A Studied Look Toward Stock Market Year-End

By: Money_Morning

Michael E. Lewitt writes: Markets traded quietly this week as oil prices continued to move lower. The Dow Jones Industrial Average rose 61 points or 0.35% to 17,634.17 and the S&P 500 added 8 points or 0.4% to 2,039.82. The Nasdaq Composite Index rose 56 points to finish at 4688.54. The small cap Russell 2000 ended the week unchanged at 1,173.81. Bonds ended a quiet week with the yield on the benchmark 10-year Treasury closing at 2.32%, up from 2.31% the week before. The main focus was falling crude and its possible effects on consumers.

Wal-Mart Takes on an Internet Titan

U.S. October retail sales were up 0.3% from September (when they declined a similar amount), suggesting that lower gasoline prices may be starting to translate into higher spending in other areas of the economy. But department store sales were down 0.3% for the month, suggesting that the retail sector remains challenged by ecommerce and other factors. Wal-Mart Stores, Inc. (NYSE: WMT) announced a better than expected third quarter with same-store sales increasing a modest 0.5%.

The stock rose 5.8% on the week to close at $82.96, which would seem to be an overreaction in view of upcoming margin pressures likely to affect the company. The real story with WMT, however, may be what is happening outside its stores in its competition with Amazon.com, Inc. (NYSE: AMZN). The company announced that it will match AMZN's prices at all of its stores in time for Black Friday. This means that the upcoming holiday season will be extremely promotional and place pressure on the margins of all retailers. WMT has become a major competitor to AMZN that didn't exist five years ago, something to keep an eye on as the pressure mounts on AMZN to demonstrate that it can make money.

Macy's Inc. (NYSE: M) confirmed the tough retail trend with a weaker than expected third quarter report last week. Sales trailed expectations and management cut its full-year guidance.  Sales of $6.195 billion were down 1.3% year-over-year and $150 million below Street expectations. Interestingly, while management stated that it sees "positive trends in the economy, lower gas prices, lower unemployment, and healthy financial markets," it is "balancing these factors with the reality of the recent trend [i.e. the sales miss] caused in part by customers spending more of their disposable income on categories we don't sell like cars, healthcare, electronics and home improvement."

In other words, consumers may be spending more of the money they are saving on gas or earning from their new jobs on essentials rather than disposable items. Such a trend might be seen as consistent with the general malaise about the economy exhibited by recent election results. They may also help place in proper context the University of Michigan consumer survey results that show extremely high levels of consumer confidence. Stock market bulls like to point to this survey as a buy sign but it may be the case that it is unduly influenced by the plunge in gasoline prices, which retain a "top of mind" place in consumer consciousness.

In the energy sector, news broke that oil-service giant Halliburton Co. (NYSE: HAL) was in talks to buy rival Baker Hughes (NYSE: BHI) in what would be one of the biggest energy sector deals in years with a combined market value of $70 billion. There are major regulatory obstacles to a deal being completed and the latest press reports indicated that HAL might make a hostile bid for BHI.

The stocks of Apple, Inc. (Nasdaq: AAPL) and Alibaba Group Holding Limited (NYSE: BABA) both continued to rise with no end in sight last week. AAPL now has a market cap larger than that of the entire Russian stock market at $670 billion while BABA's market cap has doubled from its IPO to $286 billion. BABA is now widely owned by large hedge funds, something it now shares with AAPL. Investors are again starting to believe that AAPL can become the first company to attain a $1 trillion market capitalization, but history teaches us that the law of large numbers tends to stop such dreams from coming true.

When companies become that large, they end up being unable to grow at a sufficiently high rate to maintain their market values. This happened in the past to Microsoft Corporation (Nasdaq: MSFT), General Electric (NYSE: GE) and others. BABA, on the other hand, has a long way to go before reaching that level and is likely to see its stock rise significantly further before hitting headwinds in today's exuberant market. The company also benefits from extremely favorable comparisons with Amazon.com, Inc., which is far less profitable and far less diversified in terms of its earnings streams. The question with respect to BABA – a question few dare to pose – is whether it is as robust as it appears. An investment in BABA is a vote of confidence in China's brand of capitalism, one that is decidedly different than America's and one that remains untested.

Fund Managers Chase Late Year Returns

Markets are being elevated by professional investors trying to improve their performance before year end. In a world in which 75 to 80% of active managers are trailing the S&P 500 (up 10.36% year-to-date), managing equity money has become extremely frustrating. It is difficult to argue with the proposition that an investor would have been best served by simply putting his money in an S&P 500 index fund in 2009 and closing his eyes, although such an approach would completely ignore the concept of risk-adjusted returns or the certainty that the market will correct sooner rather than later. In recent weeks, a number of prominent macro hedge funds have thrown in the towel after several years of underperformance, acknowledging that this asset class has been neutered by central banks distorting natural market mechanisms and impairing the art of fundamental securities analysis.  No doubt this market phase will pass but it is trying managers' souls.

All eyes will be on the upcoming meeting of OPEC on November 27 to see if the cartel will take any steps to cut production in order to stem to collapse in oil prices. The International Energy Agency (IEA) released a report this week stating that the price of oil could keep dropping into the first half of 2015. Lower prices have already hurt the stocks and junk bonds of energy companies around the world, most likely creating a buying opportunity for patient investors.  The oil era is not over. Energy companies comprise about 17% of the high yield bond market and have lost an average of about 5% over the past three months. The oil price decrease has also seriously damaged Russian markets which were already reeling from the geopolitical effects of Vladimir Putin's invasion of Ukraine. Many analysts are calling for a bottoming and then a recovery of prices in 2015 as markets adjust to lower prices. While the supply side may adjust by cutting back production, however, the demand side may well stay subdued as the world outside the United States struggles to grow. The real question about oil is whether it is telling us something about world growth.

The main consequences of lower oil prices may be to further delay the day when the Federal Reserve raises interest rates. The University of Michigan survey also showed that consumers' inflation expectations are at a 12-year low, demonstrating the significant impact energy prices have on consumer psychology (especially as the first polar vortex of the year hits the country).  Several Fed officials last week including New York Fed President William Dudley reiterated that they expect to raise rates in 2015. While the market would be foolish to ignore those warnings, which included acknowledgements that rate hikes would likely lead to market volatility, the hikes may come toward the end of the year if oil prices fail to recover.

Source : http://moneymorning.com/2014/11/16/a-studied-look-toward-year-end/

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