Tuesday, March 04, 2014 - Everybody Clap Your Hands

Everybody Clap Your Hands

by Sinclair Noe

DOW + 227 = 16,395
SPX + 28 = 1873
NAS + 74 = 4351
10 YR YLD + .08 = 2.69%
OIL – 1.57 = 103.35
GOLD – 15.90 = 1335.40
SILV - .27 = 21.24

Ukraine has not exploded. The situation has not escalated, nor has it de-escalated. Apparently Russia and the West have both figured out that conflict has the potential for mutually assured destruction, not along the lines of the old nuclear Cold War, but potentially painful for both sides; and so today, everything is on hold. Vlad Putin said he sees no immediate need to invade Ukraine; the Obama administration is trying to put together $1 billion in loan guarantees.

Secretary of State John Kerry visited Kiev and there is still talk of sanctions if things don’t de-escalate. Putin says sanctions would be cause for retaliation. The Ukrainian military has shown remarkable restraint, adopting a Gandhi-like non-violence stance in the face of overwhelming firepower. And for the moment, there is a standoff but not a truce. That could change tomorrow.

A story in Politico today says the Russians no longer respect or fear Western leaders. Why?

“Russia thinks the West is no longer a crusading alliance. Russia thinks the West is now all about the money.”

Quite so. More specifically,

“Putin’s henchmen know this personally. Russia’s rulers have been buying up Europe for years. They have mansions and luxury flats from London’s West End to France’s Cote d’Azure. Their children are safe at British boarding and Swiss finishing schools. And their money is squirrelled away in Austrian banks and British tax havens.

“They have seen firsthand how obsequious Western aristocrats and corporate tycoons suddenly turn when their billions come into play.

“They know full well it is European bankers, businessmen and lawyers who do the dirty work for them placing the proceeds of corruption in hideouts from the Dutch Antilles to the British Virgin Islands.

“We are not talking big money. But very big money. None other than Putin’s Central Bank has estimated that two thirds of the $56 billion exiting Russia in 2012 might be traceable to illegal activities. Crimes like kickbacks, drug money or tax fraud.

“The Kremlin thinks it knows Europe’s dirty secret now. The Kremlin thinks it has the European establishment down to a tee. The grim men who run Putin’s Russia see them like latter-day Soviet politicians. Back in the 1980s, the USSR talked about international Marxism but no longer believed it. Brussels today, Russia believes, talks about human rights but no longer believes in it. Europe is really run by an elite with the morality of the hedge fund: Make money at all costs and move it offshore.”

Wall Street went to work today, and it seems they were heartened by the fact that Ukraine had not exploded and possibly a few traders looked at a map and discovered the Ukraine is about 4,000 miles from the corner of Wall and Broad; and Ukrainians don’t buy enough iPhones to move the needle. Keep calm and carry on.

So, it was back to the bull market behavior that got us here. Everything is copasetic. Corporate profits are absolutely smashing; the systemically important big banks posted profits of about $76 billion last year, just a smidge off their pre-crisis bubble era peak. There’s a small cap rally underway. Take a look at the Russell 2000, which was screaming for the month of February. There’s a biotech bubble; it’s enough to take your breath away, but they have a new drug for that; 11 of this year’s 14 best performing Russell 2000 stocks are biotechs, 7 of the top 8. The Nasdaq biotech index has gained 18%, since the start of the year.

That’s cool but not as cool as Tesla, which has doubled since Thanksgiving. One analyst recently said that Tesla’s pursuit of commercializing battery packs and cheaply storing green energy is a game changer, but the Elon Musk scheme to make a self-driving car is utopia. I always thought we’d have flying cars in utopia, but the future never unfolds exactly as we imagine.

Merger and acquisition activity is exciting again and it’s creating liquidity events. Apps are selling for $19 billion. Home thermostat companies bring in a cool $3.2 billion. Warren Buffett is on the prowl for something as good as Heinz catsup. Google is buying a company called Deep Mind, which does something in the way of artificial intelligence, which means that in the near future we won’t even have to think anymore.

