Oil Falls to $35

Oil Falls to $35, Fueling a Panic in the Junk-Bond Market

by Louis Navellier

December 15, 2015

*All content in the Marketmail Introduction is the opinion of Louis Navellier of Navellier & Associates, Inc.*

The big news last week was that crude oil plunged to $35, its lowest level in seven years, after OPEC removed any semblance of production quotas.  So essentially, it is now every oil producer for itself.

The S&P 500 declined 3.8% last week – its worst week since August – but believe it or not, the high-yield bond market had a worse week than the stock market.  In the corporate bond market, liquidity is evaporating and a serious “credit crunch” is underway, especially in high-yield bonds (i.e., BB, B, and C-rated).  The fact that a big high-yield fund, the Third Avenue Focused Credit Fund, is prohibiting daily redemptions is an example of how disruptive and illiquid the high-yield bond market has become.  There is no doubt that low energy prices have instigated a new “credit crunch” where bid/ask spreads have widened and the underlying liquidity has effectively dried up in high-yield and emerging market debt.

Without access to credit, the bond market is capable of damaging the stock market, just like it did in 2008. However, this time around, we’re not seeing the kinds of kinky leveraged debt products (secured by credit default swaps) that were so prevalent in 2008; so I do not expect another Black Swan scenario.

Federal Reserve Building ImageThe big mystery this week will be what the Fed will say tomorrow, after its FOMC meeting.  Will they restore confidence and provide liquidity for the high-yield bond market now that yields are approaching 18% and default rates are still low – but will undoubtedly rise?  Also, since corporate bond yields have risen, the pace of stock buy-backs, largely financed by corporate debt, will  likely slow a bit.

In This Issue

In Income Mail, Ivan Martchev will delve deeper into the likelihood that the junk bond contagion could spread.  In Growth Mail, Gary Alexander will give us some hope that the lower oil prices could be good for the market (outside of Energy that is).  In his Sector Spotlight, Jason Bodner will use cosmology to explain HFT algorithms!  Jason and I will also look for more clues in the outlook for the energy sector.

Income Mail:
Junk Bond Contagion
by Ivan Martchev
The CRB Commodity Index Sets a 40-Year Low

Growth Mail:
Lower Oil Prices “Rattle” the Market (and Delight Consumers)
by Gary Alexander
Oil Prices Will Likely Fall Further as OPEC Disintegrates

This Week in Market History:
The Death of the Santa Claus Rally Has Been Greatly Exaggerated
by Gary Alexander
Some Specific Santa Claus Rallies, 1982-98

Sector Spotlight:
How Long is 15 Minutes –a Lifetime, or an Instant?
by Jason Bodner
How High Frequency Trading (HFT) Works

Stat of the Week:
Rising Service Costs offset Falling Commodity Prices
by Louis Navellier
Oil at $35 per Barrel Spooks the Stock and Bond Markets

Income Mail:

*All content in "Income Mail" is the opinion of Navellier & Associates and Ivan Martchev*

Junk Bond Contagion

by Ivan Martchev

It is well-known to professional investors that the credit markets usually lead the stock market when signaling economic trouble or an upturn in the broader economy. So what are credit markets saying now?

I have recently written about the indiscriminate selling in CCC-rated bonds and the rapid expansion of their yields relative to the relevant Treasuries, even when compared to less-junky B-rated bonds. I also noted in last week’s Income Mail that CCC- and B-rated credits are correlated and that I am watching with great interest for signs of contagion in the junk bond market.

It happened last week with the halting of withdrawals from the $789 million Third Avenue Value Focused Credit Fund. Investors may not be able to get their money back for months. Third Avenue Management chose an “orderly” liquidation of the fund as liquidity in the bond market was so poor that it was impossible for managers to raise sufficient cash to meet redemptions without resorting to fire sales and further depressing the “marks” (or reference prices) for the rest of the fund’s bond portfolio. (See the December 10, 2015 Wall Street Journal: “Junk Fund’s Demise Fuels Concern Over Bond Rout.”)

Third Avenue Value Focused Credit Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Unfortunately for Third Avenue Management the closure of its credit fund rekindled memories of money market funds “breaking the buck” at the time of the Lehman Brothers’ spectacular failure in 2008 when the Fed had to rush in and calm money markets with various programs so that money market funds could facilitate redemptions. They had no market for their commercial paper other than the Fed itself. Since the whiff of panic in the junk bond market is undeniable and panic spilled over into the stock market, I think that it may be insightful to compare where credit spreads stand relative to the memorable year of 2008.

