Thursday, July 31, 2014

Thursday, July 31, 2014 - Ugly Day, Ugly Logic

Ugly Day, Ugly Logic
by Sinclair Noe

DOW – 317 = 16,563
SPX – 39 = 1930
NAS – 93 = 4369
10 YR YLD un = 2.55%
OIL – 2.12 = 98.15
GOLD – 14.00 = 1281.50
SILV - .23 = 20.48

Well, this was just ugly. The worst day for the Dow Industrial Average in about 4 months. Back on April 10th, the Dow dropped 267 points; that same day, the S&P 500 was down 30 points. Today wiped out the gains from July, with July marking the first negative month for the Dow and the S&P since January.

The S&P is still up about 5% for the year to date, but the Dow started the year at 16,576. All those record highs for 2014 have just been washed away. That’s how it goes; the markets scratch and claw, higher and higher, inch by inch it’s a cinch, until the cinch breaks. A couple of weeks ago, we talked about shorting, and the advantage of shorting is that the moves can be quick and severe. Sure enough. And while this might just be one bad day, long overdue, the Dow dropped below its 50 day moving average, which is one of the major measurements of a trend.

So, the question is why did the stock market nosedive today? One recurring theme I’ve been hearing is that traders are afraid the Fed will pull away the punchbowl. Yesterday’s GDP report showing better than expected 4% growth in the second quarter combined with today’s employment cost index, which rose 0.7% in the second quarter, made people nervous about the prospect of an improving economy and the possibility of wages pushing inflation higher.

Now wait just a minute; that doesn’t sound so bad; the economy is expanding at a 4% pace which is certainly better than a contracting economy which we saw in the first quarter; and workers are being paid a little more – not much just a little - and that’s certainly better than watching the middle class shrink into oblivion. If you look at this explanation for the market decline, it is an example of perverse logic, where the stock market traders are in opposition to economic prosperity and are only happy in the face of hardship; other people’s hardship, not their own.

There might be something to that interpretation. Beginning in 2008, the Fed cranked up a series of programs to stimulate the economy. Of course, the Fed didn’t really stimulate the economy but they did stimulate certain financial sectors, such as housing, and very clearly the stock and bond markets. During that time, the Fed added over $3.5 trillion to their balance sheet, which now holds nearly $4.5 trillion. The basic mechanics were that the US government borrowed money by selling Treasuries, and the Fed bought a large portion of those Treasuries with freshly printed money. Since 2013 the Fed’s balance sheet has grown even faster than government debt, which has leveled off, almost. Overlay a chart of the S&P 500 with a chart of the Fed’s balance sheet; the similarities are more than coincidental. A big chunk of the money the Fed was printing sloshed over into the stock market. When the Fed stops printing all that money, who is left to buy stocks?

The accumulated “surplus” of printed money will only last a couple of months. Sooner or later (probably sooner), the stock market will start to feel the pain of this monetary tightening. Of course the Fed isn’t really exiting the money printing business. They won’t sell off the assets held on their balance sheet; they will let those treasuries and mortgage backed securities mature and expire, maybe even roll over a few. And government debt hasn’t disappeared, so the Fed will continue printing money. We don’t know how the Fed taper and eventual increases in interest rates will turn out; neither does the Fed know. It’s a big experiment; the Fed might throw a curveball or two along the way; the stock market traders might throw a tantrum, knocking down your IRA in the process. The recurring theme today was that the Fed might pull away the punchbowl; the Fed hasn’t actually done that; they said this week they would not do that anytime soon. There has been considerable consideration given to a Fed exiting. Imagine when they actually do it.

The big institutional traders may already be headed for the doors. Last week, investors added $379 million into equity mutual funds, the kind that’s popular with retail investors. At the same time, exchange-traded funds focusing on equities; the kind of securities traded by institutional investors because of their liquidity and lower cost, saw a whopping $7.97 billion in outflows. That’s the biggest outflow seen since February.

Anyway, the Wall Street traders’ logic is flawed; the 4% growth in second quarter GDP really isn’t as good as it seems. The 4% growth implies the economy is on a very slow growth path when averaged in with the -2.1 contraction in the first quarter. Taken together, the economy grew at less than a 1.0% annual rate in the first half of 2014. That is hardly cause for celebration on Main Street or trepidation on Wall Street. Also, the strong growth in the second quarter was in direct response to the weak growth in the first quarter. Inventory growth was very weak in the first quarter, subtracting 1.16% points from the quarter's growth, and so a reversion to the mean, or a return to a more normal pace of inventory accumulation in the second quarter was a strong boost to growth, adding 1.66 percentage points. Final sales grew at just a 2.3% annual rate in the second quarter. Even that rate was likely inflated to some extent by the weakness from the first quarter.

But that wasn’t the only demon plaguing the stock market today. If it’s not one thing, it’s another. And there have been a lot of other things.

The bond market has its own demons. Fitch warns a jump in US high-yield default rates looms. There have been 10 LBO related bond defaults thus far in 2014, compared with nine for all of 2013. While most sectors remain relatively calm, the utilities and chemicals sectors are seeing huge spikes in defaults. Since the Fed pushed rates down near zero people have been chasing yield and that means the high yield market has become crowded, and that means the yield on risky debt has dipped to a little less than 6% on average, compared to a more typical yield of a little less than 9% for junk  debt. If or when the Fed starts targeting higher rates, who will be looking for the junk with the not so high yield? A reversion to the mean would result in big capital losses, and it could turn ugly if people start running for the exits and can’t find a bid.

And then we can’t forget the geopolitical problems of the world. A negative July in stocks was matched by a negative July in Ukraine, and Israel, and Gaza, and Iraq, and Syria, and Libya. Toss in sanctions on Russia, which will also hurt the European Union.  And then late yesterday, Argentina put a cherry on top.

Argentina has defaulted, or as S&P described it, a “selective default”. A quick recap: In 2001 Argentina defaulted on its debt and it forced most of its creditors to take a haircut, that is a lot less money than the face value of the bonds. After the default, Paul Singer, a hedge fund manager of NML Capital, bought a lot of the bonds at a big discount, pennies on the dollar, and then demanded the bonds be paid in full. Argentina refused to pay the vulture hedge funds. So Singer took his case to the courts – not in Argentina, but in the US. The case was heard by a judge who didn’t really understand all the fancy talk about bonds, and so he ruled against Argentina. About a month ago, the US Supreme Court said they would not interfere. So now, Argentina can’t pay off the bondholders who accepted the discount, unless they also pay off the hedge fund vultures who demand full payment; which basically negates the whole idea of the default in the first place. So, the US courts have essentially told the sovereign country of Argentina that it is more important to pay off the hedge funds, than it is to default and reboot the Argentine economy on a fresh start.

While Singer’s firm has yet to collect any money from Argentina, some debt market experts say that the battle may already have shifted the balance of power toward creditors in the enormous debt markets that countries regularly tap to fund their deficits. Countries in crisis may now find it harder to gain relief from creditors after defaulting on their debt.

