The Bear Market Has Just Begun

 

Today the narrow-minded canyons of Wall Street are littered almost entirely of trend-following bulls and cheerleaders who don’t realize how little there is to actually cheer about. Stock values are far less attractive than they were on that day back in 2009 and this selloff has a lot longer to run. There are hordes of perma-bulls calling for a V-shaped recovery in stocks, even after multiple years of nary a downtick.

Here are six reasons why I believe the bear market in the major averages has only just begun:

1) Stocks are overvalued by almost every metric.One of my favorite metrics is the price-to-sales ratio, which shows stock prices in relation to the company’s revenue per share and omits the financial engineering associated with borrowing money to buy back shares for the purpose of boosting EPS growth. For the S&P 500 (INDEX: .SPX), this ratio is currently 1.7, which is far above the mean value of 1.4. The benchmark index is also near record high valuations when measured as a percentage of GDP and in relation to the replacement costs of its companies.

 

2) There is currently a lack of revenue and earnings growth for S&P 500 companies. Second-quarter earnings shrank 0.7 percent, while revenues declined by 3.4 percent from a year earlier, according to FactSet. The Q2 revenue contraction marks the first time the benchmark index’s revenue shrank two quarters in a row since 2009.

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  • Virtually the entire global economy is either in, or teetering on, a recession. In 2009, China stepped further into a huge stimulus cycle that would eventually lead to the largest misallocation of capital in the history of the modern world. Empty cities don’t build themselves: They require enormous spurious demand of natural resources, which, in turn, leads to excess capacity from resource-producing countries such as Brazil, Australia, Russia, Canada, et al. Now those economies are in recession because China has become debt disabled and is painfully working down that misallocation of capital. And now Japan and the entire European Union appear poised to follow the same fate.

This is causing the rate of inflation to fall according to the Core PCE index. And the CRB Index, which is at the panic lows of early 2009, is corroborating the decreasing rate of inflation.

 

But the bulls on Wall Street would have you believe the cratering price of oil is a good thing because the “gas tax cut” will drive consumer spending – never mind the fact that energy prices are crashing due to crumbling global demand. Nevertheless, there will be no such boost to consumer spending from lower oil prices because consumers are being hurt by a lack of real income growth, huge health-care spending increases and soaring shelter costs.

4) U.S. manufacturing and GDP is headed south. The Dallas Fed’s manufacturing report showed its general activity index fell to -15.8 in August, from an already weak -4.6 reading in July. The oil-fracking industry had been one of the sole bright spots for the US economy since the Great Recession and has been the lead impetus of job creation. However, many Wall Street charlatans contend the United States is immune from deflation and a global slowdown and remain blindly optimistic about a strong second half.

Unfortunately, we are already two-thirds of the way into the third quarter and the Atlanta Fed is predicting GDP will grow at an unimpressive rate of 1.3 percent. Furthermore, the August ISM manufacturing index fell to 51.1, from 52.7, its weakest read in over two years. And while gross domestic product in the second quarter came in at a 3.7 percent annual rate, due in large part to a huge inventory build, gross domestic income increased at an annual rate of only 0.6 percent.

GDP tracks all expenditures on final goods and services produced in the United States and GDI tracks all income received by those who produced that output. These two metrics should be equal because every dollar spent on a good or service flows as income to a household, a firm, or the government. The two numbers will, at times, differ in practice due to measurement errors. However this is a fairly large measurement error and it leads one to wonder if that 0.6 percent GDI number should get a bit more attention.

5) Global trade is currently in freefall. Reuters reported that exports from South Korea dropped nearly 15 percent in August from a year earlier, with shipments to China, the United States and Europe all weaker. U.S. exports of goods and general merchandise are at the lowest level since September of 2011. The latest measurement of $370 billion is down from $408 billion, or -9.46 percent from Q4 2014. And CNBC reported this week that the volume of exports from the Port of Long Beach to China dropped by 10 percent YOY. The metastasizing global slowdown will only continue to exacerbate the plummeting value of U.S. trade.

