Tuesday, July 22, 2014

Tuesday, July 22, 2014 - Curb Your Enthusiasm

Curb Your Enthusiasm
by Sinclair Noe

DOW + 61 = 17,113
SPX + 9 = 1983
NAS + 31 = 4456
10 YR YLD - .01 = 2.46%
OIL - .17 = 104.42
GOLD – 4.70 = 1308.50
SILV + .04 = 21.07

We start with a couple of economic reports. The National Association of Realtors reports existing home sales were up 2.6% in June to a seasonally adjusted rate of 5.04 million, compared to 4.91 million in May. Sales in June were 2.6% higher than last month, but were 2.3% below the June 2013 rate. Total inventory rose 2.2% in June to 2.3 million existing homes for sale; unsold inventory is up 6.5% from a year ago.

At June’s pace of sales, there was a 5.5 month supply of homes for sale. The Realtors’ group considers a 6-month supply to be a balanced market. Higher supplies favor buyers and lower supplies favor sellers. The Federal Housing Finance Agency says home prices in May rose 0.4% from the prior month and were 5.5% above their level of May 2013. Distressed sales accounted for just 11% of sales in June, down from 15% last year, 25% in 2012, and 30% in 2011. Fewer distressed sales probably explains why there were fewer sales than June of last year.

The Consumer Price Index, or CPI, measures inflation at the retail level; the CPI increased 0.3% in June. The core CPI looks at prices excluding food and energy, which is important for people who don’t eat food or drive cars or use electricity; core CPI was up 0.1% in June. On a year over year basis, CPI is up 2.1%, and the core CPI is up 1.9%. The big driver for the increase in June was higher prices for gasoline.

In earnings reports:
Quarterly profit at McDonald's fell more than expected. Second quarter net income fell almost 1% to $1.3 billion, or $1.40 per share. Sales at McDonald’s restaurants in the US dropped for a third straight quarter.

Coca Cola’s 2Q net income dropped to $2.6 billion from $2.68 billion a year earlier.

Verizon reported second quarter earnings nearly doubled, but it was a confusing report because Verizon paid for Vodaphone shareholders in the quarter, plus they sold some of their wireless spectrum to T-Mobile; cutting through the clutter, Verizon added 1.4 million devices; Verizon added three tablets for every new smartphone. Earnings were just a smidge above expectations.

Comcast reported net income of almost $2 billion for the second quarter, with total revenue of $16.8 billion, up 3.5% from the same period last year. The revenue increase came from high speed internet service. Comcast lost cable video customers, as more people bypass cable and satellite subscriptions in favor of cheaper streaming alternatives.

Credit Suisse reported a second quarter loss of $779 million, the largest loss since 2008; reflecting the charge of $2.6 billion related to the settlement with US law enforcement for a guilty plea to conspiring to aid tax evasion in helping American customers hide money in Swiss accounts. Or another way to look at it, they were one criminal conviction away from a $1 billion quarterly profit. Credit Suisse also announced it would exit the commodities trading business.

Meanwhile, it looks like bond traders are exiting the bond trading business. Trading in US government bonds has dropped 25% in the past few weeks compared to the same time period a year ago. Since the end of the second quarter, trading in investment grade bonds has dropped 17% and trading in junk bonds has dropped 8%.

Last week, Fed Chair Janet Yellen talked about overvaluation in the biotech and social media sectors. One of the most common measures of value is the P/E, or price to earnings ratio; there are certainly other measures of value, but PE is common. Generally, a low PE can point toward value, while a high PE might indicate overvaluation, or even an unprofitable company. Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share. So, you might think a PE of 165 would mean a stock was extremely overvalued, ready to crash; or not. In September 2003, Apple had a PE of 165; since then it has gained about 6,000%.

After the close of trade today, Apple posted fiscal third quarter results. Revenue came in at $37.4 billion versus $38 billion expected; EPS was $1.28 versus $1.23 expected; iPhone sales were on track; iPad sales were a little weak; Mac sales were a little better than expected. Apple posted profit of $7.75 billion, up from $6.9 billion in the year-ago period. Apple announced a new iPhone 6, not yet available, but ready to swamp stores before the end of the year; it will have a bigger screen. Curb your enthusiasm.

Also after the close, Microsoft posted profit of $4.6 billion, or 55 cents a share, on revenue of $23.4 billion. During the year-ago period, the world's largest software company earned $4.97 billion, or 59 cents a share, on $19.9 billion in sales. So, sales were up, profit was a slight miss, due to the Nokia acquisition. Bing search ad revenue is up 40%, and Bing now has about 20% of the market share for search engines. Microsoft is big in the cloud, where revenue is up almost 150%, topping 4 billion.

Hedge fund manager Bill Ackman went on CNBC yesterday and promised he would deliver the death blow against Herbalife. Ackman has been shorting the stock for about a year, a $1 billion bet the company will crash. Then he delivered a 3 hour diatribe with 250 slides in his PowerPoint presentation, alleging that Herbalife is not just a multi-level marketing nutritional club, it is a pyramid scheme preying on minorities, and the biggest fraud since Enron. Ackman didn’t present a great deal of evidence. Today the stock was up 15%, for no apparent reason, other than surviving an Ackman death blow.

There were two rulings from two federal appeals court panels on Obamacare today. The question was whether the government could subsidize health insurance premiums for people in states that use the federal insurance exchange; 36 states use the federal exchange, while the other states set up their own state exchanges. This goes back to wording in the original law that says subsidies can be applied to state exchanges.

 The United States Court of Appeals for the District of Columbia Circuit said that the government could not subsidize insurance for people in states that use the federal exchange. That decision could potentially cut off financial assistance for more than 4.5 million people who were found eligible for subsidized insurance in the federal exchange, or marketplace.

A couple of hours later, the United States Court of Appeals for the Fourth Circuit, in Richmond, upheld the subsidies, saying that a rule issued by the Internal Revenue Service was “a permissible exercise of the agency’s discretion.”

For now, nothing changes, with the exception that there will be many more billable hours for the attorneys.

Bloomberg reports that regulators are ready to label Metlife a potential threat to the financial system, subjecting the insurer to oversight by the Federal Reserve. MetLife, the biggest US life insurer, could be subjected to stricter capital, leverage and liquidity requirements as a result of Fed supervision. A decision by the Financial Stability Oversight Council may come as early as July 31, and MetLife would have 30 days to request a hearing before the FSOC to contest the decision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now 4 years old, even though it isn’t really in effect; just 52% of the rules mandated under Dodd-Frank have been finalized by regulators; Another 23% have been proposed but they’re still working out details, and regulators haven’t even gotten around to 24% of the rules. A recent report by consumer watchdog Public Citizen called out the Securities and Exchange Commission as a particularly egregious delayer, noting that it had pushed back the deadlines for 13 of the 23 rules it was supposed to finalize this year.

City workers and retired city workers in Detroit have agreed to pension cuts to help bailout the city from bankruptcy. General retirees would get a 4.5% pension cut and lose annual inflation adjustments. They accepted the changes with 73% of ballots in favor. Support for the pension changes triggers an extraordinary $816 million bailout from the state of Michigan, foundations and the Detroit Institute of Arts. The money would prevent the sale of city-owned art and avoid deeper pension cuts.