Bank of America Merrill Lynch High Yield Bonds Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The spread between Treasuries and CCC-rated bonds is now 16.19%. The spread between CCC-rated bonds and B-rated bonds is also blowing out. As of Friday it stood at 900 basis points (bps) or 9.0%, higher than at any point in the first nine months of 2008, just before Lehman Brothers went bust; after Lehman failed those B/CCC spreads blew out quite a bit more (see chart). This is rather peculiar as in the first nine months of 2008 the Fed engineered a series of panicky rate cuts driving the fed funds rate from 4.25% at the start of 2008 to 2% just before the Lehman failure. The single fed funds target rate was discontinued and ended up being a target range of 0-0.25%, where it stands now, as the FOMC meets.

The junk bond market is roughly 40% BB-rated bonds, 40% B-rated bonds, and about 20% CCC-rated bonds, according to Mike Lanier, a money manager with Dial Capital Management with over 30 years in the trenches managing bond portfolios for some of the nation’s largest financial institutions. There are some “split credits” by one of the rating agencies (either Moody’s or S&P) and Investment Grade by the other, or defaulted issues rated D; but those are few and far between, and are definitely much smaller compared to the three main junk categories.

While the spreads to Treasuries between BB- and B-rated bonds have not yet blown past their 2008 pre-Lehman highs, the action in the junk market last week suggests that the contagion is spreading.

In my view, the present situation is clearly deteriorating, so I took time after Friday’s close to check in with bond expert Mike Lanier, who spent 90 minutes on Friday evening giving me his perspective.

“Oil at $35/bbl. is good for the U.S. consumer but bad for high-cost oil companies,” he began. “With a large service economy, the U.S. is OK, even though some overleveraged oil companies may go bust – the smaller ones that don’t have access to the bond market but only bank credit.  Bank loans and credit lines can be reduced or called if credit ratios fall beyond the banker’s comfort level. Each year-end oil companies run a calculation to estimate the value of their reserves which is based on the average price for oil & gas they realized during the calendar year.  Lenders use this valuation in their borrowing base calculation to decide how much to lend. The calculation for 2015 will be a substantially lower value than it was for 2014 for most companies. Some may have credit lines cut or pulled entirely. The same is true for high-cost producers that have outstanding bonds. It will be difficult for them to roll bonds over. There may be a relatively high level of bankruptcies in the energy sector in 2016. This would explain the situation in CCC-rated junk. As of Friday, bonds of energy companies represented 23% of the CCC Index Par value but only 14% of market value, having an average price of 55 cents on the dollar with an average yield to maturity of 33%.”

Commodities Research Bureau Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The CRB Commodity Index Sets a 40-Year Low

I told Mike I think oil can go under $20/bbl, which would be similar to what happened at the time of the Asian Crisis. While we were on the phone, I sent him a chart of the CRB Commodity Index which closed last week at 174.86, the lowest weekly close in over 40 years. Last week’s CRB close was below the 180 level that had held for over 40 years and below the previous low weekly close of 175.9, set in 1975.

I mentioned to Mike that based on the deteriorating economic situation in China commodity prices can go a lot lower. He responded noting, “Falling oil may be good for economies with large service sectors like the U.S., but I doubt it means the same for emerging markets that depend on commodities, like those in Latin America. Falling oil is also symptomatic of the economic deterioration in China where the service sector is underdeveloped and cannot bail out the economy.”

While Mike is less gloomy on China than I am, he is worried that the U.S. bond market is facing a serious stress test. The new rules that were introduced after the Great Financial Crisis have led to dramatically limited dealer bond inventories (see Forbes January 28, 2014: “Banks' Retreat From the Bond Market Means More Risk For Investors”). Dealers stopped being dealers. They simply connected buyers and sellers in the bond market and if there was no buyer – as the Third Avenue Value Focused Credit Fund found out – then prices can cascade lower, which won’t necessarily entice buyers to step in. When dealers held substantial inventories of bonds they had a strong incentive to protect the price of the bonds they held by being the buyer of last resort if another buyer could not be found. Those days are over. The regulators in their over-zealousness have inadvertently removed an important cushion for the over-the-counter market for risky credit.