 

6) The Fed is promising to no longer support the stock market. Back in 2009, our central bank was willing to provide all the wind for the market’s sail. And despite a lackluster 2 percent average annual GDP print since 2010, the stock market doubled in value on the back of zero interest rates and the Federal Reserve ‘s $3.7 trillion money-printing spree. Thus, for the past several years, there has been a huge disparity building between economic fundamentals and the value of stocks.

But now, the end of all monetary accommodations may soon occur, while markets have become massively over-leveraged and overvalued. The end of quantitative easing and a zero interest-rate policy will also coincide with slowing U.S. and global GDP, falling inflation and negative earnings growth. And the Fed will be raising rates and putting more upward pressure on the U.S. dollar while the manufacturing and export sectors are already rolling over.

I am glad Ms. Yellen and Co. appear to have finally assented to removing the safety net from underneath the stock market. Nevertheless, Wall Street may soon learn the baneful lesson that the artificial supports of QE and ZIRP were the only things preventing the unfolding of the greatest bear market in history.

Michael Pento produces the weekly podcast “The Mid-week Reality Check,” is the president and founder of Pento Portfolio Strategies and author of the book “The Coming Bond Market Collapse.”

 

Tesla: Morgan Stanley – Stock Could Double

Forget about a mere 15 percent increase in stock value — how about a 90 percent one? That’s how bullish Morgan Stanley analyst Adam Jonas is on Tesla.

In a note this morning, Jonas has increased the price target for Tesla to $465 from $280. (The stock opened at $243 on Monday morning before rising about 4 percent in early trading). The key reason behind this is what he calls “Tesla Mobility, an app-based, on-demand mobility service.” The race for autonomous driving is nothing new, with tech giants such as Apple and Google also making a push in this realm, but the report says Tesla is well positioned to get large market share. Jonas is telling clients that “Tesla is uniquely positioned, in our view, to solve the biggest flaw in the auto industry, <4% utilization, via an app-based, on-demand mobility service.”

Here’s more:

Given the pace of technological development both within Tesla and at rival technology and mobility companies, we would be surprised if Tesla did not share formalized business plans on shared mobility within the next 12 to 18 months… We view this business opportunity as potentially additive to Tesla’s existing model of selling human-driven cars to private owners and see potential for this model to conceivably more than triple the company’s potential revenues by 2029. That is, selling miles in addition to selling cars… If Tesla wants to make good on its mission to accelerate the world’s transition to sustainable transport, we see the move to a shared mobility model as critical…

Here’s a look at how this new mobility segment plays into the price target. It adds $244 a share in the bull case scenario, the second largest contributor behind the traditional Tesla Motors.

The report goes on to say that Tesla has five critical attributes a company needs in order to be a successful shared mobility firm, which are:

In terms of a timeline for Tesla Mobility, Jonas says there will be three stages. The first version will be a semi-autonomous car, where there is still a human driver. This would take place in the years of 2018-2021. The second stage is a car that is closer to being fully autonomous, but would still need what they call an “operator.” This essentially means that there is no need for human intervention in as much as 99 percent of various situations. Jonas expects this to encompass the years of 2021-2025. The final stage is a phase-in of fully autonomous and shared vehicles, expected to begin 10 years from now.

Jonas points out that Tesla has remained fairly quiet about ride sharing, although he did ask Elon Musk about this on the company’s second quarter conference call.

Here’s the transcript:

Jonas: First question: Steve Jurvetson was recently quoted saying that Uber CEO Travis Kalanick told him that if by 2020 Tesla’s cars are autonomous, that he’d want to buy all of them. Is this a real, I mean, forget the 2020 for a moment, but is this a real business opportunity for Tesla? Supplying cars to ridesharing firms, or does Tesla just cut out the middleman and sell on-demand, electric mobility services directly from the company on its own platform?

Musk: That’s an insightful question.

Jonas: You don’t have to answer it.

Musk: I don’t think I should answer it.

