Stocks are in the red today, following a week in which global equities posted gains, led by energy and commodity-sensitive companies. West Texas Intermediate (“WTI”) crude prices rose to $43.39 from $39.77 a week ago, and global Brent crude prices rose to $44.53 from $41.80 as talks among oil-producing nations to cap production fell apart. One would be justified in wondering why oil prices would rise based on such news. Chalk it up to the power of positive thinking - oil jumped after Iraq’s oil minister said OPEC and other petroleum producers “could” meet next month to freeze supply.
Actually, the talks in Doha, Qatar went nowhere. Saudi Arabia refused to freeze oil production without Iran's participation, while Iran elected not to participate at all. Both Iran and Saudi Arabia remained focused on retaining oil market share in an ongoing price war for European customers. Meanwhile, Saudi Arabia is trying to raise about $10 billion in credit to offset a budget shortfall caused by the drop in oil prices. It is difficult to imagine an oil production freeze in the current environment.
While broad-based equity indexes advanced for the week amid earnings reports, the news was not quite as rosy in tech land. The widely-followed Nasdaq 100 index lost ground following disappointing results from bellwethers Microsoft, Netflix, and Alphabet – the artist formerly known as Google (RIP, Prince). In a reminder that price competition is alive and well, even for tech giants, Amazon announced a stand-alone online streaming service. The monthly subscription is priced at $8.99, lower than that offered by Netflix. So far, Amazon has offered its video service to its Prime customers. This comes as Netflix reduced its forecast for international growth, which sent shares lower for the week.
Meanwhile, the European Commission brought charges against the aforementioned Alphabet/Google. The charges are expected to focus on Google's insistence that smartphones with the Android operating system include Google applications, which has boosted advertising revenue for Google's mobile unit. Android accounts for a large portion of the smartphone market in both the United States and Western Europe (59% and 71%, respectively). In related news, Alphabet missed earnings due to rising costs from long-term projects such as driverless cars and home automation.
Thus far, with 130 of the S&P 500 members reporting results to date, 76% have exceed expectations on the bottom-line, above the five year average of 67%. Earnings results have been mixed, and top line revenue growth can only be characterized as disappointing. To wit, banking giants Goldman Sachs and Morgan Stanley posted sharp declines in revenue as market volatility curtailed investment-banking fees and trading revenue. In all, five of the largest six US banks missed their earnings target in the first quarter. In addition to lower levels of trading desk revenue, the low interest rate environment has impacted net interest rate margins.
Here at MPCA, while we would always prefer to be on the bullish side of things, a couple of things concern us. One is slower than normal global economic growth. To that end, over the past few weeks, the central banks of India, Indonesia, Turkey, Taiwan and Hungary have all lowered policy interest rates in an attempt to improve slow economic growth. Additionally, Singapore's central bank eased monetary policy through its currency exchange rates. This comes as emerging market stock indices have rallied from their lows, although investors remain understandably cautious of the impact that the US Federal Reserve may have on emerging market stock prices when US rates finally begin to normalize.
Another concern we have relates to market valuations. The Fed may have backed down for the moment, but the reality remains that rates will rise eventually. It is hard to justify the market’s current valuation level given the uncertain earnings and interest rate backdrop. The S&P 500 index is currently trading at 18.3 times this year’s consensus bottom-up EPS estimate, based on Friday’s close and Zacks Research’s current estimate of $114. Sustained secular bull markets generally launch from much lower P/E levels. The Fed will therefore be challenged by basic math in its continued attempts to elevate asset prices.