The regulatory-induced limits of dealer capabilities have damaged the liquidity of the secondary market for bonds. “The trouble is,” Mike noted, “this also damages the primary market or underwriting of bonds as without a liquid secondary market institutions may be less willing to take on new issues. We have not had a stress test under the new rules and it looks like one is coming.”

“If GDP falls below 2%,” Mike added, “default rates tend to rise. If the economy is strong enough to withstand any telegraphed fed rate hikes – and it does not feel all that strong to me – this sell-off in junk bonds will prove to be a big opportunity. If prices fall in a meaningful way in response to liquidity concerns about the bond market you may be able to pick up bonds with recession-sized credit spreads without the actual primarily recession credit risk of steeply falling corporate cash flows.”

Welders Working ImageI told Mike that neither the employment picture, with a dramatically falling labor force participation rate since the last recession, nor the inflation picture – with the CPI rate of change near zero – warrant rate hikes. He agreed in principle but for the time being it still seemed that he viewed the glass half full.  He noted that 1) High Yield is primarily a domestic credit exposure, 2) Low energy prices are particularly beneficial to the U.S. economy as the world’s largest energy consumer, and 3) The U.S. economy, albeit still growing only modestly, looks to be stronger than most of the rest of world going into 2016.

Mike thinks the glass is still half full. My glass looks quite a bit emptier than that.

Growth Mail:

*All content in "Growth Mail" is the opinion of Navellier & Associates and Gary Alexander*

Lower Oil Prices “Rattle” the Market (and Delight Consumers)

by Gary Alexander

“OPEC has abandoned all pretense of acting as a cartel. It’s now every member for itself.” 

--Bloomberg, December 4, 2015

The S&P 500 fell 3.8% last week and most pundits blamed the decline on the falling price of oil.

Here are two sample headlines (among many I could cite):

  • “Dow Falls 310 Points as Oil Plunges Below $36 a barrel: It looks like oil is the Grinch stealing the typical Santa Claus rally…” (CNN/Money, December 11)
  • “Slumping Oil Prices Send Stocks Around the World Lower; U.S. Markets Lose Most in Week Since Summer” (U.S. News & World Report, December 12).

The second article begins by saying “Another drop in the price of oil rattled stock investors….” But consumers don’t feel “rattled” at all. As I will show in “Market History” below, it’s too early to say “the Grinch killed Santa.” As Christmas nears, consumers have a lot more money in their pockets due to low gas prices.   Low gas prices might yet deliver a Santa Claus rally in the malls of America.

Even though the energy sector is being decimated, overall stock averages tend to rise when oil prices fall. Oil prices have fallen by 50% or more five times in the last 25 years. In the first three of those instances (1986, 1990-91, and 1997-98), the S&P rose sharply. Then, in late 2008, both the market and oil fell sharply together. This time around, the S&P 500 is up only 2.5% after a 67% drop in oil.

Oil Price Declines Table Image

From this table, you can see that the 2008 market was an anomaly – a commodity price collapse in the midst of a global financial panic – but the three previous oil price declines (and stock market surges) were based on fundamentals (supply and demand) and geo-politics. First, in late 1985, Saudi Arabia wanted to gain market share, so they flooded the world with oil.  In 1990, Saddam Hussein pushed oil prices up by invading Kuwait, but oil prices came down rapidly when Allied forces liberated Kuwait in early 1991.  The 1997-98 decline had roots in the Asian Currency Crisis of late 1997. At the start of 1998, OPEC misjudged the depth of the damage in Asia and increased its oil export quota by 10%, causing an oil glut.

So, we must ask ourselves: Is this current oil decline based on fundamentals, or a financial crisis? The answer seems obvious – massive new supplies have come on stream due to fracking in North America; OPEC has fallen apart and has joined the mass stampede to bring more oil to market, while the global economy, particularly commodity-guzzling China, has slowed down. This oil decline is clearly based on fundamentals, not a financial crisis. The junk-bond collapse is an effect, not a cause, of oil’s price decline.

To me, this means the market is oversold based on overblown fears of another financial crisis.  The S&P 500’s flat performance during oil’s decline masks the fact that the S&P “460” (the S&P 500, minus 40 energy components) is up 9.8% since June 30, 2014, while the “Energy 40” is down 37% (Source: Gene Epstein’s “Economic Beat” column in the December 14 Barron’s: “The Pluses in Falling Oil Prices.”)