Jonas: Sometimes you can tell more from the non-answer than from the answer.

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Shilling : “Oil is headed for $10 to $20 a barrel.”

If crude’s slump back to a six-year low looks bad, it’s even worse when you reflect that summer is supposed to be peak season for oil.

U.S. crude futures have lost 30 percent since the start of June, set for the biggest drop since the West Texas Intermediate crude contract started trading in 1983. That beats the summer plunges during the global financial crisis of 2008, the Asian economic slump in 1998 and the global supply glut of 1986.

It even surpasses the decline of 2011, when prices fell as much as 21 percent over the summer as the U.S. and other large oil-importing nations released 60 million barrels of oil from emergency stockpiles to make up for the disruption of Libyan exports during the uprising against Muammar Qaddafi.

WTI, the U.S. benchmark, fell to a six-year low of $41.35 a barrel Friday. It may slide further, according to Citigroup Inc.

“Summer is when refineries are all running hard, so actual demand for crude is as good as it gets,” Seth Kleinman, London-based head of energy strategy at Citigroup Inc., said by e-mail.

OPEC’s biggest members are pumping near record levels to defend their market share and U.S. production is withstanding the collapse in prices and drilling. The oil market is still clearly oversupplied and “it will get more so as refiners go into maintenance,” Kleinman said.

Oil demand usually climbs in the summer as U.S. vacation driving boosts purchases of gasoline and Middle Eastern nations turn up air-conditioning.

Crude has sunk this year even U.S. gasoline demand expanded, stimulated by a growing economy and low prices. Total gasoline supplied to the U.S. market rose to an eight-year high of 9.7 million barrels a day last month, according to U.S. Department of Energy data.

Crude could fall to $10 a barrel as the Organization of Petroleum Exporting Countries engages in a “price war” with rival producers, testing who will cut output first, Gary Shilling, president of A. Gary Shilling Co., said in an interview on Bloomberg Television on Friday.

“OPEC is basically saying we’re not going to cut production, we’re going to see who can stand lower prices longest,” Shilling said. “Oil is headed for $10 to $20 a barrel.”

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Iran Targets 45 Oil Projects To Boost Output : Bloomberg

Crude Reserves

Iran has selected 45 oil and gas projects to show international companies at a conference in London in December when new oil contract models will be discussed ahead of exploration auctions to double the country’s crude output.

The projects, including oil and gas exploration, will be discussed along with details of a new oil contract model at the Dec. 14-16 conference, Mehdi Hosseini, chairman of Iran’s oil contracts restructuring committee, said in an interview in Tehran. Iran hopes to boost crude production to 5.7 million barrels a day, he said.

The Persian Gulf nation’s output was 2.85 million barrels a day in July, according to estimates compiled by Bloomberg. Oil producers such as BP Plc and Royal Dutch Shell Plc have expressed interest in developing Iran’s reserves, the world’s fourth-biggest, when sanctions are removed following last month’s nuclear agreement with world powers.

“We will define projects in the oil and gas sector as much as feasible and necessary since we believe this sector will bring wealth and economic development,” Hosseini said. “As far as this conference is concerned, we have defined around 45 projects which include exploratory blocs at varying development costs.”

Iran may give companies two to three months to decide whether to bid on the projects, he said. “The exact length will be decided by the time of the conference.” Shortly after that, Iran will call for bids, he said.

“We consulted with almost all medium and major oil companies over our contractual contents and projects. And the feedbacks have been positive,” he said.

New Contract

Iran will adopt “risk service contract” models which will offer investors payback in the form of cash or oil allocation, he said. They won’t be allowed to claim ownership of the country’s energy reserves, he said.

“They would resemble production sharing but with different characteristics,” he said. “The international oil company, or the investing company, would be accepting certain risks in view of which it would be entitled to a portion of the oil thus produced. Or the reward of that risk is a share/portion of the oil.”

Iran’s production costs are $8 to $10 a barrel so, “our projects will be attractive to investors,” Hosseini said. Falling oil prices are in Iran’s interest at this point because high prices encouraged uneconomical fields, he said.