The big question, however, is whether Argentina will ever pay Singer and his vulture fund fellows what it wants. If the firm fails to collect, that would underscore the limits of its legal strategy. There is no international bankruptcy court for sovereign debt that can help resolve the matter. Argentina may use the next few months to try to devise ways to evade the US courts. In dire economic crises countries need to be able to slash their debt loads. The idea is similar to bankruptcy for individuals, a chance to restructure debts and start fresh because we long ago learned that throwing people in prison for the debts didn’t help anybody. The legal victories of the holdouts may embolden creditors to drive harder bargains after future defaults, which in turn could prolong or postpone debt restructurings and extend the economic misery of over-indebted countries. So, the problem in Argentina is not unique to Argentina, it affects the global economic system, we just don’t know to what extent.

Wednesday, July 30, 2014

Wednesday, July 30, 2014 - GDP, Fed, Vultures, and Banksters

GDP, Fed, Vultures, and Banksters
by Sinclair Noe

DOW – 31 = 16,880
SPX + 0.12 = 1970
NAS + 20 = 4462
10 YR YLD + .09 = 2.55%
OIL - .72 = 100.25
GOLD – 4.30 = 1295.50
SILV + .06 = 20.72

Last week we told you that this week would be very busy. Well, here we are; today we had a big report on second quarter GDP and the Fed wrapped up a policy session, and that’s just the beginning. 

This morning, the Commerce Department reported the gross domestic product grew at a 4% pace in the second quarter. Boom. And first quarter GDP was revised from negative 2.9% to negative 2.1%; but any way you look at it, this was a massive turnaround.

The government also published revisions to prior GDP data going back to 1999, which showed the economy performing much stronger in the second half of 2013, growing at a 4% pace, the strongest 6 months since late 2003. This was the first estimate of second quarter GDP, and the first revision will be released August 28.

Inventories added 1.66 percentage points to this GDP report. Stockpiles were rebuilt at a $93.4 billion annualized pace after a $35.2 billion gain in the first three months of the year. That could mean companies will keep tighter control on the number of goods on hand this quarter, which could cut into economic growth. Or it might mean companies are optimistic about sales.

Consumer spending rose at a 2.5% pace last quarter, which also topped expectations, and more than double the 1.2% advance in the first quarter of 2014, in part due to less spending on healthcare. Purchases of durable goods, including autos, furniture and appliances and recreational vehicles, jumped at a 14% annualized rate, the fastest since the third quarter of 2009. Despite the pick-up in consumer spending, Americans saved more in the second quarter. The saving rate increased to 5.3% from 4.9% in the first quarter as incomes rose, which bodes well for future spending.

Corporate spending on structures, equipment and intellectual property such as software increased at a 5.5% annualized rate after rising at a 1.6% pace in the prior three months. In addition to consumer spending and business investment, growth got a boost from the biggest gain in state and local government expenditures in five years. Congress is still debating spending for infrastructure improvements such as roads and bridges, and if they can’t work out differences that could prove a stumbling block later in the year. A widening trade gap subtracted 0.6% from growth. Excluding inventories and trade, so-called final sales to domestic purchasers climbed at a 2.8% rate, the biggest increase since the third quarter of 2011.

Still, the big swing from negative 2.1% contraction to positive 4% growth seems like a very big swing, almost freakish. We know that the first quarter was hit by bad weather and the polar vortex …, still. So, we can smooth out the numbers by looking at the full year growth rate; over the past 12 months the economy expanded at a 2.4% rate, pretty much in line with the past 3 years; in fact, 2.4% growth would be decent in normal times, but the economy is still in recovery mode, and 2.4% is not enough to achieve “liftoff”. The economy is headed in the right direction, it is gathering momentum, but it is still operating below potential. By the Congressional Budget Office’s estimates, the level of output reported for the second quarter is still $770 billion below the nation’s current economic potential, or 4.2% below. That implies that the nation still has plenty of room to grow if a faster expansion ever kicks in.

The economy is far from perfect, we have a long way to go, but today’s report indicates progress, real, honest to goodness progress.

A price index in the GDP report rose at a 2.3% rate in the second quarter, the quickest in three years, after advancing at a 1.4% pace in the prior period. A core price measure that strips out food and energy costs increased at a 2.0% pace, the fastest since the first quarter of 2012. The inflation picture should lend support to the Fed hawks who want to hike interest rates sooner rather than later, but for now the Fed is standing pat.

The Federal Reserve Federal Open Market Committee reaffirmed it was in  no rush to raise interest rates, even as it upgraded its assessment of the economy and expressed a level of comfort that inflation was moving up closer to its target, and the taper is  still on track. The Fed has kept overnight rates near zero since December 2008 and has more than quadrupled its balance sheet to $4.4 trillion through a series of bond purchase programs. The Fed announced, as expected, that it would reduce its monthly bond purchases to $25 billion per month, but it gave no indication that recent signs of stronger economic growth had changed its previously announced plan to hold short-term interest rates near zero well into 2015.

The Fed acknowledged both faster economic growth and a decline in the unemployment rate, but expressed concern about remaining slack in the labor market. The Fed’s statement said: "Labor market conditions improved, with the unemployment rate declining further… However, a range of labor market indicators suggests that there remains significant underutilization of labor resources."

Some Fed officials see evidence that the economy is settling into a pattern of slower growth, and that monetary policy has substantially exhausted its power to improve the situation. They want the Fed to retreat more quickly from its stimulus campaign, fearing higher inflation, or that it will encourage bubbles in financial assets. Fed chairwoman, Janet Yellen, and her allies have taken a more cautious view, arguing that the decline in the unemployment rate appears to overstate the improvement in the labor market, because it counts only people who are looking for work. Yellen expects some people who had been discouraged about their job prospects will return to the labor force as the economy continues to improve, and she has pointed to weak wage growth as evidence that it remains easy to find workers.

More optimism for the economy came in a report from ADP, the payroll processing company; private employers added 218,000 jobs last month, which was down from 281,000 in June. It was the fourth straight month of job gains above 200,000. While ADP’s numbers offered reason to be hopeful, the company’s figures cover only private businesses and often do not track with the government’s jobs report, which will be released Friday.

The ratings agency Standard & Poor’s says Argentina has defaulted after it failed to make a $539 million interest payment due on its discount bonds. The downgrade came late this afternoon as representatives for Argentina and New York hedge funds sought to reach a last-minute agreement on Argentina’s debt. Yet after more than five hours of mediated talks, neither side appeared closer to a deal. Standard & Poor’s lowered its rating on the country’s debt to “selective default”, noting that Argentina had a 30-day grace period following the June 30 scheduled interest payment date to make payment.