Most people travel to or from Israel by air, and the major airport, really the only airport is Ben Gurion in Tel Aviv; last year, 14 million people went through Ben Gurion Airport, in a country with a population of 8 million.  Yesterday a rocket from Gaza landed about one mile from the airport; we don’t have further details on that rocket; it didn’t hit the airport; it was a mile away. When news spread, Delta diverted a flight to Paris. United airlines cancelled flights. The Federal Aviation Administration banned all US passenger and cargo flights to and from Tel Aviv for at least the next 24 hours. European airlines cancelled flight to Israel. The possibility of a passenger jet being shot down over a war zone is a very realistic and fresh memory.

US and United Nations diplomats are in Israel, trying to broker a ceasefire of some sort. Israel continues to pound targets across the Gaza Strip. It does not appear a ceasefire is near. If there is any light at the end of the tunnel, the tunnel will be destroyed.

The European Union today threatened Russia with harsher sanctions if Russia doesn’t cooperate in the investigation of the downing of the Malaysian flight 17 and if Russia doesn’t stop sending weapons to Russian backed separatists in Ukraine. But it was just a threat, and they’ll get together later in the week to draft proposals for sanctions.

Monday, July 21, 2014

Monday, July 21, 2014 - A Three Legged Stool

A Three Legged Stool
by Sinclair Noe

DOW – 48 = 17,051
SPX – 4 = 1973
NAS – 7 = 4424
10 YR YLD - .01 = 2.47%
OIL + 1.46 = 104.59
GOLD + 1.30 = 1313.20
SILV + .04 = 21.03

First leg:
Let’s start with earnings reporting season, which kicks into full gear this week with 140 of the S&P 500 companies posting results.

Netflix reported a profit of $71 million, or $1.15 a share, on revenue of $1.34 billion. This was in line with expectations, but for Netflix, an important component is how fast they are adding subscribers; turns out – pretty fast; 1.69 million new net streamers in the second quarter; 570,000 in the US and 1.12 million international subscribers; now topping 50 million worldwide.

Allergan, the Botox company, posted better than expected 2Q profits and sales but also announced it is cutting 1,500 jobs in a restructuring.  BB&T, the southeastern financial company, posted weak 2Q results as mortgage activity lagged; this has been a theme among banks for the second quarter, but the bigger banks have been compensating with profits in investment banking and trading; smaller, regional banks find it harder to compete in that arena. Chipotle Mexican Grill, theme park operator Six Flags, oilfield services company Halliburton, Manpower Group, and chip-maker Texas Instruments all reported better than expected results.

Tomorrow we’ll get the earnings report from McDonalds; after the close we’ll get earnings from Microsoft and Apple. Wednesday’s results include Facebook. Thursday we’ll hear from General Motors and Amazon.com.

So far, earnings season has been strong, of the S&P 500 companies that reported through the end of last week, earnings are up 7.6% from the same period last year on 4.2% higher revenues, with 65.9% beating EPS estimates and 68.2% coming out with better than expected revenue. This is better performance than we have seen at this stage in other recent reporting cycles. The +7.6% earnings growth at this stage in Q2 compares to an earnings decline of -3% for the same group of companies in Q1 On the revenue side, the +4.2% growth thus far compares to growth rates of +1.7% and +3% in Q1. The earnings and revenue beat ratios for these companies are similarly tracking better relative to Q1.

Second leg:
Israel and Hamas continue to battle in the Gaza Strip and Russian separatists continue to impede Malaysia Airlines Flight 17 investigation efforts. President Obama delivered a statement this morning on the geopolitical hotspots. Secretary of State John Kerry was dispatched to Cairo to discuss cease-fire negotiations with international officials. Though Obama cited Israel’s “right to defend itself” against Hamas missile strikes that now number in the thousands, he said he has instructed Kerry to prioritize de-escalation.

Obama said investigation efforts into what caused the crash of Malaysia Airlines Flight 17 have been impeded by pro-Russian separatists, who have assumed control of the crash site and have begun removing evidence. “Unfortunately, the Russian-backed separatists continue to block the investigation,” Obama said of the militants. “All of which begs the question, what exactly are they trying to hide?” Obama said responsibility lies with the Russian government, and Russian President Vladimir Putin, to convince the separatists to cooperate with an international investigation.

A train carrying the remains of most of the almost 300 victims of the Malaysia Airlines plane downed over Ukraine left the site on Monday, after the Malaysian Prime Minister reached a deal with the leader of pro-Russian separatists controlling the area. The aircraft's black boxes, which could hold information about the crash in rebel-held eastern Ukraine, will be given to the Malaysian authorities.

At the United Nations, the Security Council unanimously adopted a resolution demanding those responsible "be held to account and that all states cooperate fully with efforts to establish accountability". It also demanded that armed groups allow "safe, secure, full and unrestricted access" to the crash site. It will be difficult to use the forensic evidence at the site to determine exactly what happened, but it is becoming increasingly obvious the plane was shot down with Russian weaponry.

Clearly Putin did not want nearly 300 civilians to die, but it happened and it probably happened because of things he set in motion. If Russia is even loosely tied to the destruction of the passenger plane, even if it was an accident, the incident could represent another escalation of Russian aggression and mark a major turning point in how Russia is perceived around the world.

British Prime Minister David Cameron will urge other European leaders to consider imposing tougher sanctions Russian oil, gas, defense, and banking sectors at an EU meeting tomorrow. However, EU diplomats made clear today that sectoral sanctions would still be extremely difficult for some of Europe's poorer nations. They are especially nervous about the energy sector, central to the Russian economy, but also to the European Union.

EU nations rely on Russia for about 30% of their gas demand and have intertwined interests based on decades of energy reliance. Russia exports around $60 billion a year in gas and the Netherlands was Russia's biggest export destination last year, mostly oil and metals. Energy sanctions would most likely derail the fragile European recovery in general and might even lead to a complete economic collapse in certain member states. Many Eurozone countries see sanctions as collective economic suicide that helps no one. What they should see is that dependence on imported fossil fuels has made them economically weak and subservient. As long as the Eurozone relies on Russian gas to heat their homes in the winter, Putin can get away with murder.

Third leg:
Financial markets have been largely whistling past geopolitical hotspots, with just the occasional jittery pullback. The simple fact is that the Federal Reserve and all other global central banks have been providing the markets with unusually accommodative monetary policy; which is to say, the central banks have been throwing easy money at the markets. And there is growing concern that the continuation of this “unconventional” and “extraordinary” state of affairs involves an entirely new set of risks.

Clearly the Fed would like to do what it can to prevent bubbles from forming while they hold off on raising rates; it’s a delicate balancing act. If the Fed raises rates too soon, it risks a downturn in the economy, just as the Fed expects the economy is ready for liftoff. If the Fed continues with its easy money policies it risks the chance of bubbles; already Fed Chair Janet Yellen has acknowledged pockets of overvaluation. Last week, during Humphrey Hawkins testimony of Capitol Hill, Yellen singled out social media stocks and biotechs.

