Tuesday, March 26, 2013 - Miles to Go

Miles to Go

by Sinclair Noe

DOW + 111 = 14,559
SPX + 12 = 1563
NAS + 17 = 3252

10 YR YLD - .01 = 1.91
OIL + 1.40 = 96.21
GOLD – 5.90 = 1600.50
SILV - .09 = 28.86

The Dow Industrial hit a record hit close today, taking out the March 14 closing high. The S&P 500 came within a couple of points of the high close; it is having a hard time breaking through the ceiling; you just have to content yourself with the idea that the index has more than doubled from the lows of March 2009.

The Chicago Board Options Exchange Volatility Index, which measures the cost of using options as insurance against declines, fell 7.1 percent to 12.77. The gauge has tumbled 29 percent for the year. It is a reflection of complacency.

We have many things to cover today.

Home prices were up in January and the year over year improvement in prices was the fastest in 6 years. The S&P Case Shiller Index of existing home sales was up 0.1% in January, and the year over year gains were 8.1%. On a year-over-year basis, all 20 cities measured by the Case-Shiller index improved, led by a 23.2% surge in Phoenix, with New York bringing up the rear with a 0.6% advance.

Sales of new U.S. homes fell 4.6% in February to mark the biggest drop in two years, though poor weather likely played a big role. Sales slowed to an annual rate of 411,000, down from a revised 431,000.

The consumer confidence index dropped to 59.7 in March, down from 68.0 in February. Most of the drop came from a decline in the expectations index, which slumped to 60.9 from 72.4, though the present situation index also fell, to 57.9 from 61.4. Consumer fears about the sequester are believed to have hurt the confidence numbers. We have nothing to fear but fear itself. It still holds true.

Orders for long-lasting goods surged in February largely because of gains in the volatile aircraft and defense segments, but demand was mixed for other manufacturers. Durable-goods orders climbed 5.7% last month to a seasonally adjusted $232.1 billion after a revised 3.8% drop in January. Orders outside of transportation fell 0.5% to mark the first decline in six months.

There has been a great deal of attention focused on the Dow Industrial Average back to new record highs; less attention on the Dow Transportation Average. The Transports include railroad companies. Shale-energy production exceeds pipeline capacity, and this will continue to be the case for many years ahead. Eventually, new pipelines will be built, but it takes time, and the production of shale oil is just getting started, and it's unlikely that the new pipelines will be enough. Railroad systems are already in place. Energy companies have invested over $1 billion dollars in new rail terminals near the shale operations. They have also put 20,000 new tank cars in service, which is an investment in the billions of dollars

There had been plans to reopen the banks in Cyprus today. Not gonna happen. Maybe Thursday. And when the banks open, there will be capital controls in place, meaning there will be restrictions on withdrawals. Larger depositors could see 40% confiscations. And that is just to raise the money for Cyprus to earn the dubious right to a bailout; the terms of which will likely drive the economy into a depression. Yes, there are protests in the streets of Nicosia.

A state-appointed emergency manager has taken control of the Detroit city government and started a drastic restructuring of its finances and operations. The first order of business was to extend an olive branch to the city government. The manager, Kevin Orr made clear that he alone would be responsible for decisions on how to stem the city’s mounting cash shortfall and reduce an estimated $14 billion in long-term liabilities.

“The statute spells out some pretty clear powers,” he said, referring to the state emergency-manager law that allows him to sell city assets, renegotiate labor contracts and possibly recommend a bankruptcy filing.

There were protests in Detroit, just a few dozen.

Another day, another mind-blowing fact about the staggering difference between the haves and the have-nots. Incomes for the bottom 90 percent of Americans only grew by $59 on average between 1966 and 2011 (when you adjust those incomes for inflation), according to an analysis by Pulitzer Prize-winning journalist David Cay Johnston for Tax Analysts. During the same period, the average income for the top 10 percent of Americans rose by $116,071.

The Federal Reserve has cited Citigroup for failure to comply with federal law requiring banks to establish protections against money-laundering. They did not impose a fine. The Fed's action follows up on a similar order issued against Citigroup last year by two other bank regulators, the Office of the Comptroller of the Currency and the FDIC, which cited it for "deficiencies" in its compliance with the Bank Secrecy Act. The Fed said that Citigroup lacked effective systems of governance with respect to its Bank Secrecy Act and anti-money-laundering compliance programs. Citigroup has 60 days to submit a plan explaining steps the bank has taken to boost its compliance efforts. Some day, some day.

As it did before the financial crisis, Wall Street is bankrolling academics to bolster its case against regulation. Back then, the research gave warm tongue-baths to the virtues of derivatives. This time, the beneficiary is high-speed trading.

A highly publicized research paper from Columbia University claiming that high-frequency trading benefits society and shouldn't be regulated too much was paid for by -- surprise -- a high-speed trading firm.

Unlike most academic papers, this one, by Columbia Business School economics professor, was announced to the world last week and turned into an op-ed headlined "The Reality Of High Frequency Trading."

The argument is that high-speed trading bolsters that magical market stuff known as "liquidity," pushing stock prices higher and making companies richer and more willing to spend money, making us all wealthier. None of that has actually happened yet, of course, with markets and the economy flat since the advent of high-speed trading a decade or so ago. Never mind all that, though: Regulate high-speed trading too much and the liquidity could go away; so says the new research paid for by high speed traders. And bad things happen when the liquidity goes away.

A derivative is a financial product derived from another financial product” (for example, a futures contract tied to a stock index) — in practice, the term applies to a whole world of financial products that are written on a one-off basis between two entities called “counterparties,” as opposed to products that are traded on a broad, well-regulated market. Futures contracts are gambling — I can bet on the Dow to go down or up, for example — but trading in futures contracts is regulated gambling, in which winners are protected from losers, and in many cases, losers protected from themselves.

Not so, derivatives, in the usual meaning of the word. Derivatives in that sense are contracts between parties who want to trade risks, but they aren’t market-traded. They aren’t standardized. And counterparties aren’t vetted by any controlling institution.

It is now estimated that derivatives market has been growing. One of the biggest risks to the world’s financial health is the $1.2 quadrillion derivatives market. It’s complex, it’s unregulated, and it ought to be of concern to world leaders that its notional value is 20 times the size of the world economy. But traders rule the roost — and as much as risk managers and regulators might want to limit that risk, they lack the power or knowledge to do so. A quadrillion is a big number: 1,000 times a trillion.

That refers to the notional value. For example, if I bet on a basketball game, say $24 on the Lakers and $26 on the Clippers, I don't really have $50 of risk, just $2 dollars at risk, or $2 notional value. But the derivatives market is so big that the notional value is now $12 trillion, give or take; a much smaller number, but almost the size of the US GDP, and about 20% of the world economy.

Those numbers about the size of the derivatives markets are just guesses, because the market is unregulated, zero controls. Nobody knows the true size or the true dangers.