Short-term, anything can happen; but long-term, it makes sense that consumers will likely want to toast the lower price of gasoline at their holiday parties, swapping stories about the prices at their local pump. With the average price of a gallon $2.01 last week, some stations offer gasoline around $1.50.  (When I was in New Orleans in late October, taxi drivers told me where the $1.50 stations were located.) And yet Wall Street seems near tears over the market outlook following the drastic (67%) drop in the price of oil.

Oil Prices Will Likely Fall Further as OPEC Disintegrates

When OPEC cut off oil exports to America 42 years ago, the stock market suffered what might be termed its worst “real” (inflation-adjusted) crash of the last 80 years.  On December 3, 1968, the DJIA reached a peak of 985.21.  On December 6, 1974, the index bottomed at 577.60.  On the surface, that’s a 41% loss in six years, but those were years of high inflation. The Consumer Price Index (CPI) rose a total of 41.4% in those six years so the “real” decline in the DJIA works out to 58.5%. If you go out 14 years to the low of 777 in 1982, the “real” decline was over 74%, since the CPI more than tripled (+205%) in those years!  That makes 1966-82 the worst “real” stock market decline since 1929-1932 – and far worse than 2008.

The 1973-82 siege of “stagflation” was launched by the “oil shock” of 1973.  Last Friday, we saw headlines at CNBC about an “Oil Price Shock,” but the shock is low prices amid deflation, not inflation.

Oil Pump Jack ImageToday, OPEC is dead.  Good riddance!  On December 4, Bloomberg wrote an obituary of sorts saying, “OPEC has abandoned all pretense of acting as a cartel. It’s now every member for itself.”  Specifically, they wrote, “OPEC went all in for the one-year-old Saudi Arabia-led policy of pumping, pumping, pumping until rivals – external, such as Russia and U.S. shale drillers, as well as internal – are squeezed out of market share.” And then there’s Iran. Bloomberg added that “oversupply is likely to continue in the new year. Iran, for years under sanctions related to its nuclear program, has promised to lift its production to as much as 4 million barrels a day by the end of 2016, up from about 3.3 million barrels a day” today.

In his Tuesday morning briefing (titled “De-Energized,” December 8), economist Ed Yardeni agreed: “December 4 might have been OPEC’s funeral day…. A cartel that can’t control the production of its members isn’t a cartel. The notion that OPEC can cut the production of non-cartel members by flooding the market with more oil and depressing prices is a sign of desperation rather than a strategy.”

This collapse of the oil cartel did not occur overnight.  OPEC produced a near-record amount of oil in October, according to Oil Market Intelligence (OMI), but non-OPEC producers boosted production even faster, setting a new record high in the same month, thereby pushing OPEC’s market share further down.  As Ed Yardeni observed, “By attempting to hold onto their share, OPEC members have moved to a variable ceiling tied to the production of non-OPEC producers. So they have lost control of the price…”

Global oil revenues have fallen 56% from last year’s peak, according to Yardeni, to an estimated $1.7 trillion in 2015, down sharply from $3.8 trillion in 2014.  From the other end of the telescope, that’s a $2.1 trillion windfall for others, who can put that money to use in other purchases – including stocks.

The energy sector is decimated, but Ed Yardeni reports that “the good news for the S&P 500 is that the renewed drop in oil prices won’t depress overall earnings as much as it did over the past year. That’s because the earnings share of the S&P Energy sector has dropped from last year’s high of 12.1% during the week of January 2 to only 4.2% at the end of November. The same can be said for S&P 500 revenues. They fell 4.0% y/y through Q3, but rose 1.5% excluding the Energy sector.”  What’s bad for the energy sector can be good for the rest of the economy.  Sooner or later, Wall Street will recognize that fact.

As Louis Navellier notes below, the lower price of gasoline at the pump today tends to boost consumer confidence.  More than any other statistic, the amount of the average family’s discretionary income, after all necessities are paid, determines their mood and their retail spending habits. Declines in gasoline prices leave more money in the average consumer’s pocket.  This is especially bullish during the holiday season.