This story goes back to 2001, when Argentina defaulted on tens of billions of dollars of sovereign bonds. It later exchanged those bonds for discounted ones with most of its bondholders, but a small group of traders, mainly hedge funds, led by Paul Singer’s Elliott Management refused to take the new bonds, even though they had purchased the discounted bonds after the default, at pennies on the dollar, they demanded full payment, and they have not backed down, and they took it to court in the US.

In 2012 a US federal judge ruled that Argentina could not make payments to bondholders who had agreed to discounted bonds, without paying the holdouts. Argentina appealed and took its case to the United States Supreme Court which rejected the appeal last month. Argentina had until the end of the day to pay the holdouts or risk defaulting for a second time in 13 years.

A federal judge has ordered Bank of America’s Countrywide unit to pay $1.27 billion in penalties for defective mortgage loans sold to Fannie Mae and Freddie Mac in 2008. US District Judge Jed Rakoff in Manhattan issued the civil penalty against BofA in the first mortgage-fraud case brought by the federal government to go to trial. A jury in Manhattan found Countrywide liable. The judge determined that Fannie and Freddie had paid Countrywide nearly $3 billion for HSSL loans, but determined that 57% of the loans were of acceptable quality. HSSL refers to a Countrywide loan program called the High Speed Swim Lane, which basically fast-tracked almost any loan; it was also known as a “Hustle” loan.

In today’s decision, Judge Rakoff wrote: “While the HSSL process lasted only nine months, it was from start to finish the vehicle for a brazen fraud by the defendants, driven by hunger for profits and oblivious to the harms thereby visited, not just on the immediate victims but also on the financial system as a whole.”

Separately, Bank of America is reportedly nearing a settlement with the Justice Department to resolve an investigation into its sale of mortgage backed bonds centered on faulty loans the company inherited from Countrywide and Merrill Lynch, which it purchased in 2008. The discussions include how much money will be paid in cash and how much in consumer relief. Potential terms have ranged from $13 billion to $17 billion. The DOJ has been trying to work out a settlement for some time, and was reportedly dissatisfied with a $13 billion deal that included $5 billion in consumer relief. The consumer relief portion of these settlements has typically been an easy out for the banks. The amount of any settlement would come on top of the $9.5 billion the bank agreed to pay in March to resolve Federal Housing Finance Agency claims.

Tuesday, July 29, 2014

Tuesday, July 29, 2014 - How Do you Feel?

How Do You Feel?
by Sinclair Noe

DOW – 70 = 16,912
SPX – 8 = 1969
NAS – 2 = 4442
10 YR YLD  - .03 = 2.46%
OIL - .63 = 101.04
GOLD – 4.70 = 1299.80
SILV un = 20.66

How are you feeling? Are you confident? Apparently more people are. The Conference Board’s consumer confidence index increase to 90.9 in July, up from 86.4 in June; it’s the highest level in almost 7 years; it marks a significant rebound from the February 2009 low of 25.3. The people who compile the index say: “Strong job growth helped boost consumers’ assessment of current conditions, while brighter short-term outlooks for the economy and jobs, and to a lesser extent personal income, drove the gain in expectations,” and the improved confidence “suggests the recent strengthening in growth is likely to continue into the second half of this year.”

Home prices dropped in May compared to April. The S&P/Case Shiller composite index of 20 metropolitan areas declined 0.3% in May on a seasonally adjusted basis, its first decline since January 2012. Prices in the 20 cities rose 9.3% year over year, the slowest year-over-year gain since February 2013. The Phoenix area posted a 0.4% increase from April to May, non-seasonally adjusted.

In a separate report form the Commerce Department, home ownership rates dropped to 64.8% in the second quarter from 65% in the first quarter.

A fairly startling report was published today by the Urban Institute and TransUnion, the credit reporting firm, showing more than one-third (35%) of Americans with credit files had debt in collections in 2013. Non-mortgage delinquent debt totals $11.23 trillion. Which sounds like a lot, and it is, but it’s down from $12.68 trillion in delinquent debt in 2009; this includes debts such as credit cards, auto loans, student loans, utility bills, or even a phone bill or gym membership.  The study looked at debts that had been reported to a credit bureau as delinquent, and turned over to collection; that means the debt is at least 180 days old, but it also means the debt can stay on the credit report for up to 7 years, maybe longer. The share of people with debt 30 days past due is about 5.3%. What this means is that when a debt becomes past due, it lingers on a credit report.

The report on delinquent debt may tell us more about debt collection methods than about deadbeat American consumers. It is very easy for a company to turn over a debt to a credit rating bureau or a debt collection company; it is very hard for a consumer to get a debt removed from a credit report, even if the debt is disputed, or in many instances, even when the debt is paid. Consumers filed 204,000 complaints with the Federal Trade Commission last year, up nearly 3% from 2012, even though the amount of delinquent debt dropped. The most common complaint concerned debt collectors that lied about the amounts a consumer owed and the nature of the delinquency.

The European Union has imposed new sanctions on Russia for its involvement in supporting separatists in Ukraine. The US also toughened its sanctions further. The latest American actions took aim at more Russian banks and a large defense firm, but they also went further than past moves by blocking future technology sales to Russia’s oil industry in an effort to inhibit its ability to develop future resources. The Euro Union agreed to restrictions on trade of equipment for the oil and defense sectors, and "dual use" technology with both defense and civilian purposes. Russia's state run banks would be barred from raising funds in European capital markets. The measures would be reviewed in three months. Previously Europe had imposed sanctions only on individuals and organizations accused of direct involvement in threatening Ukraine, and had shied away from wider "sectoral sanctions."

The orchestrated actions on both sides of the Atlantic were designed to demonstrate solidarity in the face of what American and European officials say has been a stark escalation by Russia in the insurgency in eastern Ukraine. Until now, European leaders have resisted the broader sorts of actions they agreed to today.

Though Europe’s commerce with Russia will probably slump because of the sanctions, the measures are expected to hit Russia more severely, especially the restrictions on Russian banks’ ability to raise money in Europe and the United States. European companies have been warning for some time that their earnings could suffer because of sanctions against Russia. Today, the oil company BP warned that sanctions could hurt earnings. BP owns a 19.75% stake in the Russian oil company Rosneft.

We are about halfway through second quarter earnings season. Here are a few of today’s reports:
The pharmaceutical company, Pfizer posted earnings that beat estimates, while revenue dropped; they also said they expect earnings to drop in the third quarter. Merck had a similar story, beating earnings estimates while revenue slipped. United Parcel Service missed profit forecasts, even as profits and revenue were higher than a year ago. Herbalife, the multi-level marketed nutritional supplement company posted weak earnings after the close yesterday; shares were clobbered today. Corning, the glass making company reported a sharp drop in earnings due to acquisition costs; also clobbered.

Twitter reported a net loss of $145 million, or 24 cents a share, compared to a loss of $42 million a year ago. More people used the Twitterverse during the World Cup; revenue was up 124%, but then the users fade away; globally, usage was down 7% from a year ago. Twitter shares have jumped about 30% in after-hours trading. Go figure.

