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Down on the Farm: Deere Results Surprise as Strong Earnings Week Continues

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August 19, 2016

(Friday Market Open) The retail earnings parade continued Friday, but there was also some news from the fields, as Deere & Co (DE) reported stronger-than-expected results.

Deere's strong earnings continued a string of vigorous quarterly results this week, including from huge companies like Wal-Mart (WMT) and Home Depot (HD). Aside from earnings, the market seems to lack a catalyst. Oil prices have rallied sharply, but oil’s correlation with the stock market has fallen sharply from earlier this year, so the oil market isn’t having as much impact on stocks as it did back in January and February. And there’s no major economic data on Friday’s schedule. Stocks remain stuck in a narrow range amid low volatility.

Deere shares rose 5% in pre-market trading after DE posted earnings per share of $1.55, up 2 cents from a year ago and way above the Wall Street consensus of 94 cents. That was something of a surprise, as the farm economy remains weak. Sales fell from a year ago, but DE raised earnings guidance.

The huge agricultural equipment maker has been suffering the farm economy’s slump, and said its results reflect “the continuing impact of the global farm recession as well as difficult conditions in construction equipment markets.” The pressure comes from unusually strong crop harvests that have led to excess grain supplies and pushed down commodity prices. When prices for crops like corn and soybeans fall, as they have this summer, it can push down farmers’ demand for new equipment.

Other companies reporting early Friday included Applied Materials (AMAT), which beat expectations and saw shares rise in pre-market trading, as well as retailers Gap (GPS) and Foot Locker (FL). Gap narrowly beat Wall Street’s earnings per share estimate, but same-store sales fell 2%.

Earlier this year, it sometimes seemed like the stock market was on set of strings controlled by oil prices. When oil prices rose, so did stocks. When they fell, it was often a bad day on Wall Street.

Lately, though, the corellation between equities and oil just hasn’t been so pronounced, and that’s evident in price action. Since the beginning of August, when nearby U.S. crude futures slipped briefly below $40 a barrel, crude oil has risen about 20% in a very quick rally, driven mostly by talk that major producers might agree to an output freeze. But the stock market, while certainly holding its own, is up just a touch since the oil market’s slide below $40 on Aug. 2. The S&P 500 Index (SPX) was at around 2170 at that point, and closed just above 2187 on Thursday. The corellation between the S&P 500 index (SPX) and oil is now below 70%, compared to highs above 90% last winter.

Oil futures came under a little pressure early Friday, but remained above $48 a barrel, a seven-week high. The question is whether the nearby futures contract can take out psychological resistance at $50 and then move toward the 2016 high around $53. U.S. weekly oil rig counts, due later Friday, could provide more clues into the production picture, as rig counts have been climbing most of the summer. Last week, U.S. oil rig count rose by 15 to 396 - the most since late February.

But rig count remains dramatically lower than a year ago, and U.S. oil production has fallen significantly from highs recorded in 2015. U.S. crude oil inventories sit at 521.1 million barrels, according to the Energy Information Administration (EIA), up nearly 65 million barrels from a year ago.

The yield on 10-year U.S. Treasuries was at 1.55% early Friday, up from lows last week below 1.5%.

S&P 500

FIGURE 1: LUCKY SEVEN?

The S&P 500 (SPX), plotted through Thursdaay on the TD Ameritrade thinkorswim platform, ended the day up exactly 7% so far this year and not far from all-time highs. Psychological resistance remains at 2200 Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Need a Refill? Thursday’s weekly natural gas inventory data showed stockpiles growing more slowly than historic seasonal trends for the 15th-consecutive week, the Energy Information Administration (EIA) said. Inventories rose 22 billion cubic feet to 3.34 trillion cubic feet, which was below consensus expectations from analysts. It may seem odd to talk about slow growth of anything when trillions of cubic feet are involved, and indeed, inventories remain up nearly 11% from a year ago and nearly 14% above the five-year average. That may help explain why futures prices didn’t climb much upon release of the data, analysts said. The nearby futures contract rose slightly to $2.65 per million British thermal units by midday Thursday, below highs of near $3 a month ago and much cheaper than the $4 prices that were common two years ago. Still, this is the time of year when natural gas inventories bear watching, as supplies typically build ahead of stronger winter demand for the commodity.

Digging for Dividends: One bullish factor for the market, according to S&P Capital IQ, is the continued attractive dividend yield of stocks compared with Treasury yields. The SPX’s dividend yield is around 2.1%, compared with about 1.54% for the 10-year Treasury bond yield. A situation like this, “traditionally has been favorable for equities, especially with the Fed continuing only to threaten to raise rates,” S&P Capital IQ said in a report to investors this week.

That said, SPX valuations continue to look slightly elevated from a historical perspective, at around 18 times forward 12-month earnings per share (EPS) compared to the average of 16.2 times forward EPS since 2000. Perhaps it’s instructive to remember that in July, retail investors reduced their exposure to some of the most high-flying equity names, possibly a sign that they’re seeking value.

Summer Doldrums Still Evident in Volatility: If summer doldrums linger anywhere in the market as late August looms and the kids start going back to school, it’s in volatility readings. As of late this week, the VIX index, which measures volatility, remained at historically low levels. VIX did emerge from its slumber earlier in the week right before the release of Fed minutes, but then quickly went back to dreamland after the minutes didn’t reveal much in the way of drama. VIX recently traded at 12.14, down from the week’s highs of above 13.5. It’s possible that a month or two from now, when the U.S. Presidential election gets closer and the Fed prepares for its September meeting, VIX could get a wake-up call. But for now, fear appears to remain at a low ebb.

Good Trading,
JJ
@TDAJJKinahan

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