This Week in Market History:

*All content in "This Week in Market History" is the opinion of Navellier & Associates and Gary Alexander*

The Death of the Santa Claus Rally Has Been Greatly Exaggerated

by Gary Alexander

The second half of December has often given investors a late-year buying or switching opportunity, including tax-squaring trades (balancing gains and losses for the year).  Specifically, over the past 20 years, the first half of December (about 11 trading days) has been weak, often followed by a stronger second half of the month:

Typical December Trading Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Here are the most recent five years – representing a weak first half and strong second half of December:

Most Recent Five Years Table Image

As the chart shows, December starts strong then tends to suffer a bad second week, followed by a strong and relatively smooth second-half rise. Last week’s 3.8% decline was unsettling, but it was a somewhat “normal” second week of December during a bull market. Something like this happened during the bull market of the late 1990s. Here is a rundown of what happened during the second week of December from 1995 to 2000:

Second Week of December Table Image

The outlier in this group was 1996, a month which began with a speech by Federal Reserve chair Alan Greenspan, in which he warned investors against “irrational exuberance” in the market.  December fell 2%, but 1996 still closed up 20.3%, followed by a 31.7% gain in 1997, so the Chairman was clearly unable to stop the juggernaut.  In fact, he gave the market an unintentional contrarian “buy” signal.

Some Specific Santa Claus Rallies, 1982-98

On Thursday, December 16, 1982, the DJIA closed below 1000 for the final time, at 990.25.  The decline that day was based on a Federal Reserve report that the operating capacity of U.S. factories fell to 67.8%, the lowest figure since that indicator was introduced in 1948; but recovery was just around the corner. The Reagan tax cuts took effect and the economy grew for all but one of the next 18 years. In all, it took 10 years and 1 month between the time the DJIA first closed above 1,000 (on November 21, 1972) to the last time it closed below 1,000.  The five-digit barrier was equally foreboding.  The first close over 10,000 took place on March 29, 1999, and the last close below 10,000 fell on August 26, 2010, 11+ years later.

On Monday, December 14, 1987, Santa Claus came early. The DJIA gained 66 points (+3.5%), rising from 1867 to 1933.  For the week of December 14-18, the DJIA gained 108 (+5.8%), to close at 1975.

On Tuesday, December 13, 1994, the first meeting of the World Wide Web Consortium took place at the Massachusetts Institute of Technology. The ad-hoc international association was formed to forge common protocols on the World Wide Web.  Tim Berners-Lee became the first director.  He had helped to develop the Web while he was a fellow at CERN, the European particle physics lab, in Geneva, in the early 1990s.  In the next two weeks, the DJIA gained 146 points (+4%).  More importantly, it tripled in the following five years, partly on the euphoria of this new “Internet” hatched in Geneva and nurtured in America.

On Friday, December 15, 1995, the NYSE set a new record for trading volume, at 652.8 million shares, eclipsing the 1987 post-crash record of 608.2 million shares, set on October 20, 1987. This time, the DJIA fell only 5.42 points, not 508.  The volume leader was Kmart, with 24.3 million shares traded, as Kmart hit a 13-year low.  Also on this date – 20 years ago – the European Monetary Institute (forerunner of the ECB) agreed on the name of their proposed new currency, the euro, replacing the previous term, the ECU.

On Monday, December 14, 1998, the DJIA lost 146 points, retreating to 8695.  The DJIA declined 421 points (-4.6%) in the first half of December, but the index rose 531 points (+6.1%) in the next two weeks.

We don’t necessarily advocate trading based on calendar theories but it’s nice to know that there are often two surges around the holidays – first, the Santa Claus rally and then the January Effect. Happy Holidays!

Sector Spotlight:

*All content in "Sector Spotlight" is the opinion of Navellier & Associates and Jason Bodner*

How Long is 15 Minutes – a Lifetime, or an Instant?

by Jason Bodner

“In the future everyone will be world-famous for 15 minutes.” – Andy Warhol (speaking in 1968)

Fifteen minutes: Is it a blip or a lifetime? It’s all relative.

The Big Bang is the generally accepted scientific theory of creation, the literal moment everything began. Just before the Big Bang, the entire universe and everything it was to become consisted of a concentrated single point of infinite heat and density, much like a black hole. The tipping point came and the Big Bang ignited in an explosion to rival all other explosions thereafter. After just 10-34 of a second — that is, a hundredth of a billionth of a trillionth of a trillionth of a second after the Big Bang, the universe expanded from smaller than the volume of an atom to the size of a golf ball. All of the helium and hydrogen found in the universe was created in the first three minutes after the Big Bang. This was the period of nucleosynthesis which ended after about 15 minutes, after which temperatures cooled.

