Friday, October 25, 2013 - New Records on Bad News

New Records on Bad News

by Sinclair Noe

DOW + 61 = 15,570
SPX + 7 = 1759
NAS + 14 = 3943
10 YR YLD - .02 = 2.51%
OIL + .79 = 97.90
GOLD + 5.60 = 1353.90
SILV - .13 = 22.70

The S&P 500 closed at a record high. The Nasdaq Composite closed at a 13 year high. The Russell 2000 hit a record high intraday, but closed slightly down on the day. The Dow Industrial Average did not hit a high; maybe next week, but not today, and so no milk and cookies.

For the week, the Dow was up 1.1%, the S&P up 0.9%, the Nasdaq up 0.7%. Based on results so far and estimates for companies still to report, S&P 500 earnings are expected to have risen just 3.4 percent in the third quarter, with 69 percent of companies reporting earnings above analysts' expectations. Revenue growth is seen at 2.2 percent for the quarter, with just 54.2 percent beating sales estimates, below the long-term average of 61 percent.

Consumer sentiment dropped in October to its lowest level since the end of last year. The Thomson Reuters/University of Michigan's final reading on the overall index on consumer sentiment fell to 73.2 in October from 77.5 in September and was the lowest final reading since December 2012. This report covered the time when the government shutdown. Consumer confidence is often linked to consumer spending expectations, and so there is some concern this report might foretell a weak holiday spending season.

Meanwhile capital goods orders were weak in September. Excluding orders for aircraft, orders dropped 1.1%. This report covers data prior to the shutdown. It's estimated the shutdown will shave as much as 0.6 percentage point off annualized fourth-quarter gross domestic product through reduced government output and damage to both consumer and business confidence. And even before the impasse, the pace of hiring by US employers had slowed sharply in September, as we learned earlier this week in the delayed jobs report.

This shutdown and threat of another coming in January are clearly going to change how people act and feel. Government employees and contractors (and other creditors) have been presented with a realistic scenario of not being paid either for a period of time, or even never being paid. Behavior will change in response to this newly found recognition of a vulnerability. The partial bounce back may even be muted by social security recipients realizing that they may one day find their checks delayed (and need to have a cash reserve to deal with that).

The single biggest impediment to a stronger economic recovery has been the years of dysfunction in Washington and the policies that have emerged. S&P estimates the shutdown will cost the economy $24 billion, but that's just the shutdown. Most substantively, the sharp decline in the budget deficit, from $1.4 trillion in 2009 to $642 billion in the 2013 fiscal year that ended Sept. 30, has braked the economy at a time when it was already improving only slowly.

Federal spending has been declining for 2 straight years and the Congressional Budget Office calculates that the pullback in spending, together with higher taxes will cause the economy to grow by 1.5 percentage points less this year than it would have if the deficit had remained constant, that’s the equivalent of 1.5 million fewer jobs.

So, we have bad economic news and expectations for a weak 4^th quarter and the stock market at record highs, because on Wall Street, bad news is good news. The weak economy means the Federal Reserve is not going to taper, or cut back on it's quantitative easing program of buying $85 billion a month in securities.

Right now the potential costs of withdrawing even a little bit of monetary support from the economy appear much greater than they were. For proponents of asset purchases, the cost-versus-efficacy calculation that figures into their votes each meeting is now chiefly about assessing the impact of slowing purchases, rather than of continuing them. The Fed holds its next FOMC meeting next week, and it looks like there will be about zero chance of a change in QE. The window to make changes in the bond buying program is now closed, and likely closed for quite some time.

Yesterday I addressed at length (click here) the Federal Reserve's proposals to have banks increase capital reserves, which is a positive though incomplete effort to avoid future bailouts. That process of increasing reserves would be phased in beginning in January 2015, and that taper could produce a shortage of high-quality assets. So, the pigs on Wall Street gorge at the Fed's Free Money trough, and push equities to new highs; and if it all sounds irrational and a tad exuberant, well it is; but the market can be irrational at times and brutal at others.

White House officials say the have submitted the paperwork necessary to confirm Janet Yellen as the next head of the Federal Reserve. Yellen will meet Senators next week as part of the process to install her as the next head of the central bank.

Yellen is expected to secure the 51 Senate votes needed to confirm her position. However, the hearings are expected to be contentious. Several Republican Senators have already indicated that they will oppose Yellen's nomination. Kentucky Senator Rand Paul is threatening to block the nomination to get a vote on his Fed transparency bill, which would require the Fed to undergo a complete audit by a specific deadline. 

Today, JPMorgan Chase announced it has reached a $5.1 billion settlement with the US Federal Housing Finance Agency (FHFA) over charges it misled mortgage giants Fannie Mae and Freddie Mac during the housing boom. A separate settlement with the US Justice Department is expected to be announced soon, that's the proposed $13 billion deal. It is the biggest settlement ever by a US bank. In a statement JP Morgan said the settlement resolves the biggest case against the firm relating to mortgage-backed securities.

The bank added that the agreement relates to "approximately $33.8 billion of securities purchased by Fannie Mae and Freddie Mac from JP Morgan, Bear Stearns and Washington Mutual" from 2005 – 2007. As part of the agreement with the FHFA, the bank will pay $4 billion to Fannie Mae and Freddie Mac to settle claims that it violated US securities law.

It will pay the agencies an additional $1.1 billion for misrepresenting the quality of single-family mortgages.JP Morgan has set aside a total of $23 billion to help the bank work through its many investigations by regulators in the US and abroad.

Last month, the bank agreed to pay more than $1bn to help it end various investigations into its 2012 "London whale" trading debacle, which cost the bank more than $6 billion in trading losses.

It's estimated that JPMorgan has now paid out more than $31 billion in fines and legal costs since 2009. The settlement announced today is the biggest settlement ever by a US bank. Now, what seems really crazy is that you have these massive fines and legal costs, and you still have apologists for Jamie Dimon to stay on as the chief at JPM. Either JPMorgan is incapable of turning a profit without violating the law, or they have squandered an enormous amount of profits by violating the law.

Meanwhile, kudos to Bill Black for recognizing a bit of media legerdemain, specifically, this one sentence which describes this week's jury verdict against Bank of America for the Hustle scam: “Bank of America, one of the nation’s largest banks, was found liable on Wednesday of having sold defective mortgages, a jury decision that will be seen as a victory for the government in its aggressive effort to hold banks accountable for their role in the housing crisis.”

I'm still waiting for aggressive efforts to hold banks accountable.

An earthquake of magnitude 7.3 struck early Saturday morning off Japan's east coast, the U.S. Geological Survey said. Japan's emergency agencies declared a tsunami warning for the region that includes the crippled Fukushima nuclear site. Japan's Meteorological Agency issued a 3-foot tsunami warning for a long stretch of Japan's northeastern coast, which isn't really much more than a swell.

There were no immediate reports of damage on land. Tokyo Electric order workers near the Fukushima nuclear plant to move to higher ground but there were no reports of trouble at the plant. All but two of Japan's 50 reactors have been offline since the March 2011 magnitude-9.0 earthquake and ensuing tsunami triggered multiple meltdowns and massive radiation leaks at the Fukushima Dai-ichi nuclear power plant, about 160 miles northeast of Tokyo. About 19,000 people were killed.

The Fukushima plant has been leaking radioactive water into the ground and into the ocean, and there are concerns about the stability of the damaged buildings holding radioactive fuel rods. So, something like an earthquake could easily damage the buildings, resulting in a meltdown 85 times larger than Chernobyl. But the good news is that did not happen; not today.