What does Yellen know about social media and biotech valuations? Probably not a great amount, but that doesn’t devalue her perspective; there may be some kind of asset bubble taking shape in at least some corners of the financial market. And don’t think Yellen just tossed out the overvaluation comment in a flippant or offhand manner. She is well aware of Alan Greenspan’s notorious remarks about “irrational exuberance”. This was a chance for Yellen to jawbone the markets. The very fact that she’s doing so means that she probably sees good reason for speaking out.

Yellen knows she is walking a very narrow line as she tries to guide monetary policy back toward some kind of “new normal” for the first time since the 2008 financial crisis. Yellen seemed to be saying that if small corners of the market over-inflate and pop, well tough luck; it won’t change the Fed’s path toward escape velocity. You might want to buckle your seat belts and get ready for a bumpy ride.

One reason for the overvaluation has been that the Fed has pumped up markets to such a point where it has been a bad trade to try to fight the Fed, and this has removed normal checks on overvaluation. Under normal market conditions, short sellers provide the right amount of pessimism to temper the optimism that leads to a wildly overvalued stock market. Short positions help keep companies with weak earnings potential and bad management from riding the bull market herd mentality to unjustifiably high share prices. But this market is far from normal. The stock market has climbed to fresh new highs, not today, but the Dow has hit record highs 15 times this year, even with geopolitical hotspots and negative first quarter GDP.

Short sellers are in retreat. It’s hard to fight the Fed and a bull market. The proportion of shares in short positions is at its lowest level since before the collapse of Lehman Brothers, with short interest on the S&P 500 index hovering around 2%.

Shorting a stock involves borrowing it from a broker at one price with the promise to return those shares after a certain period of time. The short seller will then sell the borrowed shares, and if the stock price goes down, they can buy them back, return them to the broker, and pocket the difference. When shorting, the risk is that the price goes up and you have to buy back the shares at a higher price. Shorting can be a good way to make big money fast. If a stock drops 50%, the short seller stands to make 100% on the trade; and when a stock starts to fall, it can fall fast.

Some traders like to look at the charts for short targets, and that is important; you never want to short a stock that is in a strong uptrend; you want to wait for it to turn over. You can also look at the fundamentals, and earnings season is a great time to look for really high price to earnings ratios, heavy debt burdens, downward guidance, or anything else that might raise a red flag. It’s good to remember shorting, especially if one of the three legs starts to wobble.

Friday, July 18, 2014

Friday, July 18, 2014 - The Fault Is Not In Our Stars

The Fault Is Not In Our Stars
by Sinclair Noe

DOW + 123 = 17,100
SPX + 20 = 1978
NAS + 68 = 4432
10 YR YLD + .01 = 2.48%
OIL - .31 – 102.88
GOLD – 7.30 = 1311.90
SILV - .27 = 20.99

President Obama today demanded Russia stop supporting separatists in eastern Ukraine, calling it “an outrage of unspeakable proportions.” Obama stopped short of directly blaming Russia for the incident but warned that he was prepared to tighten economic sanctions. He echoed international calls for a rapid and credible investigation. While the West has imposed sanctions on Russia over Ukraine, the United States has been more aggressive than the European Union. German Chancellor Angela Merkel said it was too early to decide on further sanctions before it was known exactly what had happened to the plane. Emotions are undoubtedly running high across Europe, but whether that translates into action remains to be seen.

Meanwhile, Israel says it could significantly widen a Gaza land offensive. The Israeli land advance followed 10 days of barrages against Gaza from air and sea, hundreds of rockets fired by Hamas into Israel and failed attempts to arrange a ceasefire or a truce.

How does all this play out? We don’t know. Yesterday was a terrible day, with Israel sending in ground troops to Gaza and somebody shooting down a Malaysian jetliner; it felt like an inflection point, like a moment when the narrative shifts, but for now we don’t know if that is true, or which way the winds blow.

Markets are funny; the financial markets were jittery; today, not so much. What changed? Not much. For the week, the Dow climbed 0.9 percent, the S&P 500 rose 0.5 percent and the Nasdaq gained 0.4 percent. So, volatility spiked yesterday; the VIX moved higher by 32%, but gave back 17% today. One day does not change a trend. War can change a trend, but we’re not at that point today, or maybe the markets are just ignoring reality. The market’s attention to geopolitical hotspots shifted to earnings. S&P 500 companies' profits are expected to grow 5 percent in the second quarter, according to Thomson Reuters data, down from the 8.4 percent growth forecast at the start of April. Revenue is seen up 3.2 percent.

Strong earnings from several companies kept the market in positive territory after it opened. Investors drove up shares in Google, Honeywell International, furniture company Knoll and Huntington Banchsares, among others. The Conference Board's latest index of leading indicators, designed to predict the economy's trajectory, climbed in June for the fifth consecutive month.

General Electric reported earnings today. Total revenue rose 3% to $36.2 billion, up from $35.1 billion in the year-earlier quarter. GE reported net income of $3.5 billion, a 13% increase from the year-earlier quarter. The company’s three largest industrial businesses: power and water, aviation, and oil and gas; all reported strong growth, ranging from 10% to 20%.The company also announced plans to have an initial public offer of its North American retail finance business by the end of this month; slowly but surely exiting the finance business and getting back to its industrial roots.

Beyond earnings season, Wall Street continues to be supported by Federal Reserve policy, and this week Fed Chair Janet Yellen went to Capitol Hill, and largely said it will be a while before the punchbowl is taken away. But eventually it will happen.  Since Fed chief Janet Yellen targets jobs above all else, this was bound to force capitulation by the Fed before long. It happened this week in her testimony to Congress when she said: "If the labor market continues to improve more quickly than anticipated, then increases in the federal funds rate likely would occur sooner and be more rapid than currently envisioned."

This is a policy shift. Yellen has admitted that the Fed misjudged the pace of jobs recovery. The staff did not expect unemployment to fall this low until late next year. The inflexion point has come 15 months early. Yellen added the usual caveats about "false dawns". Wages are barely rising. The jobs market is not yet drawing back the millions who dropped out of the system. The labor participation rate is still stuck at a 36-year low of 62.8%, and at the lowest ever recorded for men. Yellen said, "The recovery is not yet complete. We need to be careful to make sure the economy is on a solid trajectory before we consider raising interest rates."

You have to wonder if Yellen’s critics are making inroads. St. Louis Fed President James Bullard is concerned the Fed will overshoot on inflation. The Bank of International Settlements has warned about the Fed stoking asset bubbles.

You could make the case that Quantitative Easing has done its job, keeping growth alive as Congress and the White House pushed through draconian fiscal policy; the economy did not fall back into recession, not yet anyway. It just hasn’t been able to achieve escape velocity, or liftoff; but then that wasn’t really what QE was designed to do. It was designed to bail out the banks and avoid meltdown. The banksters are doing just fine. Time to try something new.

At some point the economy will have to stand on its own, and if it isn’t strong enough, you can bet the Fed will come up with a new idea to bail out the financial sector. When the Fed eventually takes away the punchbowl, it’s still unclear what effect it will have on the rest of the world. 

