What’s Driving the Market?

By David Nelson, CFA

In the face of so-so data and an economic pulse that looks more like an EKG going into cardiac arrest investors want to know “What’s driving the market?”

The earnings season is drawing to a close and as Goldman points out in a recent note one consistent theme seems to ring true. U.S. corporations are still able to beat on the bottom line but sales surprises are few and far between. If I was a teacher I would give earnings this season a C+. Not great but enough to keep investors in the game.

Buybacks are slowing but are still a go to source of artificial earnings to mask weak sales growth and peaking margins.

Never the less markets are once again at all-time highs along with the VIX approaching 5 year lows. Most of the economic data last week didn’t confirm the continued push higher in stocks so again investors ask the question “What’s driving the market?” (SPY) S&P 500 ETF

Non-farm productivity continues to slip and retail sales went negative after a strong showing last month.

If it isn’t earnings or the economy then the answer lies elsewhere.

Oil & Junk

For the moment oil still seems to act as a key barometer for stocks. Every time crude approaches or breaches 40 traders get nervous and stocks struggle. As I’ve pointed out in previous posts while cheaper oil certainly has its benefits, it takes a toll on credit markets in particular high yield which in turn spills over into the banking sector. The chart of (HYG) Junk ETF placed alongside a chart of crude shows a pretty strong correlation over the last 5 years. It’s still early but both (HYG) and WTI crude (USO) look like they are trying to put in a bullish reverse head and shoulders pattern.

As a reminder oil prices breaking down earlier in the year drove CEOs Jamie Dimon of JP Morgan (JPM) and Bank of Americas (BAC) Brian Moynihan to express concern regarding their loan books to the energy complex.

Oil and Banks

The banking sector still struggles with weak net interest margins and a regulatory backdrop that has stripped away many of their profit centers. However, one source of upside could come from oil if prices can hold or trade higher. Some banks have started to release some of their reserves set aside for problem loans a fact not lost on industry magazine the American Banker. In a recent post they write that it is way too early for banks to be taking this route and Jamie Dimon has said; “Put it this way: We will take them down only if we have to.”

If oil can find its way back to 50 I’m pretty certain they will release reserves pushing earnings higher whether it’s justified or not. Admittedly this is a big IF especially considering each $ higher in crude brings more rigs and wells back online adding to supply

Central Banks Still Call the Shots

Like it or not central banks still pull the puppet strings. Even if the Fed is looking to continue the normalization process other central banks push the insanity of negative rates keeping pressure on treasury yields here. With 10 year sovereign debt yields in negative territory our 10 year at just over 1.5% still attracts buyers.

How long central banks will walk down this path has been the subject of heated debate for most of the last year. With more than $11 Trillion of global debt yielding less than zero it begs the question; “is it working?

My good friend and economist Larry McDonald of ACG Analytics believes it isn’t and at some point soon bankers will abandon a policy that isn’t accomplishing any of its stated goals.

For now earnings and the economy continue to take a back seat to central banks and oil as a driving force behind stock prices. It can’t and won’t last forever. Either earnings turn north or stocks will turn south.

*At the time of this article funds managed by David Nelson were long SPY