Go Your Own Way
"You can go your own way
Go your own way
You can call it
Another lonely day
You can go your own way
Go your own way"
- Lindsey Buckingham (Fleetwood Mac) - 1977
Unraveling Of the Cartel?
What does it all mean for global supplies of crude? What does it mean for the future, not only for the sometimes-infamous cartel known as OPEC but also for the cooperation between that cartel and those oil-producing nations not officially part of it, but allied with it, and collectively referred to as OPEC Plus?
Many of you may have noticed that front-month futures for Brent crude had moved above $77 per barrel on Monday evening while West Texas Intermediate (WTI) crude August futures have moved higher than $76 per barrel. OPEC Plus has been typically led for years by Saudi Arabia on the OPEC side and Russia on the "plus" side. Cracks finally started to form this week as there would be no forward-looking production plan agreed upon. Indeed, the meetings that began last week and were set to continue this week have been called off, with no set date as of yet to reconvene.
It boils down to disagreement between cartel leadership and the United Arab Emirates (UAE) as that nation rejected a Saudi-led proposal to increase oil output by 400,000 barrels a day per month into the year's end. The UAE believes planned targets are too low and apparently would prefer to move to something closer to capacity. The thing this does is leave in effect the entire group's current production limits. Hence, no new oil production that could ease increased demand as the world moves toward reopening its economies.
Why does the UAE not just increase production on its own? Under the cartel's charter, all decisions of this magnitude must be unanimous. In order to openly increase production, the UAE not only would need to leave the cartel, but also the cartel plus the alliance. This for now is seen as unlikely by the marketplace.
What that does, in effect, is increase energy prices, which in turn puts upward pressure on inflation. Remember when I told you that parts of our broader inflationary move could become more structural than transitory? I am not saying for sure that the upward trajectory of energy pricing is structural, but there will certainly be change of some kind.
Could the UAE (or Saudi Arabia and Russia) have a change of heart? Right now that seems unlikely. U.S. production could ramp back up. That said, U.S. producers have been burned before by this alliance after greatly increasing production levels. That was also under an energy-industry-friendly administration and less toxic (for the fossil fuel industry) investment allocation environment, which the current leadership in D.C. as well as the current investment environment most certainly is not.
The result for now is higher energy prices that not only push up the cost of doing business across a number of industries, but also do the same to household budgets, leaving less room for discretionary spending. These impacts will be seen at least for now as upward pressure on U.S. dollar valuations as well as downward pressure on the longer end of the U.S. Treasury yield curve. This could prove temporary. Why is that? First, most of the world buys oil in U.S. dollars. Second, energy inflation lies outside of core inflation, which the Federal Reserve focuses on more closely, and markets appeared to see Friday's June employment report as positive, though there are clearly bizarre discrepancies in the results of those surveys.
My expectation for energy markets is that these guys all start cheating on each other in short order. Another emergency meeting is then called a little while after that. Let's continue.
Using SPDR sector select ETFs as proxies, 10 of 11 sectors traded higher last week, with only Energy (XLE) in the red over the five-day period. At the index level, the Nasdaq 100 screamed 2.7% higher as the Nasdaq Composite soared 1.9%, in large part due to the outperformance of an Information Technology sector (XLK) that ramped 3.2%. The sector, in addition to Health Care (XLV) , Communication Services (XLC) and Consumer Discretionaries (XLY) , all finished the week up at least 1.8%, which forced the S&P 500 itself up 1.7%.
By the way, within that tech sector boot stomp, the Dow Jones U.S. Computer Hardware Index popped to the tune of 4.82%, led by Apple (AAPL) which was up 5.2%. Beyond Apple, the Dow Jones U.S. Semiconductors Index ran 3.4% as Advanced Micro Devices (AMD) (+10.4%), Xilinx (XLNX) (+9.4%), Nvidia (NVDA) (+7.7%) and Oorvo (QRVO) (+6.7%) all simply hit the cover off the ball last week.
One should point out that at least technically the Nasdaq Composite, Nasdaq 100 and S&P 500 are all into overbought territory according to their individual readings for Relative Strength. This comes just a week ahead of earnings, as all of our most closely watched small- to mid-cap indices posted negative weeks last week and as the 12-month forward price-to-earnings (P/E) ratio for the S&P 500 has reached back up to 21.4x in aggregate. Yes, the market for most of our large-cap indices did run higher last week, but did so on successively lower trading volume toward the three-day weekend.
The markets reacted well to rising home prices, rising consumer confidence, slowly ebbing first-time jobless claims and supposedly strong headline employment data for June. There is a catch, though.
