Investing.com – Crude oil gave up some of its overnight gains on Thursday, as the U.S. dollar firmed after Data showed that U.S. economic growth accelerated in the second quarter, supporting the case for higher interest rates later this year.
The Commerce Department said earlier that the economy grew 2.3% in the three months ended June 30, missing expectations for growth of 2.6%. The economy expanded 0.6% in the preceding quarter, compared to a previously reported contraction of 0.2%.
The data showed personal consumption rose 2.9% in the second quarter, above expectations for a 2.7% gain, and compared to a 1.8% increase in the preceding quarter. Consumer spending typically accounts for nearly 70% of U.S. economic growth.
At the same time, the U.S. Department of Labor said the number of individuals filing for initial jobless benefits rose by 12,000 last week to 267,000 from the previous week’s total of 255,000. Analysts had expected initial jobless claims to rise by 15,000 to 270,000 last week.
First-time jobless claims have held below the 300,000-level for 21 consecutive weeks, which is usually associated with a firming labor market.
The data came after the Federal Reserve said in its rate statement on Wednesday that the economy and the labor market had continued to strengthen, reinforcing expectations for an initial rate hike at its September meeting.
The , which measures the greenback’s strength against a trade-weighted basket of six major currencies, was up 0.5% to 97.71 early on Thursday, improving from 97.08 by close of trade on Wednesday.
Dollar-denominated oil futures contracts tend to fall when the dollar rises, as this makes oil more expensive for buyers in other currencies.
On the ICE Futures Exchange in London, for September delivery tacked on 16 cents, or 0.31%, to trade at $53.55 a barrel during U.S. morning hours after rising to an intraday peak of $54.37.
A day earlier, London-traded Brent futures fell to $52.51 before erasing losses to end at $53.38, up 8 cents, or 0.15%.
The Wall Street Journal reported that Saudi Arabia could slash crude output by 200,000 to 300,000 barrels a day, to roughly 10.3 million bpd as early as September. In June, the kingdom produced more than 10.5 million barrels a day, amounting to its highest level on record.
London-traded Brent futures are down nearly 16% in July amid concerns a resumption of Iranian oil exports will add to a global glut.
Iran and six world powers reached a long-awaited nuclear deal earlier in the month that would end sanctions on Tehran in exchange for curbs on the country’s disputed nuclear program. Iran reportedly hoards 30 million barrels of oil in its reserves ready for export.
Reports of record high oil exports from Iraq and robust production from Saudi Arabia also contributed to losses.
Elsewhere, on the New York Mercantile Exchange, for September delivery inched down 15 cents, or 0.31% to trade at $48.64 a barrel.
On Wednesday, Nymex oil futures jumped to $49.52, the strongest level since July 23, before closing at $48.97, up 81 cents, or 1.69%, following the release of encouraging weekly data on U.S. oil supplies.
Crude oil inventories fell by 4.2 million barrels last week to 459.7 million, according to the U.S. Energy Information Administration. Market analysts’ expected a crude-stock fall of 0.2 million.
New York-traded oil futures are on track to post an 18% drop in July, amid ongoing worries over high domestic U.S. oil production.
According to industry research group Baker Hughes (NYSE:), the number of rigs drilling for oil in the U.S. increased by 21 last week to 659, the most since May.
Global oil production is outpacing demand following a boom in U.S. shale oil production and after a decision by the Organization of Petroleum Exporting Countries last year not to cut production.
Meanwhile, the spread between the Brent and the WTI crude contracts stood at $4.91 a barrel, compared to $4.41 by close of trade on Wednesday.
As Airlines Suffer, American Most Likely To File Bankruptcy
A few weeks ago, Boeing CEO Dave Calhoun startled the airline sector when he said a major airline would go bankrupt by Halloween.
“I don’t want to get too predictive on that subject. But yes, most likely,” Calhoun said. “Something will happen when September comes around.”
Airline stocks plunged as investors and analysts scrambled to determine which airline became most vulnerable.
RapidRatings, a risk assessment firm, recently completed a comprehensive stress test on the major U.S. airlines. They used dozens of variables including debt loads, cash flow analysis, and a loss of at least 15% of revenue.
American Airlines To Suffer The Most?