As we can see, a lot can happen in 15 minutes as the fundamental building blocks of the universe were born in that time span. But then nothing much happened for hundreds of thousands of years afterwards.  In fact, it took almost half a billion years for the first stars and galaxies to form.

Cosmic Big Bang Image

Most of the time, the stock quotes the general public sees are 15 minutes delayed. To the long-term investor, 15 minutes is a meaningless amount of time. To the day trader, however, 15 minutes can be quite a long time. To the high frequency trader (HFT), 15 minutes might as well be a million years.

Last week, each sector was down 1.82% or more, so there was not much to find in terms of leadership. It’s clear that energy has been driving the market for some time. Now, the talk of potential fallout from potential credit shockwaves is rippling fear throughout the system. Just have a look at this week’s sector performance and the 12 month’s sector performance. Energy anchors the bottom of each table.

Standard and Poor's 500 Sector Indices Changes Table Image

Some might look at the recent wild gyrations and wonder how stocks can seem to gain so much ground one week and then give it all up so quickly and violently the next week. One possible answer may rest with that algorithmic trader; let’s revisit him and look at trading through his eyes: The HFT needs speed. The HFT deals in increments of time measured in nanoseconds. Speed is so critical that many pay top dollar to locate their servers as close as physically possible to the exchange servers to reduce latency by a few nanoseconds. You see, in HFT, the earliest to the party has the best chance of winning. In fact, HFT firms process orders faster than you can blink your eye!

“Exchanges provide HFT traders with secret order types which are being executed faster and with private data feeds. These private data feeds represent “actual” and real-time market information, whereas the data feed which is presented to regular investors is 1500 to 900 milliseconds old – years in the field of HFT.”

How High Frequency Trading (HFT) Works

High Frequency Trading ImageIn a simplification of what can actually happen, the HFT pays to view the depth of the order book. When an offer to sell stock comes in from retail order flow, their algorithm tells the computer to sell stock ahead of that order and then places a bid a penny or even a fraction of a penny lower almost instantaneously. These processes are repeated for buy and sell orders across thousands of stocks. Thousands of trades may be placed each second by just one firm, and there are many HFTs out there. This explains why they have suddenly become responsible for such a large percentage of the daily trading volume in recent years.

But what happens when volatility spikes? That fraction of a penny spread can now become several pennies. You see, when uncertainty surges, liquidity tends to dry up. So HFTs can hit bids further away and bid lower helping to blow out bid/offer spreads to even wider levels. And when order flow is going one way – say, selling – HFTs are not necessarily specialists so they are not required to post liquidity. They can pull out of the market entirely. The spreads become even larger. Many still blame the flash crash of May 6, 2010 on this exact type of occurrence. This, in part, is how moves in stock prices can become so exaggerated in volatile markets. We are almost certainly witnessing some of this lately. (It’s important to note that HFT firms typically do very well in these types of markets.)

In a time when volatility is king and outsized moves seem standard, let’s take a look back in time when energy first started weighing on the market. Energy first started to crack in August of 2014. Let’s look at a chart of WTI Crude Oil back then (below). Prices began collapsing, but it didn’t become mainstream news for months after that. At this point, very few people were talking about it. In September, crude had taken out its lows and, as the S&P 500 Energy Index shows, stocks were playing catch-up. The slide didn’t stop until March of 2015, and the decline has now resumed. In the two lower charts, it’s interesting to see how resilient the S&P 500 Consumer Discretionary Index and S&P 500 Health Care Index have been. They seem to be trading almost inverse to crude oil and its lagging sister, the energy index. This is still true in a time when the broad indexes seem to trade in lockstep with crude.

Standard and Poor's 500 Sectors Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

At this time scale of two years in the charts above, we can see how the large trend develops. These are massive moves we are witnessing here. But in the world of the High Frequency Trader, the charts above could look the same for one day. So the next time you look up a stock quote on the internet and see it tagged with a “delay,” think about that 15-minute lag. It may mean nothing or it may mean everything. It’s all relative. And who better to define relativity than Albert Einstein: “When you are courting a nice girl, an hour seems like a second. When you sit on a red-hot cinder, a second seems like an hour.