Tens of thousands of prisoners serving time for federal drug offenses will be eligible to seek early release beginning next year. The United States Sentencing Commission, which voted in April to reduce the penalties for most drug crimes, voted unanimously today to make that change retroactive. It will apply to nearly 50,000 federal inmates who are serving time under the old rules. The Sentencing Commission said the move would help ease prison overcrowding and reduce prison spending, which makes up about a third of the Justice Department’s budget. The change comes amid a bipartisan effort to roll back the harshest penalties set during the height of the drug war.

President Obama plans to sign an executive order on Monday barring discrimination against gay, lesbian, bisexual and transgender employees of companies that do federal government work. The order would also for the first time explicitly protect federal employees from discrimination on the basis of gender identity. The order will not include a religious exemption many faith organizations had requested.

Next week’s economic calendar includes a report on inflation, the CPI, on Tuesday. Also, a report from the Labor Department on real earnings. Nominal hourly wage growth has hovered around 2% for all of this recovery, a sign that labor markets are still weak. The National Association of Realtors will report existing-home sales Tuesday, and the Commerce Department will tally up new-home sales Thursday.  Next Friday’s durable goods orders will offer details on June capital-spending activity.

This weekend, Sunday July 20th at 1:18 PM (Pacific) to be precise, we’ll mark the 45th anniversary of the first man on the moon. Maybe you remember where you were back in 1969; maybe you weren’t even here in ’69, but it was a remarkable event to watch Neil Armstrong and Buzz Aldrin, and of course Michael Collins; something that humankind had dreamed about for thousands of years, and it actually happened. It seemed that anything was possible. Apollo 11 not only achieved its mission to perform a manned lunar landing and return safely to Earth, it raised the bar of human potential.

I wonder if we could do it today. Or anything equivalent? It seems unlikely. There is so much divisiveness in the country today, and for all the advances of the past 45 years, we are rife with problems. But then, I’m old enough to remember that 1969 was full of problems: the country was at war in Asia, and there was a Cold War as well, and there were deep problems at home including race riots and campus protests, the assassinations of Martin Luther King and Robert Kennedy were fresh in peoples’ hearts.

Maybe we don’t achieve our full potential when everything is set up for success, it is not when all the stars are in perfect alignment; maybe we outperform when our backs are to the wall. In 1962, JFK issued the challenge, saying, “We choose to go the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win, and the others, too."

For the past 45 years, we’ve heard the phrase, “Well, if we can put a man on the moon…” ” How many times have you heard that expression? If we can put a man on the moon, why can’t we cure cancer; or get our economy going? It’s a cliché now right? But it didn’t start out as a cliché. It started as a challenge. And 45 years ago, when I was much younger, I remember watching Neil Armstrong and Buzz Aldrin walk on the moon. I’m sure many people around the world share this same memory. President Nixon spoke to Neil Armstrong and his crew while they were on the moon and he said, "for one shining moment the people of the Earth are united as one." He was right. And I remember looking up at the moon that night, realizing humans were on the surface, and thinking anything is possible. This weekend I’ll look up at the moon again, and I still believe anything is possible – both success and failure. And if we don’t do those things that should be done, the fault is not in our stars, but in our selves.

Thursday, July 17, 2014

Thursday, July 17, 2914 - Unleash the Hounds of War

Unleash the Hounds of War
by Sinclair Noe

DOW – 161 = 16,976
SPX – 23 = 1958
NAS – 62 = 4363
10 YR YLD - .06 = 2.47
OIL + 2.55 = 103.75
GOLD + 18.40 = 1319.20
SILV + .37 = 21.26

A Malaysian Airlines passenger jet, Flight 17, a Boeing 777, has crashed near the Ukrainian-Russian border; all 295 passengers are dead. US intelligence officials say the jetliner was shot out of the sky by a surface to air missile; they could not confirm who fired on the plane but it is believed the missile was launched by separatists in Ukraine or by Russian forces positioned across the border from the crash site.

Yes, more than four months ago, another Malaysia Airlines plane, Flight 370 from Kuala Lumpur to Beijing, disappeared with 239 people on board, and that plane remains lost, despite ongoing searches in the Indian Ocean. Flight 17 is believed to have had 280 passengers and 15 crew. Early reports indicate the passengers included 55 Dutch, 23 Americans, and 9 Britons.

The crash today involved a flight from Amsterdam to Kuala Lampur, but the flight went down in the Donetsk region of eastern Ukraine where pro-Russian separatists have been fighting Ukrainian forces for several months. The separatists denied responsibility. The separatists were quoted by the Russian news agency Interfax as saying that they had found the “black box” flight recorder. Other Russian reports said the rebels planned to call a three-day cease-fire to allow for an investigation.

Aviation authorities knew this was a dangerous area prior to today’s crash. Three months ago, the FAA prohibited US airlines and US pilots from flying over parts of Ukraine. Today several airlines re-routed flights. Ukrainian military planes have been shot down in the conflict in eastern Ukraine, including earlier this week, but the crash Thursday was the first downing of a commercial airliner.

Ukraine’s recently elected president, Petro Poroshenko, called it an act of terrorism. Russian president Putin says Ukraine is responsible for the crash, apparently because they have not maintained peace in the area and have not been in control of their airspace. Shooting down a 777 at 33,000 feet would require fairly sophisticated military equipment.

Any sign or Ukrainian, Russian, or separatist involvement in the downing of a civilian airliner could lead to an escalation of tensions in the region. Already, there is a recording of an alleged phone conversation between a leader of the separatist movement in Donetsk and a Russian military intelligence officer, where the Russian officer says they have shot down a plane. No groups are claiming responsibility.

If it turns out that the separatists shot down the passenger jet, the incident almost certainly will become a tipping point in marking them as terrorists and not mere rebels. To the degree he continues to support them, Putin himself risks shifting to dangerous new diplomatic terrain and harsh new sanctions by a West united against him to a degree it has been at no time since the Cold War. He will be seen as backing an indefensible rogue element. This might convince doubters in the EU to move forward with tougher sanctions against Russia and it could lead to tougher US sanctions. Russia’s deniability of direct support for the rebels would be demolished, making Putin’s international position more difficult.

Just yesterday President Obama imposed a new round of sanctions against Russia, targeting some of the largest Russian companies in finance, energy, and the defense industries. The announcement reflected a decision by Obama to take more stringent steps than those taken by the United States’ European allies, which have far deeper economic ties to Russia. Meeting in Brussels, leaders of the European Union refused to match the American measures and instead adopted a more tempered plan that blocks new development loans to Russia and threatens to target more Russian individuals.

Washington imposed sanctions on Russia’s largest oil producer Rosneft, its second largest gas producer Novatek, its third largest bank Gazprombank, and also 8 arms manufacturers, and a few others. Yesterday, Moscow denounced the sanctions as primitive revenge for events in Ukraine and pledged to retaliate. Also yesterday, Ukraine officials accused Russian forces of shooting down a Ukrainian military jet in the Donetsk region. Obama said Wednesday that the new sanctions were largely aimed at punishing Russia for not preventing the flow of weapons into Ukraine to supply pro-Russia rebels seeking independence from Ukraine.