As you know, the Bureau of Labor Statistics (BLS) publishes employment data every month from two surveys. The Establishment survey includes the Non-Farm Payroll (NFP) number, which on a seasonally adjusted basis printed at 850,000 job gains, an impressive number for job creation. The crowd cheered. The Household survey showed that jobs actually contracted in June by an also seasonally adjusted 18,000 job losses. The crowd as well as the media simply ignored the idea that one survey showed a contraction in employment for the month.
Now, last Wednesday, ADP reported private sector job creation of 692,000 for June, which is ballpark close to the BLS private sector June job creation number of 662,000 (meaning that according to the NFP number 22% of all June hires were in the public sector). This does tell me that the Establishment number is probably closer to the actual employment situation, but clearly something is wrong with the way we collect data.
If advertisers know immediately what different people in a household browse on the Internet, then how hard can an accurate payroll headcount be? Should we as a nation still be relying upon sample-size surveys of either establishments or households and then extrapolate that number across the entire population? A better way must be found to measure employment, and every subcomponent of said situation that is key to determining national labor market health.
That said, what do I know? I'm sitting way up in the cheap seats. Some say the cheap seats, at least strategically, provide the most complete view of each play as the game develops.
The Attraction of Positive Yield
You'll recall that at the conclusion of the most recent Federal Open Market Committee (FOMC) policy meeting the Fed had announced technical changes (increases) made to two short-term interest rates. The RRP (overnight reverse repo) moved from 0% to 0.05% and the IOER (interest on excess reserves) moved from 0.10% to 0.15%. These rates are helpful in keeping a lower bound on the entire spectrum of interest rates, which includes keeping the fed funds rate within the targeted range as market forces place downward pressure on the short end of the yield curve.
I am sure, like most market watchers, you have noticed cash reserves flocking into the Fed RRP facility of late. If you read this column often then you know that we have surmised that the large banks had been pouring cash into T-bills as a means of producing some kind of return with their (rather large) excess reserves. Over the weekend, Credit Suisse strategist Zoltan Pozsar suggested that this large influx into the overnight repurchase facility will likely draw cash out of the market for Treasury bills.
Such a rotation certainly makes sense. The Fed has incentivized the overnight stashing of cash at the central bank for a positive return when before there was none. Indeed, both U.S. 30-day paper as well as 90-day paper pay less than 0.05% here on Tuesday morning. Heck, one-year T-bills only pay 0.07%. As quantitative easing continues and the nation runs up against the debt ceiling, Pozsar does not predict the "end of days'' or even trouble for the banks with the largest reserves to find homes for, such as JPMorgan Chase (JPM) or Bank of America (BAC) . However, he does warn investors that there could be a "weirdness" to the markets toward the end of summer as more and more T-bills mature.
Just an idea, again from the cheap seats: Would not a slightly negative overnight reverse repo rate force the big banks to pin the short end of the Treasury curve to zero, thus allowing the Fed to potentially reduce asset purchases of this type? Perhaps -- 0.05% still keeps the fed funds rate at 0%, which is still within the targeted range.
Or perhaps such an action would force the big banks to lend more of these reserves at interest rates lower than they lend to the public now. Hmm, that would release currency created through quantitative easing into the general economy instead of being confined to the banking system. Interesting. More cash moving through the economy. Less cash in reserve. Increased velocity. You know what that sounds like, right? Inflation. Structural inflation. Perhaps there is a reason the Fed is willing to pay 0.05% overnight in order to keep this cash confined where it is. Perhaps this is the economy's trap door. Perhaps. Time will tell.
In Other News.....
Tesla (TSLA) delivered more than 201,000 new vehicles in the second quarter, which is a new record, and for now quite impressive. As Chinese electric vehicle (EV) manufacturers such as Nio (NIO) and traditional U.S. car companies such as General Motors (GM) and Ford Motor (F) ramp up investment and capability in the EV space, the gains for EV sales overall may stay on their current trajectory, or probably accelerate, but those gains are going to be more evenly spread out across the competition.
Jeff Bezos has stepped down as planned as CEO at Amazon (AMZN) , replaced by Andy Jassy, who built Amazon Web Services (AWS), Amazon's cloud computing business. I see no reason to add or subtract from current Amazon long positions until we know more about how Jassy will run the company, including the potential for an eventual stock split.
Didi Global (DIDI) is trading much lower less than a week after the Chinese ride-hailing and autonomous-driving business made its U.S. debut. Obviously, there was a rush to go public and a broad lack of due diligence as Chinese regulators cracked down on the business almost immediately after going public. Why anyone would be interested in investing in Chinese companies listed in the U.S. is beyond me. Even if these companies were held to the same standards as publicly traded U.S. companies, there is just too much interference at home for these companies. No thank you.
Economics (All Times Eastern)
09:45 - Markit Services PMI (June-F): Flashed 64.8.
10:00 - ISM Non-Manufacturing Index (June): Expecting 63.6, Last 64.0.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
After the Close: (SGH) (1.09)