Weather Report at Dow 18,000

With the Dow testing record prices over 18,000 and new records Friday in the SP 500, Nasdaq, S&P Mid-Caps and the Russell 2000 indexes along with new records in European indexes it looks like a great time to be heavily exposed to US stocks. {Exec Spec remains 90% Stocks, zero fixed income}. 

Dow feb 2015

With renewed optimism courtesy of cheap gasoline prices and signs of a strong rebound in Europe, stock prices are breaking out on expectations that earnings will rise more than previously expected. The underlying low inflation, cheap credit and massive excess central bank liquidity are providing plenty of juice for global equities to power through almost any surprise that can be thrown in its path. Deep corrections can be bought.

In addition our KDelta short term breakout model had new Buy signals last week in all of the previously mentioned indexes except the Dow.

sp feb 2015

 What could go wrong?

1) Grexit

2) Lower earnings expectations

3) Oil in the $30’s

Grexit: An exit of Greece from the Eurozone looks increasingly likely and for that matter the entire Eurozone risks an eventual breakup upon the next global recession years down the road. Greece has dug in its heels as we addressed in the last newsletter and only a blink by Angela Merkel of Germany with unconditional bridge loans seem likely to prevent a Greek exit before year end. As we have pointed out before, a default by Greece would have minimal economic impact upon any other country, except the potential for temporary contagion fears that would send stocks lower for the short term. Nonetheless a Grexit has potential for a short term scare – a panic that should be bought.

Earnings expectations fall:   The first quarter bottom-up EPS estimate (Earnings Per Share) dropped by 7.5% during the past 6 weeks according to  Factset.com John Butters. He notes this is the sharpest  “percentage decrease in the bottom-up EPS estimate for the S&P 500 for the first half of a quarter” in almost 6 years. Earnings expectations are a major driver of stock price action. With every major index now ticking to new record highs while earnings expectations are being revised lower, something has to give ground: either earnings will immediately rebound higher on the new hopes of a European and Japanese recovery and higher multiples (P/E ratios) or prices will have to reflect the reality of lower earnings and inventory reductions with cheaper stock valuations.stock earnings downgrade

Oil in the $30’s: Currently Oil and gasoline have bottomed and staged a substantial 25% rally back to $54 a barrel. Oil is even threatening an upside breakout to test $60. However, the fact remains that Oil markets are oversupplied with inventories 27% higher than normal for this time of year. You have likely heard over and over that Oil rigs are being shut down at an impressive pace with a whopping 30% decline from the peak of just 4 months ago. This does NOT mean Oil production is also going to fall sharply, in fact it is likely to rise, flatten later this year and rise again in the future. When the Great Recession hit in 2008 and Natural Gas prices collapsed 86% and the ensuing gas rigs taken out of drilling production reached almost 80%, there was no fall in total gas production. Natural Gas supplies stayed in overproduction for the past 6 years and counting. Thus even an 80% reduction in drilling rigs is a poor barometer of future supply expectations.

Nat Gas rig chart

Today Natural Gas rigs remain at a very low ebb and prices continue in a 6 year Bear market. Oil rigs are the topic today. The reason a rig count drop isn’t always indicative of future supplies is that the sunk cost of mature rigs keep producing in large and rising quantities while the marginal often non-producing rigs are shut down. Furthermore state controlled economies such as OPEC and Russia are extremely dependent upon Oil revenues for their bank reserves and will not curtail production while prices fall and may even increase supplies. The mitigating factor is demand medium to long term and seasonality short term. In February and March US refineries shut down production to change blends to a summer mix which often causes a price bottom at this time of year. Medium to long term the excess liquidity, low interest rates and massive stimulus in Europe, UK, Japan and the US should lead to at least a cyclical economic rebound and accelerating energy consumption. Look for signs of either a continued growth path in Europe or temporary slowing to forecast stable to higher Oil prices or a scary decline to new lows. $47.37 and $54.25 are the Oil price levels to watch near term for a new trend breakout. Any new lows in Oil <$43 will put another scare in Junk Bonds and stocks would then decline.

The current technical breakout of stock prices in the US and abroad should be watched carefully this week for follow through to confirm the short term upside in stock prices.

 

 

 

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