At this point, nobody really knows who did what and for what reason. Civilian planes have been shot down by various militaries in the past and it did not necessarily result in war, however, the conflict in Ukraine has just escalated significantly.

Meanwhile, Israel moved ground troops into Gaza today. The ground offensive includes heavy artillery and naval shelling and helicopter fire and tanks. For the past 10 days Gaza militants and Israel have been firing rockets at each other. The Gaza militants have reportedly fired more than 1,300 rockets into Israel, but Israel has a high tech defense system called the Iron Dome, and so the bombing has only resulted in one Israeli death. The Israeli rocket attack on Gaza has been much more precise, even to the point where the Israelis would phone ahead and tell civilians they had a minute or so to vacate a building before a bombing. Palestinian health officials say more than 230 Palestinians have been killed in Israeli air and naval strikes.

Before dawn on Thursday, about a dozen Palestinian fighters tunneled under the border, emerging near an Israeli community. At least one was killed when Israeli aircraft bombed the group. The United Nations said Thursday that it had discovered 20 rockets hidden in a vacant school in Gaza during a regular inspection on Wednesday. Earlier on Thursday, Palestinian, Egyptian, Israeli and American officials said intense discussions were underway on terms for a cease-fire. Israel had accepted an Egyptian proposal for a cease-fire that was rejected by Hamas, which continued to fire rockets at Israel.

Palestinian residents and journalists in Gaza reported heavy artillery fire from ground troops in the north and from Israeli naval gunboats stationed near Gaza’s port, as well as a continuing air assault. Residents in the northern Gaza Strip said tanks were moving in. The Israeli strikes hit a range of targets, including a rehabilitation hospital and earlier killed four young children as they played on a roof in eastern Gaza City. At the same time, scores of rockets from Gaza continued to stream into cities all over central and southern Israel.

On Wall Street, the geopolitical problems made folks jittery. The VIX was up 3.54 to 14.54, which represents a 32% increase. We saw oil and bonds and gold jump higher in what looks  like a safe haven move.

It is still earnings season, and let’s touch on a few of the big reports today. Google reported a second-quarter profit of $3.4 billion, or $4.99 a share, compared with a profit of $3.2 billion, or $4.77 a share, for the year-earlier period. Revenue was $12.6 billion, up from $11.1 billion in the year-earlier period. Google missed expectations on earnings but beat revenue projections. Shares were down in after-hours trade.

Just the opposite for Big Blue; IBM said its second-quarter earnings climbed 28%, helped by its restructuring moves, while IBM reported its ninth consecutive quarter of lower revenue.

As expected, Microsoft announce massive layoffs today, what was unexpected was just how massive, 18,000 jobs will be cut, 15% of the workforce; 12,500 coming from newly acquired Nokia. Just after Microsoft bought Nokia, Nokia started making Android-based phones. This was a surprise since Microsoft makes its own mobile operating system — Windows Phone. The new Microsoft CEO Satya Nadella had no desire to continue with Android. He wants Microsoft's operating system to be the company's only mobile operating system.

A threatened strike on New York's Long Island Rail Road was averted on Thursday when the transit authority and labor unions reached a tentative contract deal.

Truckers will be back on the job Monday at the ports of Los Angeles and Long Beach, ending a five-day strike that disrupted cargo flow. The truckers voted to end their work stoppage against three companies late Friday after the firms promised no retaliation. The truckers say they have been unfairly classified as independent contractors rather than employees, allowing the companies to avoid labor laws and charge the drivers for fuel, maintenance and other fees. The drivers walked off the job last Monday in the fourth such protest this year and dockworkers refused to cross the picket lines.

Coincident to the plane crash and the story of Russian sanctions, Bloomberg Businessweek reports today on a nearly 4 year old story dealing with a different type of attack by Russia.  Reportedly, the Russians hacked into the Nasdaq in October 2010. And this was not just some silly hackers putting a virus on your computer, this was an attack on the code of a major financial institution, a digitized weapon, orchestrated by the Russian government.

It isn’t the first time a country has launched a cyber-attack against another country. The US was probably the first, with deployment of the Stuxnet worm, which switched off the safety mechanisms at Iran’s uranium processing facility in 2010. The October alert prompted the involvement of the National Security Agency, and just into 2011, the NSA concluded there was a significant danger.

While the Nasdaq hack was successfully disrupted, it revealed how vulnerable financial exchanges are to digital assault; as well as banks, chemical refineries, water plants, and electric utilities. One official who experienced the event firsthand says he thought the attack would change everything, that it would force the US to get serious about preparing for a new era of conflict by computer. He was wrong.

In fact the investigation revealed that Nasdaq networks had been infected for quite some time, by a variety of sources. The rules of cyberwarfare are still being written, and it may be that the deployment of attack code is an act of war as destructive as the disabling of any real infrastructure. Just think of the possibilities if the Nasdaq were to really crash, completely and totally, and if everything run through the exchange was deleted.

Wednesday, July 16, 2014

Wednesday, July 16, 2014 - The Color of the Day is Beige

The Color of the Day is Beige
by Sinclair Noe

DOW + 77 = 17,138
SPX + 8 = 1981
NAS + 9 = 4425
10 YR YLD - .01 = 2.53%
OIL + 1.38 = 101.34
GOLD + 6.20 = 1300.80
SILV + .07 = 20.89

A record high close for the Dow; the 15th record high close of the year for the Dow. The S&P 500 did not take out the old high from July 3rd. We have a few economic reports to cover, plus Fed Chair Yellen continued testimony on Capitol Hill, and lots more.

Industrial production increased 0.2% in June to 103.9. This is 24.1% above the recession low, and 3.1% above the pre-recession peak. For the second quarter, industrial production advanced at an annual rate of 5.5%; so the quarter was good but the month of June was less than expected.

The Commerce Department reports producer prices increased by a seasonally adjusted 0.4% last month, above forecasts for a 0.2% gain, after falling 0.2% in May. Year-over-year, the producer price index rose at an annualized rate of 1.9% in June. The core rate, stripping out food and energy prices, was up 0.2%.

This afternoon, the Federal Reserve released its Beige Book, a collection of reports from the 12 Fed districts. The general consensus is that economic growth was moderate to modest. Most Districts were optimistic about the outlook for growth. Consumer spending increased in every district. Retail sales grew modestly in most districts. Auto sales, which have been on the upswing for more than a year, continued to stand out as particularly brisk support for the economy, but broader retail sales were more subdued. Labor market conditions continue to improve with all districts reporting slight to moderate employment growth. Several districts reported "some difficulty" finding staff for skilled positions, however there doesn’t seem to be any pressure on wages. Here’s a hint, if you can’t find skilled workers, try offering higher wages. The report gave a mixed appraisal of the US housing market. Conditions "varied" across the country, with some regions suffering from weak demand.

