Words From The Rhino #2
EXTREME MARKET VOLATILITY
Markets went for a rollercoaster ride on the 24th of August, with over 4,500 high speed market crashing events, triggering market circuit breakers throughout the day. This liquidity event was much worse than the Flash Crash which occurred May 6, 2010. Market liquidity, which is the ability to convert stocks to cash, disappeared without warning. Meaning that people trading the markets were unable to determine fair pricing. For example Apple lost then regained over $80 Billion in market capitalization today alone. This is high frequency trading run amok and needs to be investigated and curtailed immediately to restore faith in the markets.
U.S. stock markets have now turned negative for 2015, while bond markets are more or less in limbo both due to the Federal Reserve’s inaction on deciding whether to actually raise interest rates. Minutes from meetings released by The Fed reveal that they have yet to make a decision due to the anticipated negative economic impacts a raise in rates may cause. Their biggest worry appears to be the latest developments in China, and possible spillover into the U.S. markets.
As earnings information on companies is released, it is evident that many major companies are anticipating declines in their numbers going forward. In the most recent quarter, John Deere has seen revenues down 22% and profits down 39%, a major miss that shows weakness in the agriculture and construction sectors. Twitter is now below its IPO price, and Apple is down over 20% from its highs this year.
Many sectors are seeing broad based weakness. This appears to be due to the ending of the short term positive effects of stock buybacks. Stock buybacks are when a company issues debt to buy back shares of the company. This may make a corporation’s earnings look better since the main ratio which represents this is earnings per share (EPS).
For example, a company has a profit of $1,000 with no dividends and there are 1,000 shares, leading to an EPS of 1. Then the company decides to buy back 250 shares leaving 750 shares remaining with the same profit of $1,000, but the EPS is now 1.33, a 33% increase just by using low interest rate debt to buy back shares. The company is then able to report that their EPS rose 33%, even though it’s due to the company getting into debt. This may lead to analysts valuing companies higher if they just look at the ratios without digging deeper into a company.
UPDATE ON CHINA MARKETS AND THE TIANJIN EXPLOSION
China has had an incredibly bad few months. After the initial market drop in the Shanghai exchange which eliminated $3.25 trillion in weeks, there was a major chemical explosion in the port city of Tianjin causing an estimated $1.5 billion in damages, with over 100 dead and over 700 injured. Our hearts go out to all those who were affected by the blast.
The chemical released in the explosion, sodium cyanide, was stored in amounts many times above what was authorized and licensed. Sodium cyanide is a deadly chemical that is water soluble and lethal in doses as low as 200 milligrams. At release, it may have also turned into the gas hydrogen cyanide, another deadly chemical. It appears that the company Tianjin Dongjiang Port Ruihai International Logistics (or Ruihai Logistics) is also partially owned by former employees of Sinochem, which was a state owned chemical company until 2009. This knowledge has begun to cause unrest among the local populace, as it appears the government was complicit in allowing this dangerous situation to be created.
The chemicals are beginning to create additional environmental and health issues as the sodium cyanide in the air is feared to have mixed with rain storms in the area. There is now an eerie white foam covering much of the streets around the blast site, and there are reports of mass fish deaths in the port. China’s markets continue to be a rollercoaster, and are showing major losses even with major direct government intervention. China has been buying large amounts of gold, recently purchasing over 600 tons in one month. This in itself is not a big surprise, as China has been trying to establish their currency as the dominant world trade currency. However, China has also been a major seller of U.S. treasuries. So far, in 2015 they have sold $107 billion! China is the second largest holder of U.S. treasuries, holding an estimated $1.2 trillion, behind the U.S. Federal Reserve which holds about $2.4 trillion. It appears China may be using the money from the sale of treasuries to try to prevent further losses in the Chinese markets. If China decides to sell treasuries at an even faster pace, this may cause ripples in the U.S. bond market.
China has also decided to devalue their currency by a considerable margin. This devaluation should help increase China’s exports across the world as their goods are now cheaper, especially for western buyers. This devaluation will also help them as their foreign assets (like the U.S. treasuries they are selling) become worth more when converted back into the Chinese renmimbi (China’s currency). For example, you go to China where $1 U.S. was worth about 6.2 renmimbi, then China’s central bank decides to devalue their currency and your $1 U.S. will now get you 6.4 renmimbi, increasing your purchasing power by over 3%. This is great for those trying to purchase from China using outside currencies, however not so good for those who are trying to buy things using renmimbi.
Greece’s Prime Minister Alexis Tsipras has decided to resign and call for new elections in September. The bailout terms have created some irreconcilable differences between and even inside Greece’s political parties. As Greece has already begun repaying the banks using more borrowed money, there will be little to report until it is clear if the major anti-austerity parties unify and decide to break off from the Eurozone.
OIL PRICES AND ENERGY COMPANIES
Oil prices have continued to stay low, and while this is better for filling up your tank, it is having a negative effect on many U.S. and foreign oil companies, specifically, those involved in the shale oil boom. Many of these companies need oil at $25 per barrel just to break even on their extraction cost. This means that with oil at around $40 per barrel compared to over $90 per barrel about a year ago, their profit margins are more than cut in half. This is an issue since many of the oil extracting companies grew their businesses by issuing debt. These companies have debt payments due even though their revenue is declining. Expect to see stock prices and bond prices of these oil companies decline unless oil prices rebound.