6/20/12
Welcome
to this special Fed edition of the Lewison Letter. As I’m sure all of you are already aware, Big Ben and the
Fed decided to extend “Operation Twist” through all of 2012, in a move to help
boost up the U.S. economy in the face of poor economic data and a disaster in
Europe. In this type of stimulus, the
Fed will be selling short-term Treasuries (i.e. 3 years or less) and buying
back long-dated bonds (i.e 6 years or longer). The Fed plans on buying $267B in long-dated Treasuries by
the end of the year. In doing so,
the idea is that long-term interest rates continue to stay low, stimulating
growth in businesses and job creation.
The central bank also maintained its guidance that rates will stay near
zero until 2014 and revised down U.S. GDP from 2.2% to 1.9%. In addition to “Operation Twist,” the
Fed expects unemployment to stay between 8-8.2%, an increase from the previous
estimate of 7.8-8%. At the same
time, the Fed raised their unemployment outlook for 2013 from 7.3-7.8% to
7.5-8%.
Overall,
the markets, for the most part, were fairly muted. Initially, interest rates on Treasuries dropped dramatically
before rallying back, the Down dropped almost 100 points before rallying
positive on the day, gold sold off sharply before returning to pre-announcement
levels shortly afterwards. When
polled, almost 45% of investors expected the Fed to perform another round of
“Operation Twist,” which is why the markets didn’t really react favorably to
the news. I also expected another
round of Twist, however I don’t think that it will have a lasting affect on the
economy or markets. When you look
back at the previous rounds of stimulus, here’s what you get: QE1 turned in an
80% gain, QE2 that was announced near the end of 2010, produced a 33% gain,
“Operation Twist 1,” which was announced last year, produced just a 22% gain in
the markets. The more the Fed is
doing, the less impact it is having on the markets and economy, so don’t expect
this round to produce anything dramatic.
The reality is that this market is trading on the ups and downs in
Europe and unless they turn their act around (which is not happening anytime
soon), the markets will continue to be rocky, no matter what kind of stimulus
Ben puts out there.
Here’s
how I’m looking at the markets right now: We need stimulus in Europe, and I’m
not talking about bailing out the banks in Spain or Greece. What needs to happen is the U.S. Fed
stops “bailing out” the U.S., but instead spends that money bailing out
Europe. If the situation in Europe
gets better, consumers will become a lot more confident in the global economy,
start spending more, and will even start taking on mortgages at these record
low interest rates. At the same
time, businesses will become more confident that consumers are starting to feel
better about things, which should stimulate job creation. We saw the initial reaction on the
Spanish bank bailout and the Greece “pro-bailout” party win, where the markets
opened sharply higher on the news, but quickly sold off because of continuous
worries about the overall European economic picture. If you bail out Europe, you bail out the world.
While
the Fed announcement was big, that was not the only thing that happened
today. If you closely follow the
commodities markets like I do, you would have soon a complete disaster in the
oil markets, as August crude oil dropped almost $3/barrel to close at $81.45/barrel,
which is the lowest close since September of last year. The oil market is in a complete
freefall, especially after the EIA reported crude oil supplies were up almost 3
million barrels, which was way off
from the expected 600,000 barrel decline. Not only is that incredibly bearish for
oil prices, but it also tells me the worldwide demand for oil is shrinking
which is bearish for world economies, but great for U.S. companies. Lower oil prices lead to lower prices
at the pump, which means that consumers have more money to spend on goods and
services. The other thing that has
changed over the last couple weeks, is that oil is no longer trading
hand-in-hand with the stock market, which is good, because my price target on
WTI (West Texas Intermediate) Light Sweet Crude Oil is $76/barrel, which would
be the lowest it’s been since September 2009. I would stay away from energy plays like Exxon Mobil or
Conoco Phillips, but instead stick with energy transport stocks like Kinder
Morgan Energy Partners, a stock that pays a hefty dividend and has good growth.
Another
market that has gotten my attention is in the grains, where soybeans have
rallied more than 10% ($1.21/bushel) since the beginning of June. This particular market has two things
going for it: 1) a strong technical formation and 2) a major heat wave across
all of America forcing bean planters to re-grow their crops. As for the technicals, Soybeans built a
long-dated inverted head-and-shoulders at the bottom of a 5th wave
down, which is about as bullish as it gets. Future weather conditions point to cooler temperatures but
still very little rain, all bullish for soybean prices. I’m looking for another 27 cents in
beans before hitting resistance at $14.65/bushel. That means that agriculture plays are still good to invest
in, such as CF Industries (my long time favorite), Potash (one of my previous
recommendations that has only gotten cheaper), and Mosaic. I think all three are still very cheap
and have a lot of room to the upside.
As
for now, despite a nice rally off the lows of the year, I am still cautiously
optimistic about the stock market, as there are still plenty of reasons for
stocks to go lower, especially since the situation in Europe is a mess. I’m looking at the S&P to trade in
a range of 1326-1363 (today’s high).
Look for a sell-off tomorrow on the heals of what I think will be a
disaster of a Spanish Bond auction.
Full
disclosure: I am currently short S&P puts (i.e. long S&P) and long CAT
calls.
Jeff Lewison
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