Fed Chair Janet Yellen returned to Capitol Hill to deliver her second day of Humphrey Hawkins testimony. The prepared remarks were the same as yesterday, then they open up for a Q&A. Some of the key points from today’s hearing:

Yellen said she is optimistic about the economy, “We had a very surprising negative growth in the first quarter, which is a number that in a way doesn't seem consistent with the underlining momentum in the economy and many indicators of spending and production. And I do think the economy is recovering and that growth is picking up and that we have sufficient growth to support continued improvement in the labor market."

Yellen said threats to financial stability are moderate “and not a very high level.” She again weighed in on valuations, saying: "Some things may be on the high side and there may be some pockets where we see valuations becoming very stretched but not generally. The use of leverage is not broad-based, it hasn't increased, and credit growth is not at alarming levels by any means."

Yellen did not single out specific sectors today. Yesterday she said biotech and social media looked a bit over-valued. That had some talking heads complaining; the funniest rant came from Jim Cramer, who said: “Next time, Fed Chief Yellen, it might pay to point out that there are plenty of cheap stocks out there, too. At least that way you can help us make money, not just lose it.” Maybe someone can tell Cramer the Fed is not in business to help him make stock picks, no matter how much help he needs. The Fed has been incredibly accommodative to Wall Street, and Cramer still complains. The Fed doesn’t issue a price target on Twitter. But if you read between the lines, Yellen was likely saying that there are no plans to raise the margin requirements on brokers.

There were some questions about a bill in the House that would require the Fed to follow a mathematical rule for when to raise or lower interest rates. Yellen didn’t like that idea; she said there is no magic formula for raising rates. Yellen again expressed confidence the Fed can exit when the time comes. The Fed has a variety of tools it can use to raise interest rates. In the distant future, the Fed’s balance sheet will shrink in size.

The best line from the Fed did not come from Yellen; Dallas Fed President Richard Fisher was speaking today at the University of Southern California. Fisher said ending asset purchases this fall isn’t enough; the Fed should start to taper the reinvestment of maturing securities in October. Fisher said: "Monetary policy is a bit like duck hunting. If you want to bag a mallard, you don't aim where the bird is at present, you aim ahead of its flight pattern. To me, the flight pattern of the economy is clearly toward increasing employment and inflation that will sooner than expected pierce through the tolerance level of 2%."

Meanwhile, it’s earnings reporting season. Bank of America said profit declined 43% as it spent $4 billion to cover litigation costs, including a mortgage settlement with AIG. There seems to be a trend developing in banks’ earnings reports; they are making money on investment banking and some other areas, but results are weak for mortgage originations, and they are setting aside big chunks of earnings to pay for legal settlements.

Bank of America and the Department of Justice are reportedly negotiating a mortgage securities settlement, which could cost the bank around $13 billion.

Intel was up more than 9% after a very strong earnings report after the close yesterday. Yahoo fell today following weaker than expected earnings. EBay posted lower than expected 2Q results and even though sales were up this month, EBay cut its outlook for the third quarter.

Merger and acquisition activity has been wild lately. Today’s M&A stories revolved around Rupert Murdoch’s plan to buy Time Warner for $85 a share, or about $75 billion. Time Warner says it isn’t interested in exploring a sale, but if they sell, there are other potential suitors. General Electric is in talks to sell its household appliances business; that’s a part of the company that’s been around since 1905, when they invented the electric toaster. Yesterday, the number 2 tobacco company, Reynolds American agreed to buy the number 3 tobacco company, Lorillard for $25 billion.

One of the motivating factors behind mergers lately has been something called inversion, basically merging with an overseas company to avoid corporate taxes in the US. Members of the House and Senate have made proposals to curb the inversion trend in recent months, and the president included a provision in the budget he presented to Congress this year that would have effectively banned the move. But none of these efforts have yet gained traction. Today, Treasury Secretary Jack Lew called on Congress to enact legislation to halt inversion, effective immediately and retroactive to May.  Making any new legislation retroactive through May could disrupt several megadeals that have already been struck, such as the Medtronics deal.

Global M&A volume in the first half was the highest since 2007. One of the side effects of the M&A frenzy back in 2007-2008 was the frenzy of pink slips that followed. Deals are sold to investors on the basis of “creating value” with terms like “efficiencies” and “synergies”; code words for cost cutting and mass-layoffs. Acquisitions, layoffs, and cost-cutting are the simplest things to do for a CEO, as opposed to inventing things and boosting sales organically, which is hard. Analysts love M&A, investors too, and of course the investment bankers promote it as the best thing since sliced bread, or maybe electric toasters.

Last year, Microsoft acquired Nokia’s mobile phone business and promised $600 million in cost saving and efficiencies and synergies. Now, Microsoft employees are bracing for up to 12,000 layoffs, the biggest ever for Microsoft. The layoff news will come before the company holds its post-earnings conference call after the market closes July 22.

Leaders of the five BRICS nations agreed on the structure of a $50 billion development bank by granting China its headquarters and India its first rotating presidency. The leaders also formalized the creation of a $100 billion currency exchange reserve, which member states can tap in case of balance of payment crises. Both initiatives, which require legislative approval, are designed to provide an alternative to financing from the International Monetary Fund and the World Bank, where BRICS countries have been seeking more say.

Tuesday, July 15, 2014

Tuesday, July 15, 2014 - The Path We're On

The Path We’re On
by Sinclair Noe

DOW + 5 = 17,060
SPX – 3 = 1973
NAS – 24 = 4416
10 YR YLD + .01 = 2.54%
OIL - .74 = 100.17
GOLD – 13.20 = 1294.60
SILV - .19 = 20.82

We’ll start with a couple of quick economic reports.

The Commerce Department reports retail sales increased 0.2% in June. The sales figures from May were revised from a 0.3% increase to a 0.5% increase. The increase in June was below consensus expectations of a 0.6% increase; however sales in April and May were revised higher, so it all levels out and was fairly strong report. Sales were up 4.3% year to year.

The Empire State Manufacturing Survey for July was up 6 points to 25.6, a four year high.

The state of California released its monthly cash report for June; the state’s General Fund ended the fiscal year with a positive cash balance for the first time since 2007, so the state won’t have to borrow to meet all of its payment obligations.

Federal Reserve chairwoman Janet Yellen delivered her semiannual Humphrey Hawkins testimony before the Senate Banking Committee today. Tomorrow, Yellen will repeat the process with the House. Yellen said progress has been made to restore the economy to health and strengthen the financial system, yet too many Americans remain unemployed and inflation remains below targets and there hasn’t been enough financial reform.

After prepared remarks, Yellen fielded questions from the senators, and this is where it gets a little interesting. Yellen said, “equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched.” Some folks felt this was an “irrational exuberance” moment for Yellen. Social media and biotech stocks declined immediately after her comments. Yellen has a good reputation on forecasting. Back in 2006, when she was president of the San Francisco Fed, she gave a speech pushing back against former Fed Chair Alan Greenspan’s claim, with respect to the housing crisis, that the “worst of this may well be over.” Greenspan was wrong, Yellen was right, or at least not as bad as Greenspan.

Yellen said the Fed is still concerned about the housing market: “While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year’s increase in mortgage rates, and readings this year have, overall, continued to be disappointing.”

