always demanding of me an intellectual toughness that I did not know that I was capable of. Always Faithful.
Sure, I did write about Micron Technology (MU) going into earnings last night. I would not classify my feelings going into those earnings as confident. I cannot deny, however, that I was hopeful. Perhaps optimistic. The straight up results for Micron's fiscal first quarter were not awful. An EPS beat, a revenue miss that still printed at a handsome-looking number for year over year growth.
That is where the fun stops. The guidance was, to say the least, a shock. We did acknowledge in Tuesday's Market Recon that these shares were either undervalued, or that forward-looking earnings projections were wrong. Forward-looking earnings projections were wrong. During the call, CEO Sanjay Mehrotra's firm was forced to cut second-quarter guidance to both earnings and revenue to a degree that is difficult to look at. I feel, if not misled (I guess I should have known better), then at least numerically mismanaged.
In an effort to not mislead my readers, I want to make something clear. I will not be selling the name on weakness. I do not do that. In all likelihood, I may buy more. I will certainly be active in the options market. Make no mistake, I am still trying to get out of this at or better than my net basis ($36.08), but my thesis has changed. As of yesterday, I was still looking at this name as an investment. As of this morning, I am simply trying to improve my exit from the name. See ya, Sanjay.
Down 40% in just a couple of months. Astounding. Now, an old story. Everyone who trades the energy space already knows that Russian and Saudi production had ramped higher when crude was trading near the top. In addition to that, the United States in the autumn released in size WTI crude from the Strategic Petroleum Reserve, while granting at least eight waivers to nations requesting exemption from the sanctions placed on Iran. Effectively, that leaves Iranian oil in the marketplace.
WTI traded at more than 52-week lows on Tuesday. The energy sector has been in near free fall. That's no secret. According to the Wall Street Journal, there have been no high-yield bonds issued in the United States this month. None. This space is often dominated by the energy sector. Part of the story is growth -- or lack thereof, globally. The Chinese and German manufacturing sectors are experiencing slowdowns of the multi-year variety. What this does to crude from a demand perspective could get even uglier. U.S. production has only increased. Shale production alone is expected to hit 8.2M barrels a day as soon as next month.
All of that said, market prices are now approaching levels where rig count could start dropping in a meaningful way. I am still adding in an incremental way to my energy longs, but carefully. Carefully? What does that mean? Listen, according to Kallanish Energy Consultants, there is about $240 billion (with a B) worth of long-term energy sector debt maturing by 2023 (as in, under five years). Understand that this is maturing debt. Total debt is another story entirely. What this will do at these prices is put the whammy on credit ratings across the space. It does not help the banks either, by the way.
Back to investing in the space. My thought had been to gravitate to the energy space for the huge dividends paid by many firms in this sector, and the reliability of those payments. It becomes imperative, I believe, to trust capital only to high-profile names sporting attractive cash flows. Then button up, through the sale of both calls and even appropriately priced puts. The entire industry needs to see inventories contract before the proverbial foot is removed from the proverbial throat. How long? Six months is a timeframe being thrown around. That may be too optimistic.
I remain in a few names across the sector, but my faves are still Exxon Mobil (XOM) , British Petroleum (BP) , and Royal Dutch Shell (RDS.A) . All three of those, while down of late, remain at or close enough to my net basis to keep me around. Stick with sustainable positive cash flow, for now. This space could and will likely get messier before the sun shines again. The sun, however will shine again.
Wednesday afternoon, for the first time in several years, markets really don't know what to expect from the FOMC at the conclusion of the committee's two-day policy meeting. It is interesting to note that futures markets in Chicago are still pricing in a 68% probability of a 25 basis point increase in the Fed Funds Rate. I bet that at least some of you did not know that those futures are now pricing out any interest rate increases at all in 2019. That's right. As of this morning, according to those markets, which admittedly can be volatile, there is now only a 38% probability that there will be any increase at all at some point in calendar 2019.
Let's not forget that in 2019, Jerome Powell's intent is that every policy meeting be a live one. That's a big change from the recent past, where every other meeting had been meaningless due to the lack of the whole dog and pony show. On Wednesday, they'll bring out the jugglers, the plate spinners and the alligator wrestlers. They'll drag out their constantly erroneous economic projections. I know that I am hard on the FOMC. They have earned far more criticism than they have received, to be honest. Two things that the Jerome Powell era has gotten right is that move toward making every meeting live and the reduction in verbiage in the official policy statements.
Something that this Fed has gotten completely wrong -- outside of policy, which we can disagree on -- has been the lack of communication with the public over the removal of assets from the balance sheet. This "quantitative tightening" program, that amounts to the actual "burning" of $50 billion worth of liquidity every month, is tightening monetary conditions, and is every bit as experimental as was the easing policy that had taken the balance sheet so far in the first place. That "easing" policy was inappropriately extended years beyond what should have been its rightful conclusion. Those errors are the cause. This current Fed's errors are errors of aggression, not intent.
With the entire planet engaged in a synchronized slow-down, with dollar strength at unhelpful levels, with emerging markets gasping, with the Chinese and German manufacturing sectors in serious decline, with the U.S. housing and auto sectors (really anything requiring the consumer use of credit) simply reeling, and with U.S. spending on core capital goods floundering, it becomes clear that the FOMC has displayed a dire lack of situational awareness to a degree difficult to describe.
Whether the Fed has caused all this damage is highly debatable. I will grant that the Fed did not cause any trade war. The Fed did not cause slow downs now visible across Europe and Asia. The Fed did indeed exacerbate the negative impact of these issues though, solely on their belief that a tight labor market would produce more inflation than it has. Janet Yellen did not understand why the Phillips Curve does not work in the modern age. At least she admitted that much.
Bottom line, a softer economy will surely put the labor market in harm's way. That is inevitable. Domestic manufacturing data is starting get wonky. Unfilled orders printed in contraction in the December Empire State survey. The energy sector is bound for a likely broad reduction in head count, and those will be good jobs lost. There are a plethora of good reasons to take a more sentient approach to monetary policy -- the potential for an inversion of the 2s/10s curve chief among them. Another step down the road of normalization without some kind of clearly overt messaging on the need to be more cautious on both interest rate policy and balance sheet management in 2019 can only be considered "intent to harm." Harm who? Harm you.
Economics (All Times Eastern)
08:30 - Existing Home Sales (Nov): Expecting 5.2M, Last 5.22M SAAR.
10:30 - Oil Inventories (Weekly): Last -1.208M.
10:30 - Gasoline Stocks (Weekly): Last +2.087M.
14:00 - FOMC Policy Decision.
14:00 - FOMC Economic Projections.
14:30 - FOMC Press Conference.