We may never know which airline that Calhoun was alluding to. Although, RapidRatings’ analysis says that American Airlines is the most likely to go bankrupt in the coming months.
The company also looked at Delta, United and Southwest, but none of them are in such dire circumstances as American.
In an interview with Yahoo Finance, RapidRatings CEO James Gellert said, “American is the most at risk and that’s it in every way you look at it. American stands out as the weakest of this cohort.”
The stress tests run by RapidRatings produce both a short term financial health rating (FHR) and long term core health score (CHS). According to RapidRatings, the FHR measures a company’s short-term resiliency and default risk. Meanwhile the CHS analyzes risk and company efficiency over a three year period. A score lower than 40 means a company is at risk of failing.
Gellert says the analysis has more than a decade of proven results. Also, “over 90% of companies that failed have been rated 40 and below on our scales.”
The stress tests found that American was the weakest U.S. airline going into the recent pandemic. It has a financial health rating of 59 and core health score of 66.
As the pandemic unfolded and air travel plunged 90%, American’s FHR score plunged to 29. Meanwhile, its CHS score fell to 27.
Gellert added that “I would be quite certain that is the airline in the crosshairs of the Boeing comment.”
The Future Of American
American, in response to the sub-40 stress test scores, said in a statement that it was “focused on rightsizing the airline for the current environment, and plan to reduce our 2020 operating and capital expenditures by more than $12 billion.”
Analysts, however, are starting to smell blood in the water. Cowen equity research analyst Helane Becker recently told Yahoo Finance, “American’s liquidity position is dependent on government aid, bucking the trends we’ve seen from other airlines. The company is receiving a total of $10.6 billion … [and] we expect another capital raise” in the 3rd quarter.”
Savanthi Syth, an equity analyst at Raymond James, also agrees American will need more capital to weather the storm. “I mean, if you look at the cash on hand that’s definitely the case,” Syth said. American has six months of cash on hand, United has 10 months, Delta has 12, and Southwest has almost 19 months, according to Raymond James.
Syth added, “I don’t think bankruptcy is a foregone conclusion… it’s just going to take longer for American to kind of dig themselves out of this kind of debt burden, and therefore equity could be challenged in the near term.”
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Buffett Recommending S&P Index Fund A Mistake, Says Berkshire Shareholder
In an article earlier this week, we posed a simple question: has Warren Buffett lost his touch?
Mark Hulbert, of the Hulbert Financial Digest, says skeptics are being “unfair” on Buffet. Hulbert adds that anyone suggesting he’s lost his touch should cool their heels. He says Buffett hasn’t lost money in the last 10 years. He also mentions that nobody beats the market all the time.
Others, like Howard Gold, a columnist at Marketwatch, points out that Buffett has been “profoundly underperforming” against the S&P 500 and most of his recent deals have been duds.
Buffet Gives Advice
But what irks one investor, in particular, was Buffett’s advice that the average investor should just buy an S&P index fund.
Buffett’s comment came during the Berkshire Hathaway conference call, when he stated “In my view, for most people, the best thing to do is to own the S&P 500 index fund.”
That may be practical advice for the vast majority of Americans. However, Tony Scherrer, a CFA at Smead Capital Management, says that Buffett’s comment completely goes against his own advice.
Scherrer believes that by recommending an S&P index fund, Buffett is telling investors to buy the exact type of companies that he himself has spent his career avoiding.
Specifically, a quote from the 2007 Berkshire Hathaway shareholder letter, where Buffett says:
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”
Scherrer takes each part of the statement and points out where Buffett contradicts or simply ignores his own advice. He starts with:
“The worst sort of business is one that grows rapidly…”
The S&P 500 has 21% of its weighting in just five stocks: Microsoft, Apple, Amazon, Facebook and Alphabet. Scherrer points to research by David Kostin at Goldman Sachs that shows these top five names have an expectation of revenue growth of 14% over the next two years, and trade at 28x the forward two-year earnings average. The other 495 stocks in the index are expected to grow revenue much slower, at 4% over the next two years, but also trade at a much lower 14x the forward two-year earnings average. In other words, buying the S&P index fund means paying twice as much (28x vs. 14x) for a handful of stocks that are growing rapidly.
“…requires significant capital to engender the growth…”
Netflix, Amazon and Facebook are among the heavily weighted stocks in the index, and Scherrer says they are all burning through significant amounts of money to keep growing.