The housing market slowed last year when mortgage rates spiked on the possibility of taper. Yellen said that while the rise in rates is “the most obvious explanation for the weakness in the housing market over the past year,” it “seems unlikely that interest rates are the whole story.”

Yellen says the Fed is keeping a close watch on what it sees as potentially excessive risk-taking in the market for leveraged loans, but downplayed the possibility that its policies of ultra-low interest rates could be fueling asset bubbles. Still, there are some areas of financial markets, such as lower rated corporate debt, that are showing looser underwriting standards. Yellen and her Fed colleagues seem generally unfazed by concerns of bubbles and she said in testimony that the prices of real estate, stocks and corporate bonds “remain generally in line with historical norms.”

Yellen said most officials expect rates to start rising in 2015 and to finish the year around 1%. “That gives you a feeling for what participants thought would be appropriate given their projections in June,” she said. “What will actually happen clearly is going to depend on the progress the economy makes.”

Yellen seems pleased with the trajectory of the economy; investors seem complacent. She reiterated the Fed’s view that the economy will continue to grow at a moderate pace, and that the Fed is in no hurry to start increasing short-term interest rates.

All in all, Yellen’s testimony didn’t reveal much new. The Fed has been telegraphing this information for some time. The idea is that they can float information, and if the trial balloon gets shot down, they aren’t stuck in actual policy; if the trial balloon is accepted they can slowly implement the policy. It’s called forward guidance, and it seems to be working. The problem with forward guidance is that the Fed doesn’t know the future, and so they keep the guidance a little on the vague side, and then everybody fills in the blanks based upon their own particular bias.

It is earnings season and a couple of the big banks posted today.

JPMorgan reported a profit of $6 billion, or $1.46 a share, down from $6.5 billion, or $1.60 a share, a year earlier. Goldman Sachs posted net income of $2.04 billion, compared with year-earlier net income of $1.93 billion. Both banks saw share prices move higher after the reports.

These earnings came during a quarter in which fixed-income trading and mortgage refinancing were weak; so in that regard, the banks performed well. More likely the banks managed earnings expectations.

Johnson & Johnson reported higher-than-expected quarterly results on strong sales of its new hepatitis C drug. J&J said it had earned $4.33 billion, or $1.51 per share, in the second quarter. That compared with $3.83 billion, or $1.33 per share, a year earlier. They also raised guidance for the full year.

Intel posted better than expected Q2 revenue and profit; then they raised their Q3 revenue forecast well ahead of expectations; then they announced they would increase their share repurchase program. Intel posted a profit of $2.8 billion, or 55 cents a share, from a year-earlier profit of $2 billion, or 39 cents a share. Gross margin widened to 64.5%, compared with 59.6% in the first quarter. Intel still makes most of its profits from chips for computers; they’re still trying to get into the mobile market, but this past quarter they made more than a half billion in profits making chips for the internet of things, which is basically the idea that all of our mundane possessions will eventually be connected devices.

A study by the International Data Corporation calculates the internet of things market will grow to $7.1 trillion in the next 5 years. More than 1.9 billion once-inert devices are already connected to the internet, from parking meters to home thermostats, and by 2018 that number will top 9 billion.

The Federal Communications Commission website has crashed. Today is the last day to submit comments on the FCC’s proposal to regulate the internet. The proposal at issue would allow internet providers to charge content companies for more direct connections to their customers. These so-called “fast lanes” have sparked a vehement reaction from internet activists, who claim that the new policy could turn the web into a plutocracy where companies that are willing to shell out cash receive premium treatment. As of last week, the FCC had received almost 650,000 comments, mostly in favor of net neutrality; which is another way of saying no toll booths on the information superhighway.

Real highways are another matter. This afternoon the US House approved an $11 billion plan to replenish the federal fund for highway and mass transportation projects, but just through next May. Passage of the bill only puts off a larger debate over raising taxes to pay for long-term infrastructure financing. This was a stop-gap measure, as federal funds were 2 weeks from drying up which would have resulted in work stoppages during the peak of the summer roadwork season.

The Department of Transportation has said that without an agreement in Congress, federal payments to states will begin to slow by the end of the month. Also, the existing two-year law authorizing about $50 billion in highway and transit funding annually expires on Sept. 30; and with it the ability of the government to levy the 18.4-cent-per-gallon gas tax that finances the work.

Longer term plans have been dragged down by disagreements on how to fund projects. The short-term proposal signed today, raises money through an accounting gimmick called pension smoothing, which allows for a delay in the payments that corporations make to their pension funds resulting in a higher corporate tax bill. It’s a temporary, inadequate response to a long-term problem, better than nothing, even if it doesn’t do what it needs to do; which seems to describe everything in Congress these days.

The road ahead may be full of potholes, but on the road of life, most people think the ride will be smooth. A new survey conducted by the National Council on Aging, Untied Healthcare and USA Today finds that older adults are pretty optimistic; 89% say they’re confident they can maintain a higher quality of life through their senior years. On the financial front, 45% of the older group surveyed said they wished they had saved more money; almost one-third (31%) said they wished they had made better investments. The new survey finds more financial optimism than last year, but still almost half (49%) of the 60-and-older respondents say they're concerned that their savings and income will be sufficient to last the rest of their lives. In 2013, 53% expressed that concern.

So what is behind the optimism? The reasons vary, but support of family and friends is at the top, followed by being happy about their living situation, and being in good health.

There seems to be something to the good health part of the optimism equation. The medical journal JAMA released a study today showing people are having fewer strokes and dying less often in the wake of strokes. It’s still a big problem, striking 800,000 people a year and killing 130,000, but the numbers are down.

Another study released this week says better heart health and more education means the onset of Alzheimer’s begins later in life now than 30 years ago in developed nations. One trial in Finland suggested the body can be conditioned to hold off mental decline with gym exercising, good food choices and cognitive training.

It is good to have an end to journey towards, but it is the journey that matters in the end.

Monday, July 14, 2014

Monday, July 14, 2014 - Clearing Up Outstanding Issues

Clearing Up Outstanding Issues
by Sinclair Noe

DOW + 111 = 17,055
SPX + 9 = 1977
NAS + 24 = 4440
10 YR YLD + .03 = 2.55%
OIL + .22 = 101.05
GOLD – 32 = 1307.80
SILV - .54 = 21.00

The Dow Industrial Average hit an intraday high of 17,088, but couldn’t close above the old closing high of 17,074 from July 2.

I woke up this morning and checked the Euro markets; the headline read: Global Stocks mostly higher as Portuguese debt concerns ease. Banco Espirito Santo’s parent company sold part of its stake in the bank to pay off short-term debt, so everything is cool. Portuguese bond prices popped. Nothing to see here. Move along, move along.