The Federal Reserve FOMC started its two-day meeting today. They will issue a statement tomorrow. The Fed is in the midst of reducing the amount of money it is pumping into the financial system by way of large purchases of mortgage backed securities and Treasuries, a process of tapering the Quantitative Easing. So far, the Fed has reduced purchases from $85 billion a month to $35 billion a month, and tomorrow they are expected to drop that down to $25 billion a month. QE is scheduled to end in October.

Then the Fed will shift their focus to raising its target for short-term interest rates, which have been near zero for more than 5 years. The Fed has already said they will take their time in raising rates. That exit from an accommodative policy is considered dangerous, and today the International Monetary Fund, the IMF, said it could reduce output in the United States by as much as 2% through 2016.

Volatility in the US could ripple through to emerging markets and likewise depress growth, but even worse; cutting growth by as much as 9% in more vulnerable developing countries due to higher interest rates and tighter financial conditions; and then it gets worse, with larger declines coming in time due to lower productivity, weaker trade, and falling commodity prices.

In addition to when the Fed will raise rates, it is also important to consider how high they will raise rates, and if they will wait long enough for liftoff to occur first. Liftoff is when the US economy has regained its strength and momentum and is able to cope with higher rates because of its economic strength. Fear of inflation could prompt the Fed to raise rates before liftoff; there is an even greater chance the Fed will raise rates before emerging markets could bear the burden of higher rates. If the Fed gets it wrong, we could end up stuck in sluggish or permanently lower growth.

Swiss bank UBS and German bank Deutsche Bank have disclosed that they are facing inquiries from the New York attorney general’s office. The UBS inquiry deals with dark pools, or alternative trading platforms, generally used by larger institutional clients such as pension funds and hedge funds, trying to hide orders from public observation. At its core, the dark pools are a form of price manipulation. Deutsche Bank is facing inquiry into high frequency trading and dark pools.

The Financial Times reports: “The Federal Reserve Bank of New York is stepping up pressure on the biggest banks to improve their ethics and culture, after investigations into the alleged rigging of benchmark rates led officials to conclude bankers had not learnt lessons from the financial crisis…

“Fed officials were surprised that some of that reported behavior occurred after the 2008 crisis, leading them to believe bankers had not curbed their poor conduct. To make sure the biggest banks are paying enough attention to ethics and culture, NY Fed bank evaluations have begun incorporating new questions emphasizing such issues. Topics include whether the right performance structure is in place to punish bad behavior, especially when it comes to compensation.”

Well, that is just great, the NY Fed suggests banks pay smaller bonuses when they encounter unethical behavior by the banksters. We’ll file that one under “Cruel and Unusual Draconian Punishment”.

But if you’re really looking for a funny story about banksters, check out the New York Times Dealbook. It seems the banksters are cashing in on advising companies how to do inversion deals to evade taxes. Inversions are behind the recent rash of merger deals in which major US corporations have renounced their citizenship in search of a lower tax bill offshore. It is important to understand that inversion does not in any meaningful sense involve American business moving overseas; all they’re doing is dodging taxes on those profits.

Investment banks are estimated to have collected, or will soon collect, nearly $1 billion in fees over the last three years advising and persuading American companies to move the address of their headquarters abroad (without actually moving).

The leaders in this growing field include Goldman Sachs, JPMorgan, Morgan Stanley, and Citigroup; they’ve made hundreds of millions aggressively promoting these transactions to major corporations, arguing that such deals need to be completed quickly before Washington tries to block them. These same banks received hundreds of billions from US taxpayers in the form of bailouts. The Joint Committee on Taxation estimates these inversion deals are expected to cost taxpayers nearly $20 billion over the next decade.

Monday, July 28, 2014

Monday, July 28, 2014 - You Might Not Like the Solution

You Might Not Like the Solution
by Sinclair Noe

DOW + 22 = 16,982
SPX + 0.57 = 1978
NAS – 4 = 4444
10 YR YLD + .02 = 2.47%
OIL - .52 = 101.57
GOLD – 4.80 = 1304.50
SILV - .18 = 20.67

This will be a busy week for economic reports. Today’s reports included the National Association of Realtors’ index of pending home sales for June; it dropped 1.1%. This index looks at contracts signed, and usually about 80% of signed contracts result in a sale within 2 months. The pending home sales index is up 9% from February, but it is down 7.3% compared to June a year ago. The blame can be placed at the usual suspects: tough credit requirements, rising home prices, and weak wage growth.

In a separate report the Markit preliminary services Purchasing Managers Index for July was 61, unchanged for June; a reading above 50 indicates expansion. The services sector continued to add employees, though at a slower pace. The employment index fell from 56.1, the fastest rate on record, to 52.8 in July.

Wednesday morning brings the first estimate of second quarter gross domestic product. It is widely anticipated the economy grew at about a 3% pace in the second quarter, following a 2.9% contraction in the first quarter, largely blamed on bad winter weather combined with the expiration of long term unemployment benefits and working through excess inventory accumulation. So, the first quarter and second quarter will kind of cancel each other out and result in a flat first half. If the economy can maintain 3% growth for the next couple of quarters, it will result in annualized growth a little below 2%. Wednesday’s GDP report will include revisions to output for the past 3 years.

A few hours after the GDP report, the Federal Reserve FOMC will wrap up a 2 day meeting on monetary policy, and issue a statement. However, the Fed will not update its economic forecast, nor will they hold a press conference until the September 17th FOMC meeting; so don’t expect any major changes to Fed policy this week. Still, Fed watchers will look for nuances to the Fed statement for any hint of policy changes, specifically when the Fed will start to raise interest rates.

Friday brings the non-farm payroll report for July. It is expected the economy added about 235,000 net new jobs in July; anything close is in the ballpark; anything under 200,000 or over 300,000 would shock the markets. The unemployment rate is expected to drop to 6%, but the unemployment rate has quite a few variables to consider, including the participation rate – the percentage of the population still looking for work or working. The participation rate has dropped from 65.8% in 2007 to 62.8% last month. This means that a lot of people have dropped out of the labor market. If some of those people re-enter the labor market and start looking for jobs, the unemployment rate could move higher, even if the economy adds a bunch of new jobs.

We kick off the week with a Merger Monday. Zillow will buy Trulia for $3.5 billion. Zillow and Trulia are No. 1 and 2 in the online real estate market, followed by No. 3 Move Inc. Zillow reported nearly 83 million monthly unique visitors in June. Trulia reported 54 million. The combination would create something like a monopoly in the online home hunting market.

Dollar Tree has agreed to buy Family Dollar Stores for $8.5 billion. The deal was pushed forward by investor Carl Icahn, who had built up a 9.5% stake in Family Dollar, and with the bump up in price from the merger, Icahn pockets a cool $150 million increase this weekend. The new Dollar Tree, or maybe Dollar Family Tree, would keep operating separate chains, but would have about 13,000 locations across the US and Canada, with 145,000 employees and about  $18 billion in revenue.