“The drop in prices from $100 a barrel to around $50 a barrel now is only in the short run,” Hosseini said. “Looking at the international oil industry over the long-run, the demand will rise and so will the prices.”

Production Boost

Pending the end of sanctions, Iran wants to boost oil production to about 15 percent of the Organization of Petroleum Exporting Countries’ output, or more than 4 million barrels a day, he said. “As OPEC’s share increases so does our share and we will need to build capacity. As a preliminary goal in the short run we plan to produce 5 million barrels a day and then go from that to 5.7 million barrels a day.”

Iran’s oil reserves are estimated at 157.8 billion barrels by BP Plc. That’s enough to supply China for more than 40 years. Iran can boost oil production by 500,000 barrels a day within one week after international sanctions are lifted, Oil Minister Bijan Namdar Zanganeh said in an interview with state TV earlier this month. Sanctions against Iran’s oil industry should be lifted by late November, he said.

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Natural Gas Drillers Can’t Catch a Break : Bloomberg News

Natural gas drillers who flocked to liquids-rich basins in search of better profits just can’t seem to catch a break.

Seven years ago, as shale output surged and gas futures tumbled more than 60 percent, producers abandoned reservoirs that only yielded gas and moved rigs to wells that also contained ethane, propane and other so-called natural gas liquids, or NGLs. These NGL prices were tied to oil futures, which climbed in 2009 as the economy recovered. It was a strategy that worked well — for a while.

Drillers fled natural gas for oil and liquids as commodities collapsed.
Drillers fled natural gas for oil and liquids as commodities collapsed.

Those days are over. Oil has plunged 56 percent from a year ago, and propane at the Mont Belvieu hub in Texas has tumbled 64 percent. The spread between NGL prices and natural gas shrank 9.2 percent last week to $7.02 a barrel, the lowest in at least two years, squeezing producers’ profits.

The spread between natural gas liquids and natural gas prices has narrowed, squeezing producers' profits.
The spread between natural gas liquids and natural gas prices has narrowed, squeezing producers’ profits.

The culprit is a repeat offender: shale production. This time, the boom in oil output from reservoirs like the Bakken in North Dakota has created a glut of NGLs, and the market is poised to remain well supplied. To survive, gas producers will have to focus on the lowest-cost wells.

Production of natural gas liquids has surged, creating a glut as drillers flee dry gas.
Production of natural gas liquids has surged, creating a glut as drillers flee dry gas.

“Drillers are going to have to retreat to where the sweet spots are,” said Bob Yawger, director of the futures division at Mizuho Securities USA Inc. in New York. “At these price levels, the rig count isn’t going to move higher.”

 

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Forbes Predicts Chesapeake Running Out Of Options

The Dim Outlook For Chesapeake Energy

The highly leveraged shale gas champion is burning cash, selling assets and running out of options. 

Chesapeake Energy CHK +1.8% is in pretty bad shape. Shares are down 67% in the past 12 months, to $8.70 today. The last time Chesapeake traded at such a low range was in 2003. Its equity market cap is less than $6 billion. Think this looks like a bargain? Only if you’re really bullish on oil and gas prices. On the contrary, if oil and gas stays low for a couple more years it is hard to see how Chesapeake’s equity is worth anything at all.

Chesapeake’s earnings report last week provided no comfort. The company started 2015 with $4.1 billion in cash. It ended the first half with $2 billion. That’s half its cash evaporated in six months. During that time Chesapeake did not buy or sell any assets. It reduced its capex levels by about 40% over last year. So that cash burn rate pretty well represents the sorry state of its underlying business.

This highly leveraged company is becoming even more leveraged. In the first half, total debt net of unrestricted cash increased from $7.4 billion to $9.5 billion. As profitability has collapsed, net debt has risen to more than 6 times annualized Ebitda. In normal conditions 4x is considered rich. This is worrisome for a company that will need to refinance $5 billion in debt over the next five years.

