The Day Before Comey’s Testimony & The ECB Meeting

Wednesday’s market action was tepid because it is the day before two important events. The former FBI director, James Comey, will be testifying in front of Congress and the ECB will be meeting tomorrow. There’s not much I can say about Comey’s testimony which will add to the conversation about the potential political consequences for the GOP and how that will affect the market. What I can say is the market went up modestly after Comey’s statement was made public because the market feels no bombshell will be released. The uncertainty now lies in what he will say when he faces questions.

ECB Responds To Great GDP Growth & Low Inflation

I don’t expect the ECB’s statement to affect the markets much, but obviously it’s worth watching because something unexpected can happen. The chart below shows the G-7 countries’ Q1 GDP growth rates. As you can see, Germany, France, and Italy all grew faster than America. The ECB’s forecast for 1.8% 2017 GDP growth looks like it might be beat. This gives the ECB reason to pause or slow down its $60 billion per month in bond buying when the program expires in December. The ECB is probably going to raise rates from -0.40% after it starts to slow down the bond buying program which means rate hikes are a 2018 event. While this great growth, pushes the ECB in a hawkish direction, it will only change the language in the statement and not policy. The GDP reports which come out in the 2^nd half will have a greater effect on policy because that’s when the ECB will discuss publicly how its bond buying program will change in 2018.

The ECB is in a perfect situation. GDP growth is beating expectations, while inflation is decelerating. The ECB’s bond buying isn’t causing inflation just like how the Fed’s QE didn’t cause inflation. There has actually been a disinflationary effect from bond buying. As you can see from the chart below, Danske’s Bank expects the ECB to lower its 2017, 2018, and 2019 HCIP inflation forecasts by one tenth of one percent. The inflation results of ECB are different from what the Bundesbank has been claiming. Whenever inflation ticks higher, it complains the ECB should stop its bond buying. There’s no doubt that the ECB’s bond buying is geared to help the risky nations like Italy because it lowers the default risk their banks have. The ECB’s bond buying will weaken the euro versus the dollar which will help German exports. Because of the latest positive European economic data and the ECB’s easy stance, the European stocks have outperformed their American counterparts.

The disinflation because of declines in food and energy prices means the ECB doesn’t have to be as hawkish as the GDP reports would seem to necessitate. The ECB’s only goal is to keep inflation below 2, but near that rate. The chart below shows the ECB’s expectations for inflation as of the March meeting. The ECB may actually want inflation to move higher if the disinflation continues. Lower inflation causes the euro to strengthen versus the dollar, but it shouldn’t have much of an effect because America is seeing the same disinflationary pressure as oil prices have stopped increasing on a year over year basis since oil bottomed in early 2016.

Oil Prices Crash 5.1% Wednesday

Although today was the calm before the storm for politics and European monetary policy, there was a storm in the oil market. It’s impressive to see the S&P 500 up given the selloff in energy stocks. The S&P 500’s energy sector fell 1.48% which is pretty good considering the 5.1% selloff in oil to a 5-week low. WTI settled at $45.72. My prediction for this year was that oil would fall and this would hurt energy earnings in the second half. Although oil prices have fallen, it’s still not enough to have an aggregate impact on S&P 500 bottom up earnings. The selloff needs to continue for that to happen.

Wednesday’s selloff occurred because crude stocks in the US grew 3.3 million barrels to 513 million barrels according to the EIA. Forecasters predicted a drop of 3.5 million barrels. Gasoline stocks increased 3.3 million barrels which was much higher than the estimate for a 580,000 barrel increase. The EIA also forecasted that the U.S. oil production could increase from 9.3 million barrels per day this year to 10 million barrels per day next year. Obviously, the EIA didn’t include the selloff today in its projections for U.S. production growth. The lower the price, the less production.

Oil would be even lower if it wasn’t for the geopolitical issues with Qatar. Saudi Arabia, Egypt, the UAE, Yemen, Libya, Bahrain, and Maldives all severed diplomatic ties with Qatar over its financial support for terrorism. Qatar is a tiny country, so it doesn’t produce much oil. However, there was some trade disruptions which helped increase oil prices. Any increase in tensions in the Middle East will cause oil prices to increase. Without this recent news about Qatar, I’d expect oil to be a couple percentage points lower.

Conclusion

The Comey testimony will affect stock prices on Thursday. It will be great to get this over with as the political speculations should ease if nothing unexpected occurs. The ECB statement is a bigger deal, but it may get swept under the rug as the political headlines swirl. It’s likely that the underlying businesses of stocks you are watching won’t be impacted by politics which means there may be some buying opportunities for trades if a selloff occurs.

When the easy earnings comparisons are no longer being lapped in late 2017, the contributions energy firms have will affect the aggregate bottom up earnings. I’m not predicting the collapse in energy earnings seen in 2015 and 2016, but growth will be harder to come by at that point as margins will be near their peak, so oil prices in the high $30s could cause a headwind to earnings. The mega cap technology stocks cannot keep their earnings growth rates up forever because of the law of large numbers. This means information tech’s contribution to aggregate earnings may stall out soon.