Tesla and Panasonic have reached a deal for Panasonic to invest in Tesla’s gigafactory. The initial Panasonic investment will be about $200 to $300 million, but could grow to $5 billion. The gigafactory would make battery packs for cars. Panasonic is the main supplier of battery cells for Tesla. Tesla has said it is evaluating sites in Arizona, California, Nevada, New Mexico, and Texas to place its massive battery factory. The electric car maker would break ground on the gigafactory later this year. Tesla is scheduled to report earnings on Thursday.

Lloyds Banking Group has agreed to pay $370 million to US and British regulators to resolve investigations into manipulating interest rates or Libor rate rigging. There were 2 main issues with Lloyds: rigging Libor, for which seven other institutions have already been punished; and for the first time, manipulating another rate, known as the repo rate. This repo rate was used to calculate the scale of the fees paid to the Bank of England for its special liquidity scheme (SLS), which was created in April 2008 to cheapen the prices at which money could be obtained by banks as the credit crisis unfolded; in other words, Lloyds manipulated their own bailout. The British lender is the latest big bank to admit criminal wrongdoing, and they entered into a deferred prosecution agreement. Under that agreement, Lloyds will avoid criminal charges if it stays out of trouble for the next two years.

Plenty of banks have entered into deferred prosecution agreements but I have never heard of one that violated a deferred prosecution agreement; and it isn’t because the banksters keep their nose clean; it’s because the regulators never apply the DPA.

Taking a look at geopolitical hotspots. Israel had agreed to a 12 hour ceasefire, but Hamas continued to fire rockets into Israel, so the ceasefire is off. Palestinian fighters launched a cross-border raid. Israeli Prime Minister Netanyahu is now warning of a protracted war in Gaza.

The Ukrainian government said today its troops had taken more territory from the rebels and were moving towards the site of the Malaysian airlines crash which international investigators said they could not reach because of the fighting. Meanwhile, US and European leaders agreed to impose wider sanctions on Russia's financial, defense and energy sectors.

Separately, an international arbitration court at The Hague ruled that Russia must pay $50 billion for expropriating the assets of Yukos, the former oil giant. Finding that Russian authorities had subjected Yukos to politically-motivated attacks, the panel made an award to a group of former Yukos shareholders that equates to more than half the entire fund Moscow has set aside to cover budget holes. The ruling hit back at decisions made under President Vladimir Putin's rule during his first term as president to nationalize Yukos and jail Mikhail Khodorkovsky, who had criticized him. The hardline approach was seen by Kremlin critics at the time as a stark message to oligarchs to stay out of politics. Khodorkovsky, who used to be Russia's richest man, was arrested at gunpoint in 2003 and convicted of theft and tax evasion in 2005. Yukos, once worth $40 billion, was broken up and nationalized, with most assets handed to Rosneft, an energy company run by an ally of Putin.

And don’t forget Libya. Two rival brigades of former rebels fighting for control of Tripoli International Airport have been throwing bombs at each other’s positions; then somebody bombed a huge nearby fuel depot, and that is now burning out of control. The conflict has forced Tripoli International Airport to shut down. Airliners were reduced to smoldering hulks on the tarmac and the aviation control center was knocked out. Libya's government has asked for international help to try to contain the disaster at the fuel depot on the airport road, close to other tanks holding gas and diesel. With Libyan security deteriorating, the United States evacuated its embassy in Tripoli on Saturday; British, Italian, Philippine, and Australian embassies have followed suit.

The typical American household has been losing ground. According to a new study by the Russell Sage Foundation the inflation-adjusted net worth for the typical household was $87,992 in 2003. Ten years later, it was only $56,335, or a 36% decline. Even as the average American household’s wealth declined, the net worth of wealthy households increased substantially. The average wealth of the American household in the 95th percentile was $1,192,639 in 2003, and $1,364,834 ten years later, an increase of 14%.

The authors of the study said the reason for the disparity was that affluent households were able to ride the success of the surging stock market after the 2008 crash, while middle class families were severely impacted by the decreasing value of their homes. Wealth declined for everyone in the aftermath of the Great Recession, but better-off families were able to rebound. Households at the bottom of the wealth distribution, on the other hand, lost the largest share of their wealth.

So, as we look at the economic news this week, the GDP estimate and the jobs report, it’s a little hard to imagine sustainable economic growth without a strong middle class. The lesson of the past 10 years, and we might even say the past 30 years, is that pumping up the upper echelons of the economy and hoping it trickles down to the rest, doesn’t work. The middle class gets clobbered, small businesses are being knocked out of the competition; in the early 1980s small business startups accounted for 50% of all business growth, but that dropped to 35% by 2010, and more small businesses are closing than are being created; and yes, that equates to fewer jobs being created by small businesses.

Back in 1929, the top 10% earned nearly 50% of the income. Today, income inequality is even wider. In 2012, the top 10% surpassed 50% of the total US income for the first time, and the problem has only grown in the past 2 years. Wealth disparity alarms often coincide with major financial peaks, such as 1929, 1999, 2007, and today; that’s because wealth disparity and income inequality are not sustainable, and there are only 2 solutions: the first is to grow the middle class, encourage small business, lift people out of long term unemployment; the second solution, is that the wealth distribution problem tends to be solved by falling markets.

Friday, July 25, 2014

Friday, July 25, 2014 - Hot and Dry

Hot and Dry
by Sinclair Noe

DOW – 123 = 16,960
SPX – 9 = 1978
NAS – 22 = 4449
10 YR YLD - .04 = 2.47
OIL - .13 = 101.94
GOLD + 13.30 = 1308.20
SILV + .35 = 20.82

For the week, the Dow is down 0.8%, the S&P is flat and the Nasdaq is up 0.4% in its second straight weekly rise.

In economic news, durable goods orders were up 1.4% in June, but May’s numbers were revised lower to show a 1.2% decline. Shipments of core capital goods fell 1%. Core capital goods shipments are used to calculate equipment spending in the government's gross domestic product measurement. The government will release its first snapshot of second-quarter GDP next Wednesday. The economy contracted at a 2.9% rate in the first three months of the year, with business spending on equipment falling at a 2.8% rate.

Investors have been selling junk bonds. In the past week investors pulled $2.3 billion from junk bond funds. That marked the biggest outflow since June 2013, when the Fed was hinting about tapering. The high-yield market has pulled back in recent weeks, sending prices lower and yields higher. The bond market is not as liquid as it once was; trading volume is down across the board, and trading desks have been cut back, meaning a big sell-off could look more like a run on bonds.

Yesterday we told you about’s earnings report, or more specifically, a lack of earnings. Amazon has a unique business model where they manage to consistently increase sales without actually turning a profit. If it seems like this kind of model has limitations, you are correct, and today Amazon hit the wall. Yesterday’s non-earnings report went from bad to worse as Amazon announced the current quarter will result in bigger losses than the last quarter. The $126 million dollar loss will swell to a $400 million dollar loss, maybe as much as $800 million.

