The three news items which drove equities on Wednesday were the drop in oil prices, the drop in IBM’s stock, and the Fed’s Beige Book. I recently called IBM a zombie stock because of its revenue declines. The weakness is finally being reflected in the stock as it is down about 11% since March 1st. WTI oil was down 3.66% to $50.49. Just as I said I was wrong about the latest rally in oil on Tuesday, it fell the most since March 8th on Wednesday. The Dow had another day of underperformance as Goldman Sachs pushed it lower Tuesday and IBM pushed it lower Wednesday. The Dow is weighted according to the price of the stock instead of by market cap like other indices. Both IBM and Goldman Sachs are in the triple digits, so they have a big effect on the Dow. It was down 0.58%, but the Russell 2000 was up 0.38%. The Russell 2000’s underperformance had been supporting the idea that the Trump trade was over because de-regulation was supposed to help the small caps. The outperformance of the Russell 2000 may simply be a mean reversion.
Oil fell to the lowest price since March 31st because of the EIA’s latest report. The report showed gasoline stockpiles were up 1.5 million barrels which was the opposite of expectations which had them falling 2 million barrels. This 1.5 million barrel increase in inventories made up for the 1 million barrel supply increase in crude oil. The chart below shows the large increase in crude oil inputs. They were up 241,000 barrels per day from last year’s average, reaching 16.9 million barrels per day. This increase was driven by a 260,000 barrel per day boost from Gulf Coast refiners. As you can see, inputs are the largest they’ve been in the past five years, surpassing the highs seen 2016.
In a previous article, I described how index funds have been propping up weak firms because they buy stocks regardless of their performance. The term ‘dumb money’ is used to describe non-professional investors. I would describe index buying as a ‘dumb strategy’ as investors scoop up IBM stock which has had a track record of revenue declines. IBM has also issued debt to fund acquisitions to grow its revenues, which still manage to fall. The 1990s were driven by hope as the internet was a revolutionary service. This bubble is driven by financialization as growth is hard to come by. Investors wish the 1990s growth was here. At least those firms had potential.
IBM as pushed trickery in its financial statements to cover up for declining revenues as the company reported an effective tax rate of negative 23.1%. Traders weren’t fooled this time as the stock fell 4.92%. As you can see from the chart below, revenues fell to the lowest since Q1 2002. The stock is about 34% higher than Q1 2002 showing how much the manipulation of results has boosted the stock. This quarter showed the 20th straight decline in revenues as acquisitions can’t help this sinking ship.
The Fed’s Beige Book report had two interesting points in it which I will discuss. The first point is the Fed claimed the labor market is tight, but pricing pressure was modest. The idea that the labor market is tight is supported by the unemployment rate and the jobless claims, but it’s common knowledge that those aren’t accurate assessments of the labor market because hourly wage growth is subdued. The Fed tacitly acknowledges the lack of hourly earnings growth by not raising rates at a faster clip even though the unemployment rate is 4.5%. As you can see from the chart below, the core CPI has decelerated to growing at 2% in March which shows inflation pressures have waned after the Trump trade has started to back off in the past few weeks.
The second point which the Fed made was that some business activity has been slowing due to the uncertainty surrounding proposed fiscal policy changes. This is a point I have made before. It is critical because even though expectations are high, businesses cannot make investments until they have clarity on what the laws will be. The worst thing businesses can have is policy uncertainty. Businesses went into the year expecting major changes, but they’ve been met with delays as the GOP grapples with its differing factions along with the fact that the challenges are daunting. The elephant in the room is that spending is out of control and the best way to cut spending is entitlement reform. Trump campaigned on keep entitlements the way they are. It’s tough to solve a problem when Trump essentially promised not to solve it.
The latest forecast from the Fed’s GDP Now runs counter to the notion that the Fed will raise rates in June. It shows its expectation remained steady at 0.5% growth. This is the second to last update before the April 28th GDP report which means there won’t be any major changes from this forecast. A good residential construction report boosted estimates for real residential investment growth from 12.0% to 12.4%. However, the latest disappointing industrial production report knocked down the forecast of inventory investment contribution from -0.71% to -0.76%. All indications are leading me to believe the GDP growth will be below 2%. On the bright side, a disappointing report may make Trump want to accelerate the process of fiscal stimulus because a weak report makes him look bad.
Conclusion
Oil fell sharply on Wednesday which is the biggest trend reversal in this article. The other points were all continuations of prior trends as IBM continued floundering, the Atlanta Fed continued to expect a weak Q1 GDP report, and the Fed’s Beige Book continued to show that inflation is tepid and businesses are hesitant to make capital investments because of uncertainty over what Trump’s fiscal policy will be. The one bright side to this could be Trump providing leadership on tax reform and healthcare reform because he will be motivated by the weak Q1 GDP report.
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