Part of the problem is a huge glut of gas and liquids in the Utica and Marcellus, where there’s not enough pipeline capacity to evacuate it all out to market. Chesapeake has curtailed production in both regions. But that won’t solve the bigger problem. According to analyst Kevin Kaiser at Hedgeye, Chesapeake is caught in a “midstream stranglehold.” It is contractually obligated to pay fees to pipeline giant Williams Companies for its dedicated capacity. Most of Williams’ contracts with Chesapeake are on a “cost of service” mechanism, which guarantees Williams a return on its investment in building out pipelines. Chesapeake has to pay a certain amount whether it uses all the pipeline capacity or not. The less it uses, the higher Chesapeake ends up paying per unit of volume.

It’s a set-up that would work in a world of higher commodity prices and ever increasing volumes. According to Chesapeake’s February 2012 investor presentation, when the company entered into these pipeline contracts it was anticipating that in 2015 it would be enjoying $6 per mcf natural gas and $100 oil and annual ebitda of more than $10 billion. Instead, this year’s ebitda will be more like $2 billion.

According to Kaiser’s analysis, Chesapeake’s midstream pipeline expenses, at about $1.70 per mcf (or the oil equivalent) are the highest in the entire industry. In the Midcon region Chesapeake was paying 64 cents per mcf to move gas in 2012. But because gas prices have gone so low, it stopped drilling there. Now it’s paying an estimated $1.20 per mcf to move gas there. All told, Chesapeake’s payments to Williams amount to about $1.9 billion a year, according to its quarterly report. “It will take multiple years to play out, but we believe that CHK equity is ultimately a zero,” wrote Kaiser in his June report.

Chesapeake would love to renegotiate contracts with Williams, but the pipeline giant has very little incentive to play ball. Williams paid more than $8 billion to acquire its control of Access, the pipeline division that Chesapeake spun off in exchange for more than $4 billion in emergency cash back in 2012. Many of Chesapeake’s contracts with Williams carry terms of more than a decade.

Alan Armstrong, CEO of Williams, said on his quarterly conference call that he’s open to “win-win” solutions with Chesapeake. “In terms of restructuring, certainly, they take the lead on that and we try to provide support and find win-win ways where they can add volumes that help offset some of those obligations.”
Chesapeake could gain some traction by selling off assets where it’s stuck in tough contracts with Williams, or making joint ventures with other operators that can add their volumes to fill out Williams’ pipes.

Chesapeake has already tightened its belt a lot. CEO Doug Lawler has cut costs, slashed capex and improved drilling efficiency. Last month he announced that Chesapeake would suspend its dividend, saving $240 million a year.

Lawler will have to keep trying to sell off whatever acreage is attractive to buyers. In October 2014 Chesapeake sold acreage in the Marcellus and Utica to Southwestern Energy SWN +5.92% for $5.4 billion. At the beginning of the third quarter Chesapeake sold assets in Oklahoma to private equity backed FourPoint Energy for $1 billion. Lawler will need to orchestrate a lot more asset sales to make ends meet. The company says it has ample liquidity thanks to an untapped $4 billion revolving line of credit. That line may well shrink when banks do their fall borrowing base redeterminations.

Why not try to sell the whole thing? Please. Chesapeake’s big equity holders, Southeastern Asset Management and Carl Icahn (each with about 10% stakes), would like to convince the market that’s possible, but who would want to buy a business with such poor underlying performance and lots of overhead when they can just cherrypick off the decent pieces? If you’re a deep pocketed oil and gas major you’d be better off acquiring any number of healthier operators. Cowen & Company analyst Charles Robertson, Jr. notes that Cimarex Energy XEC +2.5%, with its low leverage and world-class position in the Permian Basin is “one of the easiest acquisition targets” for the majors.