Breaking down the forward guidance, about $410 million of the current quarter loss will be in the form of stock compensation. What makes this even more interesting is that the company lost about $14 billion in market cap today. Jeff Bezos lost $3.5 billion from his personal fortune; Bezos may be an internet visionary, but lacks some basic math skills.

Also yesterday, Visa reported net income for the quarter ended June 30 rose 11 percent to $1.36 billion, or $2.17 a share, from $1.23 billion, or $1.88, a year earlier. Analysts had expected $2.10 a share. Visa’s losses accounted for about one-third of the decline in the Dow today. So, the earnings side was good but the company reduced its revenue forecast for the rest of the fiscal year. One reason for the reduction – Russia. After the US imposed sanctions on Russia, Putin recommended Russia create its own payment system. Visa said that tensions with Russia may affect earnings by “several pennies,” and that headwinds, in the form of lower cross-border volumes, are likely to continue in the short term in international corridors such as Ukraine, Venezuela and Argentina.

The European Union has been holding meetings in Brussels to find agreement over imposing sanctions on Russia over its behavior in Ukraine. They’ve decided to put together an outline on sanctions and get together again next week; the outline would exclude the crucial gas sector.

Following the downing of Malaysia Airlines Flight 17, many Europeans are eager for their governments to do something to punish Putin for fomenting instability in the Ukraine. But the debate over economic sanctions is shining an awkward spotlight on the large and important trade relations between Russia and Europe. Russia is Europe’s gas station, and if Europe decides to stop doing business with Russia, they will have to figure out a new, and likely more expensive way to put gas in the car and to heat their homes.

According to the Energy Information Administration, oil and natural gas accounted for 70% of Russia’s export revenues in 2012; and most of those exports go to Europe; and most of Europe hasn’t figured out how to provide their own energy. Oil reserves in the North Sea are expensive to tap; fracking technology hasn’t happened for a number of reasons; and so Europe depends on Russia for about 30% of its natural gas. Many of Europe’s biggest corporations are directly involved in importing fuel from Russia, and many of Europe’s biggest industries, such as utilities, power-hungry manufacturers, car manufacturers, transportation systems, and anyone else who uses electricity – all rely on fuels imported from Russia.

If the EU were to suddenly grow a spine and just say no to Russian oil and natural gas, it would certainly inflict some short- term pain on Russia, but oil and gas are fungible and the market is global. One of Putin’s first moves was to sign a deal with China to make Russia a major supplier of natural gas. Europe does not have a quick replacement for Russia’s natural gas and winters in Europe can get very cold.

The US does not depend on Russian fuels, however there are a couple of strange side stories coming out of the sanctions. First, is the as-yet-unaddressed need to restart NASA, so we don’t have to depend on Russia for ride sharing to the space station. The other, is that Americans don’t really care much about Russia anyway; last week the US imposed a fresh round of sanctions on Russian companies, including weapons manufacturers. How did patriotic Americans respond? Well, you can no longer buy Kalashnikov AK-47s. Technically you can, you just can’t find any. The move sent American gun buyers into a frenzy, seeking to buy any and all AK-47s on any store shelf.

So, it should come as no surprise that Russia has stepped up its direct involvement in fighting between the Ukrainian military and separatist insurgents, unleashing artillery attacks from Russian territory and massing heavy weapons along the border. So, while the EU considers drafting a new outline of possible sanctions for further possible consideration; Russia may send in the troops.

About 34% of the contiguous United States was in at least a moderate drought as of this week.

Things have been particularly bad in California, where more than 80% of the state is in “extreme” drought, state officials have approved drastic measures to reduce water consumption. California farmers, without water from reservoirs in the Central Valley, are left to choose which of their crops to water. Parts of Texas, Oklahoma and surrounding states are also suffering from drought conditions. East of the Mississippi, rainfall has been rising. But global warming also appears to be causing moisture to evaporate faster in places that were already dry. Researchers believe drought conditions in these places are likely to intensify in coming years.

A new study released yesterday by NASA and the University of California Irvine shows we are losing water at a shocking rate in the West. Using a satellite designed to track changes in groundwater, the research team found that the Colorado River basin—which supplies water to 40 million people in seven states—lost 15.6 cubic miles of freshwater in the last 10 years. From December 2004 to November 2013 the Colorado basin lost nearly 53 million acre feet, or almost double the volume of the nation’s largest manmade reservoir, Lake Mead. (Actually, Lake Mead is no longer the biggest reservoir in the country; a lake in North Dakota takes that honor, as Lake Mead has shrunk.) More than 75% of that loss was due to excessive groundwater pumping. It’s the first study to quantify just how big a role the overuse of groundwater plays in dwindling water resources out West.

How did this happen without anyone noticing it? The answer, basically, is that up until this study, nobody had a good way of measuring how much water is stored underground. And the researchers aren’t certain how much groundwater is left. Water above ground in the basin's rivers and lakes is managed by the U.S. Bureau of Reclamation, and its losses are documented. Pumping from underground aquifers is regulated by individual states and is often not well documented.

In the last seven years, Lake Mead’s dwindling has accelerated. The lake is now just barely more than 1,080 feet above sea level, slightly below its previous record low set in November 2010. Lake Mead is expected to drop another 20 feet into record territory by summer 2016. The low water level is already affecting hydroelectric power production. If the water level drops below 1050, the Hoover Dam might not be able to produce electricity.

Well before then, perhaps as soon as next April, downstream water rationing will kick in—which has never happened before. A 2007 shortage-sharing agreement sets three elevations for which water restrictions will be imposed on the Lower Basin states of Arizona, California, Nevada, and New Mexico. The first shortage level, 1,075 feet, will likely come into effect in the next several months. It would require a total water use cut of 4.4%, with Arizona taking an 11% cut, Nevada a 4% cut, New Mexico 3.3% and California remaining the same.

Right now, Phoenix has officially recorded just over one inch of precipitation since the start of the year; the normal amount is just under 4 inches. The problem is that when above-ground water supplies run low - which is happening now, and it is common in California, even when there isn’t a drought - water managers use groundwater to meet public and farming needs. The study finds that so much groundwater has been used that it will be impossible to recover it naturally; overall supply of available freshwater will continue to decrease as a result.

Thursday, July 24, 2014

Thursday, July 24, 2014 - Bankster Logic

Bankster Logic
by Sinclair Noe

DOW – 2 = 17,083
SPX + 0.97 = 1987
NAS – 1 = 4472
10 YR YLD + .05 = 2.51%
OIL - .03 = 102.04
GOLD – 10.10 = 1294.90
SILV - .54 = 20.47

An extremely flat day on Wall Street but good enough for another S&P 500 record high close.