“Netflix’s cost for its content has mushroomed from $4.5bn five years ago to an expected $15bn in 2020 and will have to continue to expand to operate its business. Amazon… recently announced a $4bn increase in costs associated with safety of its workers and protection in its warehouses on the heels of its deficiencies… Facebook’s recent quarter included a 34% increase in expenses year-over-year to a whopping $46.7bn, as its cost to acquire new customers and increased regulatory expenses spiked.”
“…then earns little or no money”
Looking at the numbers, Scherrer says ”Netflix burned $3.1bn in free cash flow last year and must persistently ramp that up to attract and retain subscribers. Amazon’s flywheel generated an eye watering $280bn revenue number in 2019, but operating profits for everything outside its cloud business came in at a measly $5.3bn. You currently pay 68x forward price-to-earnings for Netflix, 126x for Amazon, and 28x for Facebook.”
Buffett of the Past v.s. Buffett of the Present
Scherrer believes that if 2007 Warren Buffett met today’s Warren Buffett, there’s no way he would allow him to buy an S&P index fund that is highly concentrated into a handful of stocks that are high growth, capital incinerators that earn very little money.
But 2007 Warren Buffett would probably be most appalled that 2020 Warren Buffett would be selling airlines stocks. That means at some point, Warren Buffett thought investing in airline stocks was a good idea.
In the same 2007 shareholder letter, Buffett outlined what “The Great, the Good and the Gruesome” businesses look like. Buffett described a “gruesome” business by using airlines as an example.
Incredibly, he described them as “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”
FOMC Minutes Reveal Uncertainty, Fear Over Second Wave of Outbreak
Minutes from the April meeting of the Federal Open Market Committee show that Fed officials are happy with their recent actions. The said actions aims to keep the economy afloat during the coronavirus pandemic. However, they are also deeply worried about the likelihood of further outbreaks. They also expressed concern about how the pandemic will harm lower-income families the most.
The April meeting concluded with the committee talking about the steps they took during the initial outbreak. They said those actions were were “essential in helping reduce downside risks to the economic outlook” of the country. They also decided to keep interest rates at their current level of 0% – 0.25%.
The committee said that the pandemic created both near and medium-term economic uncertainty. Also, “participants commented that, in addition to weighing heavily on economic activity in the near term, the economic effects of the pandemic created an extraordinary amount of uncertainty and considerable risks to economic activity in the medium term.”
The group expressed worry about the negative effects on unemployment and GDP growth of another outbreak of coronavirus cases later in the year. The minutes also say the group views this as a “substantial likelihood.”
“In this scenario, a second wave of the coronavirus outbreak, with another round of strict restrictions on social interactions and business operations, was assumed to begin around year-end, inducing a decrease in real GDP, a jump in the unemployment rate, and renewed downward pressure on inflation next year,” the summary said.
The minutes also mentioned that this “more pessimistic” outlook was just as likely as the baseline forecast for improvement.
Baseline For Improvement
There was discussion amongst the members to provide more explicit assurances that rates wouldn’t move higher until a recovery was “firmly in place.” This is defined by the country meeting certain unemployment or inflation rates before the committee would consider raising interest rates. Another idea was announcing a specific date which would be the soonest that the FOMC would consider raising interest rates.
They call this type of forward guidance the Evans Rule. The Fed used this in 2012 when it openly broadcast that it would hold rates steady until unemployment rates started to fall. It also used this to broadcast that there were signs of rising inflation.
The notes also reveal that the committee is very concerned that while the 30+ million jobs lost since the outbreak began also hit all socioeconomic levels. The brunt of losses “would fall disproportionately on the most vulnerable and financially constrained households in the economy.”
Some are concerned that many small businesses, the backbone of our country, simply won’t survive in the “new normal” of social distancing. Meanwhile, other businesses are going to hold off on hiring or growing. Owners say this may last until the threat of a second outbreak passes.
The minutes state “a large number of small businesses may not be able to endure a shock that had long-lasting financial effects. Participants were further concerned that even after social-distancing requirements were eased, some business models may no longer be economically viable, which could occur, for example, if consumers voluntarily continued to avoid participating in particular forms of economic activity.”
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