Further complicating Chesapeake’s outlook is the ongoing legal trouble related to alleged underpayment of royalties. In the first half Chesapeake agreed to pay a $119 million settlement in a class action brought by Oklahoma landowners who said the company bilked them on royalty payments. Chesapeake says that litigation over similar allegations continues in Texas, Louisiana, Ohio, Pennsylvania and Arkansas and that the Dept. of Justice has subpoenaed information relating to Chesapeake’s royalty payments. The company says “losses are reasonably possible” but that “we are currently unable to estimate an amount or range of loss.” What potential acquirer would want to take on that open-ended liability?

This is a company that hasn’t been able to live within its cashflow at any time in the past decade, even when oil prices were above $100. It has generated more than $16 billion in cash from asset sales since 2012, but is more highly leveraged than ever. Unless oil and gas prices recover significantly in the months ahead Chesapeake will continue to sell assets and shrink smaller and smaller until it eventually runs out of cash and runs out of options.

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Oil Bear Market Will Be Prolonged : Goldman Sachs

Oil dropped to the lowest in more than four months in New York on expectation a global glut that drove prices into a bear market will be prolonged.

Goldman Sachs Group Inc. estimates the global crude oversupply is running at 2 million barrels a day and storage may be filled by the fall, forcing the market to adjust, analysts including Jeffrey Currie said in a report dated Thursday. U.S. crude supplies remain about 100 million barrels above the five-year seasonal average, Energy Information Administration data on Wednesday showed.

Oil moved into a bear market in July on signs the global surplus will persist as the U.S. pumps near the fastest rate in three decades and the largest OPEC members produced record volumes. The Bloomberg Commodity Index, which fell almost 11 percent in July, has resumed its decline.

“Prices are under pressure because we’ve got more and more crude coming out of the ground,” Michael Corcelli, chief investment officer of hedge fund Alexander Alternative Capital LLC in Miami, said by phone. “Questions about storage capacity have already been brought up.”

WTI for September delivery fell 49 cents, or 1.1 percent, to settle at $44.66 a barrel on the New York Mercantile Exchange. It’s the lowest close since March 19. Prices are down 16 percent this year.

Supply, Demand

Brent for September settlement dropped 7 cents to end the session at $49.52 a barrel on the London-based ICE Futures Europe exchange. It touched $48.88, the lowest since Jan. 30. The European benchmark crude closed at a $4.86 premium to WTI.

“It’s the familiar theme of oversupply and shaky demand,” John Kilduff, a partner at Again Capital LLC, a New York-based hedge fund, said by phone. “The negative reaction to yesterday’s inventory report set up for another drop today. We clearly have more than ample supply.”

About 170 million barrels of crude and fuel have been added to storage tanks and 50 million to floating storage globally since January, according to the Goldman report. Global oil oversupply has risen from 1.8 million barrels a day in the first half of 2015, Goldman said. The balance between supply and demand may only be restored by 2016, Goldman said.

Shoulder Months

“While we maintain our near-term WTI target of $45 a barrel, we want to emphasize that the risks remain substantially skewed to the downside, particularly as we enter the shoulder months this autumn,” the Goldman analysts said.

Crude supplies in the U.S. fell 4.4 million barrels to 455.3 million last week, the EIA said. Output expanded by 52,000 barrels a day to 9.47 million a day, the first gain in four weeks. Refinery utilization rose by 1 percentage point to 96.1 percent, the highest level since 2005.

Inventories of distillate fuel, a category that includes diesel and heating oil, rose 709,000 barrels to 144.8 million, the most since February 2012, the EIA report showed.

Ultra low sulfur diesel for September delivery rose 1.14 cents, or 0.7 percent, to settle at $1.5499 a gallon in New York. On Monday it closed at its lowest level since July 2009.

“Diesel isn’t up because of the fundamentals,” Tom Finlon, Jupiter, Florida-based director of Energy Analytics Group LLC, said by phone. “It’s getting support from the upcoming refinery-maintenance season, the harvest season and anticipation of thermal needs later this year.”

The Bloomberg Commodity Index of 22 raw materials dropped 0.3 percent. Eighteen of the components, which include gold, have declined at least 20 percent from recent closing highs, meeting the common definition of a bear market.