In economic news: Initial claims for state unemployment benefits declined 19,000 to a seasonally adjusted 284,000 for the week ended July 19, the lowest level since February 2006. In the past six months, unemployment has fallen much faster than expected, from 6.7 to 6.1%. The labor market is still struggling with long term unemployment and part-time jobs instead of full-time work, but it seems to be making progress.

One area not showing progress is wages. The Labor Department released its latest report on median wages; on a year-over-year basis, median earnings were up just 0.8% in the second quarter, to $780 per week, not enough to keep pace with inflation. The median wage data is a bit different than the weekly earnings data that comes out of the Labor Department’s payrolls report. That one is the average earnings, and what’s likely happening is the growth for top earners is pulling that series up more. Average earnings are up 2.1% year-on-year. The report also showed that women earned 83.5% of what men did.

The Commerce Department said new home sales dropped 8.1% to a seasonally adjusted annual rate of 406,000 units in June. It was the biggest decline since July of last year. May and April sales were revised lower. So this was a very weak new home sales report, but earlier in the week we saw a fairly strong report on existing home sales.

Let’s move over to earnings reports: can sell stuff, they just haven’t figured out how make a profit. Amazon is expanding grocery service, they introduced a new smartphone, and a set-top box for TV streaming, and they managed to increase revenue 23% to $19.34 billion from $15.7 billion in the earlier period. They also reported a loss of $126 million or 27 cents per share.

Caterpillar has the exact opposite problem; revenue fell but they posted a higher profit. Caterpillar’s revenue numbers have now fallen in six of its past eight quarters, with the quarterly year-over-year decline averaging 8.3%. In the last quarter, sales fell 3% from a year ago to $14.1 billion, while profit increased 4.1%.

Starbucks posted fiscal third-quarter profit of $512 million, or 67 cents a share, up from $417 million, or 55 cents a share a year ago. Revenue for the three months ended June 29 rose 11% to $4.1 billion from $3.7 billion.

Signaling a major turnaround in the airline industry’s fortunes, the nation’s three major legacy carriers; American Airlines, United Airlines and Delta Air Lines — all posted record profits in the past quarter. Delta reported net income for the second quarter of $801 million, up 17 percent from the year-earlier period. United Airlines, which had a loss in the first quarter and has struggled with its merger with Continental Airlines, posted a $919 million second-quarter profit. Douglas Parker, the chief executive of American Airlines, said today that the airline’s second-quarter profit, excluding special charges, of $1.5 billion was its best quarterly earnings performance ever.

General Motors posted second quarter earnings of $190 million on revenue of $39.6 billion, up from $39.1 billion in the same period a year ago. The problem for GM has been recalls for safety issues, which have killed 13 people. GM set up a compensation fund with $400 million; they have also paid $2 billion this year for the recalls, and they announced pretax charges of $874 million to cover future product recalls. GM is likely to feel the financial repercussions of the millions of cars it has recalled for years to come. The company has recalled 29 million vehicles this year, many of which haven’t yet been repaired. To give a sense of the pace, GM recalled around 15 million vehicles for ignition switch related issues so far this year, and repaired around 560,000 in the second quarter. It announced a recall of more than 700,000 vehicles for a separate issue just yesterday. The surprising part is the increase in revenue, which comes in part from pricing, but also the bad press hasn’t deterred buyers.

Businesses and individuals in the US have parked about $2.6 trillion in money market funds. It is generally considered a safe place to leave money short term, or that was the thinking until 2008, when money market funds broke the buck, dropping below par value of $1 per share. Turns out, the funds weren’t guaranteed. There is no government insurance on the safety of deposits, no regulator-required capital buffer to protect against losses, no central bank ready to stand as “lender of last resort” to keep a money market fund from suffering a short-term cash crunch. Of course, the Treasury and the Fed stepped in to bail out the funds and avoid a run on the funds, which would have been catastrophic.

And so, a mere 6 years later, the government has finally managed a few reforms, but they aren’t real reforms because the bankers fought reform tooth and nail.  The new reforms do not include capital buffers, but they will allow for a floating NAV, or net asset value. So your share in a money market fund may or may not be worth one dollar. And if you try to cash out, the funds can impose extra fees to slow down a potential run. That’s about it. After 6 years. I hope you feel safe and secure in the knowledge that nothing of any substance has changed in the last 6 years.

An examination by the Federal Reserve Bank of New York found that Deutsche Bank AG’s giant U.S. operations suffer from a litany of serious problems, including shoddy financial reporting, inadequate auditing and oversight and weak technology systems. In a letter to Deutsche Bank executives last December, a senior official with the New York Fed wrote that financial reports produced by some of the bank’s US arms “are of low quality, inaccurate and unreliable. The size and breadth of errors strongly suggest that the firm’s entire U.S. regulatory reporting structure requires wide-ranging remedial action.”

Deutsche Bank, one of Europe’s largest banks, was a forceful opponent of the Fed’s push to force foreign banks to comply with the same capital requirements as domestic banks. Officials from Deutsche Bank argued that the Fed’s requirement was too restrictive.  This year, the Fed went ahead with those tougher capital requirements for foreign banks. But it gave most of them until the middle of 2016 to comply. Yes, of course it’s theoretically possible that management could go through and fix everything that’s wrong with the firm’s US operations but, really, this is more of a tear down job.

Dark pools are where institutional investors can place large buy and sell orders without alerting the broader market. Prices and transactions are not reported; it is the furthest thing from a free and open marketplace.  Different financial institutions run a variety of dark pools. Barclays runs one of the biggest dark pools called Barclays LX. They’ve been sued by the state of New York for fraud; the suit alleges Barclays favored high frequency traders over other investors in the dark pool and they falsified marketing materials, inaccurately portraying the concentration of high-frequency traders in the market, and misrepresenting a service that purported to protect investors from predatory trading behavior.

Today, Barclays filed a motion to dismiss the lawsuit, and this is classic bankster logic; they argued that Barclays’ customers were sophisticated enough to understand that “glossy marketing brochures” about the dark pool, did not reflect its actual composition; their customers knew better than to rely solely on the marketing materials. So, they basically admitted they were lying in their marketing material, but their clients were smart enough to know that banks are liars.

President Obama called today for Congress to end a tax loophole that allows big corporations to designate a foreign country as their official address, in order to avoid US taxes. The corporation doesn’t have to actually move their headquarters, just set up an address overseas. Obama called on members of Congress to close the loophole even if they disagree with his broader calls for changes to the tax system that would lower corporate rates and close several loopholes, including that one. The legislative effort is unlikely to succeed in Congress.

Nine inversion deals have been reached this year by companies ranging from banana distributor Chiquita Brands to Medtronic. The whole idea is to pay less taxes while still enjoying the benefits of doing business in the US. Of course, the legal change of corporate headquarters is essentially a process of renouncing citizenship, and it just seems corporations should face the loss of citizenship the same way people do, which means they should pay an exit tax. There are other ways to put an end to this inversion tax evasion scheme. And if we don’t, you can count on executives whose companies were born of American ingenuity and which make their profits from American customers (including the government) will troll international waters for opportunities in low-cost tax havens. It’s a race to the bottom.