“That’s relativity.”

Stat of the Week:

*All content in this "Stat of the Week" section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.*

Rising Service Costs offset Falling Commodity Prices

by Louis Navellier

Despite falling oil prices, the Labor Department announced on Friday that the Producer Price Index (PPI) rose 0.3% in November, the biggest monthly increase since June.  This was a shocker, since economists had expected the PPI to rise only 0.1%, due to the big “commodity crunch” underway in global markets.

A 0.5% rise in wholesale service costs (the largest increase in 13 months) was largely responsible for the surge in the overall PPI. Wholesale energy costs declined 0.6% in November, while wholesale food costs rose 0.3%.  Excluding food and energy, the core PPI rose 0.1% in November.  In the past 12 months, the PPI has declined -1.1% and the core PPI is up 0.3%, so deflation persists, despite the rise in service costs.

Shoppers ImageRetail sales figures for November were mixed.  The Commerce Department announced on Friday that retail sales rose 0.2% in November, which was in-line with economists’ expectations.  Gasoline sales declined 0.82% in November and auto sales declined 0.45%.  Excluding auto and gasoline sales, retail sales rose at a more impressive 0.5%. Sales at most retail stores and restaurants were strong in November, a good sign that consumers are spending the extra money in their pockets from lower gasoline prices.

The Commerce Department also reported on Friday that the inventory-to-sales ratio rose to 1.38 in October, the highest level since 2009; so I expect that if consumers do not spend up a storm this holiday season, there is going to be a lot of discounting after Christmas.  Frankly, there has already been a lot of discounting, especially on-line, so it will be interesting to see whether or not these high inventories will persist.  If these excess inventories are not reduced, it will most likely hinder GDP growth in 2016.

On the positive side, the University of Michigan’s preliminary Consumer Confidence Index rose to 91.8 in December, up from 91.3 in November.  Although this preliminary reading was slightly below economists’ consensus estimate of 92, it reflected “persistent strength” in multiple components.  This high level of consumer confidence, along with low gasoline prices, bodes well for sales this holiday shopping season.

Oil at $35 per Barrel Spooks the Stock and Bond Markets

In the U.S., crude oil production has not really declined significantly. From the point of view of an oil producer, when you complete a well, it only costs $5 to $15 per barrel in incremental costs to get it out of the ground.  So for all the crude oil producers on leased land, they literally have no incentive to curtail their production.  In addition, many have to maintain their crude oil production to pay their debt service.

This also applies to offshore drillers, due largely to the fact that major oil companies have expanded their production in the Gulf of Mexico.  Since offshore drilling rigs are on leased tracts, major oil companies have no incentive to curtail their production.  As a result, North America, OPEC nations, Russia, and other major crude oil producers will continue to boost production in the new year, further depressing prices.

Much of the energy development and expansion in the U.S. has been financed via high-yield bonds, so there is a big concern that more dividend cuts and some high-yield bond defaults are inevitable.  Right now the priorities in the energy patch seem to be to (1) preserve their credit rating and (2) cut dividends.

Due to the chaos in the energy sector, fourth-quarter sales and earnings for the S&P 500 are now expected to be even more negative than they were in the third quarter.  Currently, the analyst community is anticipating that the S&P 500’s fourth-quarter earnings will decline at an annual pace of over 3%, while sales are also expected to decline as they have for the previous three quarters thanks to a strong dollar.

The big challenges facing the market now are: (1) plunging energy prices, (2) falling commodity prices from a lack of worldwide demand, and (3) a strong U.S. dollar. Will these trends convince the Fed that deflation is spreading and getting worse?  Probably not, since in the past the Fed has convinced itself that inflation is brewing and will materialize eventually, so they must raise key interest rates now to get ahead of their perceptions that inflation will eventually materialize.  I cannot begin to tell you how bad the Fed’s inflation forecasts have been.  They can’t hit the broad side of a barn with their inflation forecasts.  The fact of the matter is that economists at the Fed have been anticipating inflation in a deflationary world.

