Given all the constructive economic data we have been receiving and an earnings season that has seen 75% of reporting companies beating Q3 consensus thus far, is the coast clear for a smooth and eventless finish to the year? US equity markets moved incrementally higher and further into record territory in Black Friday’s abbreviated session with the Nasdaq, S&P 500 and Dow Industrials ticking higher.
Should investors be as complacent as the fear gauge suggests they are with the VIX 11.43? My sense is that though there are some factors, largely tax reform-related and/or geopolitical in nature, that could upend markets between Thanksgiving and year-end, the overall health of equity markets is constructive–this, despite elevated price-earnings multiples for the major equity indices. The odds are high that we see an inline conclusion to a positive earnings season, continued modest gains in nearly all economic measures, a continued elevation in confidence readings and the passage of some form of tax reform. These themes coupled with record corporate cash on hand, record cash flows, rising dividends and solid forward-looking guidance all speak to rising equity prices. Do I expect much in the way of equity price appreciation between now and year-end? No.
Both retail sales, which proved to be significantly better than expected on Black Friday, and the expectations for a pending legislative push on tax reform, both played a hand in the day’s trade. On Thanksgiving Thursday and Friday, US retailers posted nearly $8 billion in online sales according to Yahoo Finance. Cyber Monday sales are expected to approach $6.5. Electronic games, entertainment appliances and laptops were aggressively marked down and sold in volume. Results from traditional brick and mortar retailers are expected to be very strong and will be available early this week.
While Washington DC gets closer to voting on tax reform legislation, voices in opposition have become increasingly strident. Even some of those expected to support the principle of tax reform are wavering in their support. In many respects, the tax reform legislative flight path is eerily similar to that of the ACA “Repeal and Replace” effort. Much of the run-up in equity prices that we have witnessed over the past several months has been predicated on tax reform success by the GOP. Anything that resembles a failure along the lines the GOP effort to unwind ACA would have negative consequences for equities.
Crude oil likely at the top of its range: The old adage “Buy on the rumor, sell on the news” comes to mind.
Given the methodical run-up in crude prices that has materialized in recent months, with WTI crude rallying nearly 40% since June and with it closing at a near two-year high on Friday at $58.95/bbl, energy-focused investors have once again found themselves at a potential pivot point. OPEC is scheduled to meet in Vienna to discuss production, output and price modeling among other agenda items.
Given the significance of this meeting in conjunction with the dramatic price appreciation that has materialized in recent quarters, we are likely to see a modest pullback in crude prices this week as investors take some chips off the table as a way of mitigating a degree of risk heading into Thursday’s meeting.
There are other reasons why crude oil prices may run-up against near-term resistance. Specifically, the focal point of this meeting involves the current production agreement that is set to expire in March of 2018. That deal, as it currently stands, removes 1.8 million barrels of oil per day from global production. Though not expected, obviously any indication that the agreement will not extend beyond its current deadline would naturally act as a trigger for prices to move lower.
Other themes that could potentially negatively impact pricing for crude include the practical limitations of trying to convince non-OPEC producers of aligning their production schedule with OPEC’s. Historically over time, these efforts have had little impact on the actual production of crude. Attempts at production compliance, a cornerstone of the current agreement, have also proven not to hold over time. Ultimately the long-term success of this effort by OPEC to tighten supply and support prices will be determined by factors outside its control.
That’s where US shale oil production comes into play. US shale oil supply has been extremely disruptive to OPEC control over global crude pricing over the past several years as we all know. Though with crude’s precipitous drop below $30/bbl shale oil became non-economic to produce, at near $60/bbl that changes. At these levels, shale oil becomes a competitor to OPEC.
Given the stability energy prices have provided the global economy over the past two years and therapeutic impact they have had on inflation, policymakers and investors would ideally like to see current production goals extended. However, even if the current agreement is ratified and set as policy moving forward past March, crude oil will ultimately have to compete with shale oil at roughly $60/bbl. As a result, the top end of crude’s range is likely near.