1/18/2016 0 Comments
The macro-economic outlook is clouded by the drop in commodity prices, namely energy and metals. The recessions in energy and metals & mining could spread and become an economy-wide recession. The downturn in energy and metals & mining has already had a sizable impact on industrials and transports. The oil & gas industry alone has shed 50,000 jobs since the beginning of the oil downturn in late-2014. The energy impact could begin to reach deeper into the economy and start to impact real estate, construction, small businesses, and consumer spending. No bank reported that energy weakness was spreading broadly across the economy. PNC indicated they did see some energy weakness spreading locally. None of the banks are broadly pulling back on credit availability, but 2 banks, PNC and Wells, mentioned some impact on credit availability locally.
Banks have a unique look into the economy across all sectors through their relationships with corporations, small businesses, and consumers. Bank earnings press releases, conference calls, and 10-Qs provide a lot of information about the broader economic landscape. For example, criticized and classified loans in energy-heavy communities could be on the rise. Banks would see credit deterioration on both a broad and local basis, in local real estate markets where the oil bust hit hardest.
I took a look at the earnings of the banks who reported so far: JP Morgan (JPM), Wells Fargo (WFC), PNC (PNC), US Bancorp (USB), and Regions Financial (RF). All reported significant weakness in the energy and metal & mining sectors, and all increased loan loss reserves in these areas. Only PNC reported that weakness from the energy and metals & mining sectors has begun to spread locally into non-energy related sectors of the economy. PNC mentioned, “in Texas and other areas the energy weakness is starting to spread into real estate and other service providers locally”. PNC also mentioned they have tightened real estate underwriting standards in tech heavy and energy heavy cities, but lending spreads have not blown out like capital market spreads have. Wells mentioned a pull-back in credit from small-regional banks recently, but has not changed its own credit availability.
The table below provides the size of the banks’ loan portfolio as well as the amount of energy-related loans. JP has the largest energy exposure on a nominal and a percentage basis at 5.0%. One interesting point on JP, the additive exposure of energy, metal & mining, and agriculture is 7.6%. Regions Financial has the second largest percentage exposure at 3.9% followed by PNC, Wells, and then US Bancorp.
All 5 banks reported loan growth, and several reported an improvement in credits operating in non-energy related parts of the economy. We know the industrial sector is in recession due the weakness in commodities and China, and the strong USD. It is possible that the energy downturn is having a positive impact on the consumer-related parts of the economy. The lower energy costs definitely benefit the consumer. Therefore, cheap energy could be stimulating non-energy related sectors, such as discretionary and technology.
In general, the banks did not see broad-based problems brewing in the economy from the energy downturn. PNC did see some impact on local economies, and has tightened underwriting standards locally. Wells mentioned some pull-back in credit availability from small regional banks, but Wells did not change its own credit availability. During the remainder of this earnings season, watch the banks’ reports for an indication the energy downturn is beginning to spread. Finally, keep in mind the banks could be a vehicle to spread debt problems around. A rise in defaults or just the risk of higher defaults could cause a pull-back in credit which in turn causes more stress, potentially in sectors unrelated to energy. None of the banks indicated a broad pull-back in credit… yet.
S&P 500 Top Performers of 2015
Taking a closer look at the breakdown of returns of S&P 500 Index constituents reveals 44% (220 of 500) were up for 2015 while 56% were flat or down. The top 2 performing stocks not only returned over 100%; they took market share and negatively impacted competitors in their industry.
1. Netflix +134%
Topping the leader board is Netflix (NFLX) with a +134% return. Netflix was successful in growing domestic subscribers, but the real story propelling the stock higher was strong international subscriber growth. Netflix had success with original programing both domestically and internationally. Netflix's ability to get cable subscribers to cut the cord adversely impacted the cable TV providers. The media industry posted a -7% lost overall. Cablevision Systems (CVC) was bought out posting the 5th highest return in the S&P. Disney (DIS) was up +11.6%, but even Disney started to weaken up in 4Q on subscriber loses. Time Warner Cable (TWC) was up +22.1% on a take over bid from Comcast, but Time Warner (TWX) was down -24.3%. Twenty-First Century Fox (FOX) was down -26.2% and (FOXA) was down -29.3%.
2. Amazon +118%
Amazon ranked second in the S&P 500 with a return of +118%. Amazon's impact was not on other internet retailers, but on the brick and mortar retailers. No one escaped the Amazon effect except the dollar stores which faired okay. Dollar General managed to gain +1.7%, and Dollar Tree (DLTR) was up +9.7%. The multiline retail industry was down -12.7% as a whole. Target (TGT) was not so bad, down -4.4%. Not the department stores were hit hard; Macy's (M) was down -46.8%, and Nordstrom (JWN) was down -32.8%. Even the discount stores were weak; Kohl's down -22%.
3. Activision Blizzard +92%
Activision Blizzard (ATVI) posted a +92% return. Activision Blizzard is the maker of the popular games Call of Duty and Black Ops. Activision purchased King Digital to get into the mobile gaming area.
4. Nvidia +64%
Nvidia (NVDA) is another play on gaming, but from hardware side of the business. Gaming is greater than 50% of Nvidia's revenue. Gaming revenue is growing 42% year-over-year. Nvidia's second key market is enterprise graphics. The third key market is data center, acceleration and high performance computing.
5. Cablevision Systems +55%
Cablevision was bought out by Altice for a 22% premium.
To closeout 2015, December posted a -1.6% return for the S&P 500 Total Return Index. The index was held down by energy again. The energy sector was down -10.0%, -0.6%, and -23.6% for December, 4Q, and 2015 respectively. The second worst performing sector was materials. This underperformance of energy and materials was a definite theme for the entire year. Could some of this reverse in 2016?
On the plus side for December was the staples, utilities, telecom sectors and health care. These defensive sectors were the only sectors posting a positive return in December, which shows a risk-averse investment atmosphere. For the year, the story was a bit different. Discretionary was the best performing sector followed by health care and tech.
Michael Grove, CFA