One other big question concerns how the bond market will react tomorrow after the Fed (at its current Federal Open Market Committee meeting) presumably hikes key interest rates 0.25%.  Frankly, I hope there is no material reaction, since bond yields have already risen significantly, especially on two-year Treasury notes.  So essentially, the Fed has succeeded in talking up intermediate interest rates and helped to flatten the Treasury yield curve a bit.  However, deflation persists, so it will be interesting to see if bond prices eventually reflect that fact.  If the Fed makes dovish comments, I would not be surprised if Treasury bond yields continue to moderate a bit as credit market fears begin to spread.

 

It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Click here to see the preceding 12 month trade report.

Although information in these reports has been obtained from and is based upon sources that Navellier believes to be reliable, Navellier does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute Navellier's judgment as of the date the report was created and are subject to change without notice. These reports are for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities mentioned in these reports must take into account existing public information on such securities or any registered prospectus.

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Please note that Navellier & Associates and the Navellier Private Client Group are managed completely independent of the newsletters owned and published by InvestorPlace Media, LLC and written and edited by Louis Navellier, and investment performance of the newsletters should in no way be considered indicative of potential future investment performance for any Navellier & Associates separately managed account portfolio. Potential investors should consult with their financial advisor before investing in any Navellier Investment Product.

Navellier claims compliance with Global Investment Performance Standards (GIPS). To receive a complete list and descriptions of Navellier's composites and/or a presentation that adheres to the GIPS standards, please contact Navellier or click here. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. Request here a list of recommendations made by Navellier & Associates, Inc. for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

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It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Click here to see the preceding 12 month trade report.

Although information in these reports has been obtained from and is based upon sources that Navellier believes to be reliable, Navellier does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute Navellier's judgment as of the date the report was created and are subject to change without notice. These reports are for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities mentioned in these reports must take into account existing public information on such securities or any registered prospectus.

Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any securities recommendations made by Navellier. in the future will be profitable or equal the performance of securities made in this report.

Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

None of the stock information, data, and company information presented herein constitutes a recommendation by Navellier or a solicitation of any offer to buy or sell any securities. Any specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.

Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. Individual stocks presented may not be suitable for you. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. Investment in fixed income securities has the potential for the investment return and principal value of an investment to fluctuate so that an investor's holdings, when redeemed, may be worth less than their original cost.

One cannot invest directly in an index. Results presented include the reinvestment of all dividends and other earnings.

Past performance is no indication of future results.

FEDERAL TAX ADVICE DISCLAIMER: As required by U.S. Treasury Regulations, you are informed that, to the extent this presentation includes any federal tax advice, the presentation is not intended or written by Navellier to be used, and cannot be used, for the purpose of avoiding federal tax penalties. Navellier does not advise on any income tax requirements or issues. Use of any information presented by Navellier is for general information only and does not represent tax advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance.

IMPORTANT NEWSLETTER DISCLOSURE: The performance results for investment newsletters that are authored or edited by Louis Navellier, including Louis Navellier's Growth Investor, Louis Navellier's Breakthrough Stocks, Louis Navellier's Accelerated Profits, and Louis Navellier's Platinum Club, are not based on any actual securities trading, portfolio, or accounts, and the newsletters' reported performances should be considered mere "paper" or proforma performance results. Navellier & Associates, Inc. does not have any relation to or affiliation with the owner of these newsletters. There are material differences between Navellier & Associates' Investment Products and the InvestorPlace Media, LLC newsletter portfolios authored by Louis Navellier. The InvestorPlace Media, LLC newsletters and advertising materials authored by Louis Navellier typically contain performance claims that do not include transaction costs, advisory fees, or other fees a client may incur. As a result, newsletter performance should not be used to evaluate Navellier Investment Products. The owner of the newsletters is InvestorPlace Media, LLC and any questions concerning the newsletters, including any newsletter advertising or performance claims, should be referred to InvestorPlace Media, LLC at (800) 718-8289.

Please note that Navellier & Associates and the Navellier Private Client Group are managed completely independent of the newsletters owned and published by InvestorPlace Media, LLC and written and edited by Louis Navellier, and investment performance of the newsletters should in no way be considered indicative of potential future investment performance for any Navellier & Associates separately managed account portfolio. Potential investors should consult with their financial advisor before investing in any Navellier Investment Product.

Navellier claims compliance with Global Investment Performance Standards (GIPS). To receive a complete list and descriptions of Navellier's composites and/or a presentation that adheres to the GIPS standards, please contact Navellier or click here. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. Request here a list of recommendations made by Navellier & Associates, Inc. for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

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