Just to refresh your memory, Banco Espirito Santo is 25% owned by Espirito Financial Group, which is in turn 49% owned by Espirito Santos Irmaoes, which in turn is wholly owned by Rioforte investments, which in turn is wholly owned by Espirito Santo international. What’s the point of owning a bank if you can’t make loans to yourself; and that’s what happened, until last week, when Espirito Santo International, the parent company failed to make a payment on short-term debt. The collective companies under the Espirito Santo umbrella have borrowed several billion from the bank, and then the bank made about 8 billion euros in loans to Angola, and that has a non-performance rate approaching 90%. And I know you’re wondering why you should be concerned about loans to Angola, and it’s because everything in finance is leveraged. No loan lives in isolation.

Panic ensued. The fear was that creditors and/or depositors might be on the hook in the event of a shortfall; no one could be certain because of a lack of transparency. But the bank says they have a cushion; the parent company sold a few assets to come current on the loan. Hopefully, I’ve cleared up the transparency issue. Regulators say there’s nothing to worry about and they should know because they didn’t see this coming in the first place, and so there’s nothing to worry about; the situation in Portugal is contained, and global stocks moved higher.

Here in the US, we know a thing or two about banks behaving badly. Today, as expected, Citgroup agreed to pay $7 billion to settle civil claims the bank misled investors about toxic mortgage backed securities leading up to the 2008 crash. Citigroup admitted it was aware that "significant percentages" of sample loans did not comply with underwriting guidelines but the bank pooled them into securities anyway. In one 2007 deal, a Citigroup trader told colleagues in an email he had reviewed a due diligence report on the poorest quality loans, and that they "should start praying." Many of the loans listed unreasonable borrower incomes or home values below the original appraisals, the trader wrote, saying he "would not be surprised if half of these loans went down." Citigroup still securitized loans from the pool. Quite simply, they knew the mortgage backed securities were full of bad loans, they lied about it to make the sale.

Under the agreement, Citi will pay $4.5 billion in cash and provide $2.5 billion in aid to low-income tenants and struggling homeowners; details of terms of the help and how many will benefit are not yet known, but there’s no indication people they will go back to help make people whole. Some homeowners with Citi mortgages could see the amount of their loans reduced, or could have their interest rates reduced. There will also be down payment and closing cost assistance to future homebuyers. But none of that starts until 2018. I don’t know why.

Last year Citi settled with the FHFA for $250 million. The regulator of Fannie Mae and Freddie Mac had sued the bank over soured mortgage securities sold to the taxpayer-owned entities. The cash portion consists of a record $4 billion civil payment to the Justice Department, double JPMorgan’s penalty in November, and $500 million to resolve claims from five state attorneys general and the Federal Deposit Insurance Corp.

And there is a little gift for Citi; the state AG and FDIC payments would be deductible, along with any costs Citigroup actually incurs in relation to consumer relief, which could be less than the $2.5 billion amount of relief in the settlement.

As part of the settlement, Citigroup “will take a charge of approximately $3.8 billion pre-tax in the second quarter of 2014." Second-quarter earnings results were also posted this morning, and if you exclude the multi-billion dollar settlement, Citi beat expectations. The settlement wipes out the quarter’s earnings, but if you look the other way, it was a kick ass quarter for earnings. Citigroup exceeded Wall Street expectations in the second quarter with adjusted earnings of $1.24 a share. On that basis, analysts had been expecting Citigroup would earn $1.05 a share. Citi posted a 15% drop in trading revenue. Investment banking revenue rose 16% from a year ago. Mortgage originations were down.

This is a civil settlement, not a criminal settlement. Attorney General Eric Holder at a press conference said: “Citi settlement doesn’t absolve bank, employees from criminal charges.” Of course nobody expects the Department of Justice to pursue criminal charges. Citi is also under investigation for possible fraud and money laundering in its Mexican unit. And if you look at all the wrongdoing, you might come to the conclusion that this is just a corrupt organization.

If you’re wondering where the next subprime meltdown will occur, well you can pick from a wide selection of possibilities. Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give. Debt ratios in the developed economies have risen by 20 percentage points to 275% of GDP, since the Lehman crisis. Credit spreads have fallen to wafer-thin levels. Companies are borrowing heavily to buy back their own shares, and 40% of syndicated loans are to sub-investment grade borrowers, a higher ratio than in 2007, with fewer protections from loss.

The Bank of International Settlements, the central bank for the central bankers of the world, warned it is annual report two weeks ago that equity markets had become "euphoric". Volatility has dropped to an historic low. European equities have risen 15% in a year despite near zero growth and a 3% fall in expected earnings. The cyclically-adjusted price earnings ratio of the S&P 500 index in the US reached 25 in May, six points above its half-century average. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.

Some of you might pick the student loan market, with over $1 trillion in outstanding loans and growing. The deeply indebted college graduate has become a stock character in the national conversation: the art history major with $50,000 in debt, the underemployed barista with $75,000, the struggling poet with $100,000. That’s not really typical of student loan debt. Only 7 percent of young-adult households with education debt have $50,000 or more of it. By contrast, 58 percent of such households have less than $10,000 in debt, and an additional 18 percent have between $10,000 and $20,000.

That’s not to say student loan debt is not a concern, it is, and it is growing. In 2010, 36 percent of households with people between the ages of 20 and 40 had education debt, up from 14 percent in 1989. The median amount of debt, among those with debt, more than doubled, to $8,500 from $3,517, after adjusting for inflation. Student loan debt is a problem, but it isn’t a new problem, it’s just a trillion dollar problem now, but it hasn’t imploded in the past 2 decades and there doesn’t seem to be an immediate catalyst.

How about a bubble in energy? Ambrose Evans- Pritchard writes: Data from Bank of America show that oil and gas investment in the US has soared to $200 billion a year. It has reached 20% of total US private fixed investment, the same share as home building. This has never happened before in US history, even during the Second World War when oil production was a strategic imperative.

The International Energy Agency (IEA) says global investment in fossil fuel supply doubled in real terms to $900 billion from 2000 to 2008 as the boom gathered pace. It has since stabilized at a very high plateau, near $950 billion last year. Output from conventional fields peaked in 2005. Not a single large project has come on stream at a break-even cost below $80 a barrel for almost three years….

There are, of course, other candidates for the bubble prize of the current economic cycle, now into its 22nd quarter and facing the headwinds of US monetary tightening. China’s housing boom has echoes of the Tokyo blow-off in 1989, and is four times more stretched than US subprime in 2006, based on price-to-income…Emerging markets have racked up $2 trillion in foreign currency debt since 2008. They are a much larger animal than they were during the East Asia crisis of the late 1990s, so any crisis would do more damage.

Yet the sheer scale of “stranded assets” and potential write-offs in the fossil industry raises eyebrows. IHS Global Insight said the average return on oil and gas exploration in North America has fallen to 8.6%, lower than in 2001 when oil was trading at $27 a barrel. What happens if oil falls back towards $80 as Libya ends force majeure at its oil hubs and Iran rejoins the world economy?

And that’s before we get to another threat to fossil fuel investments that Evans-Pritchard mentions: that governments might get serious about climate change and impose meaningful restrictions, like hefty carbon taxes. Right now, that seems like a tail risk, but the crisis just past was a tail event as well. And much higher energy prices resulting from restriction on fossil fuel production would slow down economic activity markedly, which again could blow back to leveraged investors in unexpected ways.