Stocks are challenging all-time highs. The S&P 500 is hitting new highs. Almost every sector is moving up, with the possible exception of Bitcoin. Global central banks are printing money with abandon. Corporate bonds and junk bonds and Treasury bonds are all moving higher. Precious metals are moving higher. Greek stocks are moving higher. And the big winner so far this year, in terms of performance and the ability to attract investors, is not the bond market or the stock market; it’s commodities. To everything there is a season. Commodity ETFs are up $887 million in inflows for February.

And the valuations in the S&P 500, well, everybody seems to think they’re still more or less fairly valued; it’s not like it was in the late 90s; this time it’s different (lol), especially if the economy grows, which everybody seems to think will happen one of these days.

The latest guesstimate is that the US economy will grow this year at the fastest pace since 2005; that, in turn, will help reduce the annual average unemployment rate for a fourth straight year. So says the White House in forecasts accompanying its 2015 budget plan released today in Washington.  Gross domestic product will expand 3.1% in 2014 after rising 1.9% last year.  The jobless rate will average 6.9% this year, compared with 7.4% last year, and average 6.4% in 2015.

The $3.9 trillion budget anticipates an accelerating economy that’s boosting employment while moving up inflation to levels that would hardly change the pulse rate of the most hawkish Federal Reserve policymakers. The estimates in the budget plan showed the annual average yield on 10-year Treasuries will advance to 3 percent in 2014, from 2.3 percent last year, and increase to 3.5 percent in 2015.

In addition to rosy economic prognostications, the budget plan for 2015 proposes raising about $100 billion in revenue over the next decade through new taxes and restrictions on US multinational companies. The changes would affect digital goods, deductions for “excessive” interest, and hybrid arrangements that can lead to income that isn’t taxed in any country. Obama also wants to make it tougher for US-based companies to move to other countries.

The tax portion of the budget plan also would expand the earned income tax credit for low income workers, exclude Pell grants from income and establish automatic enrollment in individual retirement accounts. Further it would tax private equity managers’ carried interest as ordinary income, limit deductions for high income taxpayers, and end certain subsidies for oil and gas companies.

Most of the proposal will never see the light of day. However this idea on the earned interest carry trade might be something. The money taken in by this would be enough to pay for the Earned Income Tax Credit. Today, Warren Buffett said the tax break for low  income Americans aimed at encouraging work, would actually be the most direct way to help the working poor, with the fewest negative side effects; a better choice than raising the minimum wage. The IRS claims the tax break helped lift 6.6 million people out of poverty in 2011, the most recent year for which full data is available. Currently the credit does significantly more for families with children. Obama’s proposal would expand the EITC for workers without kids.

A July study from the Center on Budget and Policy Priorities estimated that expanding the EITC by lowering the age of eligibility for childless workers would lift an additional 300,000 Americans out of poverty. Expanding the EITC would help reduce poverty in two ways. First, it would give childless low-income Americans who are already working an income boost. And expanding the credit would encourage more people to work.

The White House signaled last month that its new budget would not extend the olive branch to Republicans that was offered in its proposal a year ago. Actually, there is some bipartisan support for some things. For example, the idea of closing the carried interest loophole, which would tax fund manager pay at 35% instead of the current 15% rate, which is somehow based on capital gains because fund managers don’t earn income, just capital gains. But wealthy fund managers pay an awful lot of money to politicians to encourage them to keep the loophole closed. Wealthy fund managers get very, very angry about any effort to take away a tiny bit of their billions. Blackstone Group co-founder Stephen Schwarzman, who made $465 million in 2013, declared in 2010 that Obama's idea of raising taxes on him and his buddies was just “like when Hitler invaded Poland in 1939”. That’s a quote. He went on to say, “It’s a war.”

A reminder that the budget proposal is coming from the White House and is being sent to the Congress, both of which are located in Washington DC, where tax policy has a tendency to become deadlocked in partisan disputes between  the lobbyists who actually write the laws.

By the way, the number one song in America is by Pharrell Williams and the title is “Happy”; the chorus is: “Clap along if you feel happiness is the truth.” It’s a nice song. Go ahead, clap along.