Wednesday, July 23, 2014

Wednesday, July 23, 2014 - Another Day Another Dollar

Another Day Another Dollar
by Sinclair Noe

DOW – 26 = 17,086
SPX + 3 = 1987
NAS + 17 = 4473
10 YR YLD un = 2.46%
OIL = 103.12
GOLD – 3.50 = 1305.00
SILV - .06 = 21.01

The Standard & Poor’s 500 index rose to an all-time high, as Apple boosted technology companies and health-care shares rallied through another busy day of earnings reports. The Dow was lower, mainly due to Boeing – we’ll get to that in a moment. Apple hit its highest level since 2012, based on earnings reported after the close yesterday.

Profits at S&P 500 members probably rose 6.2 percent in the second quarter, while sales gained 3.3 percent. Let’s knock out a few earnings reports:

Facebook posted $791 million in net income, or 30 cents a share, compared with $333 million or 13 cents a share in the second quarter of 2013; revenue totaled $2.9 billion compared to $1.8 billion in the year ago period. Mobile advertising represented 62% of its ad revenue; they have figured out Facebook on a smartphone. Facebook now claims 1.32 billion monthly users.

AT&T was once the telephone company, now it’s the second largest US mobile provider; they earned  $3.6 billion or 68 cents per share in the second quarter, down from $3.8 billion or 71 cents per share a year ago; even as revenue increase from $32.1 billion to $32.6 billion.

Biogen Idec rallied 11 percent after raising its full-year forecast, while Intuitive Surgical jumped 18 percent as results topped estimates.

At first blush, Boeing’s numbers looked good; the aerospace giant earned $2.40 per share, easily beating estimates of $2 per share; the company lifted its earnings outlook for the rest of the year. Shares dropped about 2%. Revenue growth disappointed. Commercial airline sales were up less than expected; there was a substantial charge for a military tanker. Boeing is one of the dogs of the Dow – down 7% year to date.

Delta Air Lines said its second-quarter earnings were up 17%, driven by higher passenger and operating revenue as traffic increased. Delta has said it plans to reinvest about 50% of its operating cash flow back into the business, resulting in $2 billion to $3 billion of capital expenditures annually through 2018, with $2.3 billion planned for 2014.

Another day, another General Motors recall; the only difference is that today’s recall does not involve ignition switches; it’s a problem with the seats. Today’s recalls total 717,950 vehicles covering six models; bring the total for the year to about 29 million. If you own a GM vehicle, call the dealer. The problem with ignition switches hasn’t gone away, just that today, it moved to Jeep-Chrysler, which announced nearly 800,000 vehicles will be recalled for ignition switch problems.

Another month, another downward revision from the IMF. In June, the International Monetary Fund forecast US economic growth would be about 3% to 3.5% for the rest of this year, and then they revised forecasts down to 2%. Today, the IMF said US economic growth would be about 1.7%. The IMF says lower growth expectations should contribute to continued slack in the labor market for the next three to four years, with the United States remaining below full employment until 2018.

The IMF says the Federal Reserve could keep its benchmark interest rates at zero beyond the middle of 2015, the date implied by policymaker forecasts, as long as inflation and financial stability concerns remain subdued. Future US growth could be disappointing if interest rates rise too quickly, or if there is a broader and concerted slowdown in emerging markets, or if increasing geopolitical tensions in Iraq and Ukraine prompt higher energy prices and severe financial and trade disruptions. The IMF also warned that an aging US population meant the economy would not be able to grow above 2% long term without significant reforms, including tax and immigration changes, more investment in infrastructure and job training, and the provision of childcare assistance, which could help lure more Americans into the workforce. Even without these measures, the IMF said there is "a strong case" for more government spending to support the economic recovery in the near-term, as long as there is a plan to deal with high entitlement spending later on.

Meanwhile, the IIF, the Institute of International Finance says investors have been willing to take on more risk, pushing borrowing costs down and stock prices higher, based in part on strengthening confidence in the US and global recoveries, but with perhaps too much exuberance. Investors don’t seem to be taking adequate account of the uncertainties around economic growth and monetary policy, and that points to a pull-back in markets. With uncertainty likely to increase on both fronts, a correction from current ultra-low levels of volatility could continue, accompanied by a correction in asset valuation. The IIF’s concerns echo those of some Federal Reserve officials, who said at their June meeting that low volatility levels and increased risk-taking signaled “market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy.”

Another day and the fighting continues in the Middle East. The latest count has 687 Palestinians killed in the conflict. Ben Gurion Airport in Tel Aviv remains closed to US airlines, and many other global carriers. Secretary of State John Kerry is trying to negotiate a ceasefire but it looks unlikely.
In the Netherlands, a day of mourning as the bodies of the victims were returned for identification. Most of the passengers were Dutch. Two military planes, one Dutch and the other Australian, carrying the first 40 coffins landed at Eindhoven air base. They were met by members of the Dutch royal family, the Prime Minister and hundreds of victims' relatives. In Kiev, the Ukrainian government reports two Ukrainian military jets were shot down within 20 miles of the crash scene.

The downing of a civilian jetliner might turn out to be the Lusitania moment that could draw the US and Russia into a new world war, but for now, it doesn’t seem likely. The more likely reaction will be an increase in sanctions against Russia, which the US has already done; the EU is more reticent. The European Commission, the EU’s executive arm, will put forward its proposals to a committee of the 28 EU member governments in Brussels tomorrow. The bloc’s foreign ministers this week called for plans for measures that could hit “access to capital markets, defense, dual-use goods, and sensitive technologies, including in the energy sector.” Russia supplies 30% of the natural gas to Europe, and it is a major trade partner. Yesterday, France delivered a $1 billion dollar warship to Russia, saying the Russians had paid for it and it was scheduled for delivery. Business drives the truck, coffins are placed in the back.

Events in Gaza and Ukraine have, for the time being, taken global attention away from the Syrian civil war and the ISIS’s advance through Iraq. Last Thursday and Friday were the two bloodiest days yet in Syria’s civil war, with more than 700 people killed in fighting between the Syrian government and ISIS, the Sunni militant group. An ISIS suicide bombing killed 31 people, mainly civilians, in Baghdad yesterday. ISIS appears to be consolidating its newly acquired territories. The government in Baghdad appears to be struggling to cobble together something that would actually pass as a government. The civil wars in Syria and Iraq are growing increasingly chaotic and there doesn’t seem to be much hope for resolution.

The Gaza and Ukraine conflicts are not likely to draw greater powers into a major conflict. And one reason is because Gaza and Ukraine are not major oil producers. The conflict that represents the largest potential threat to markets is still the ISIS invasion of Iraq; there oil supply could be severed and the jockeying among regional middle powers could possibly lead to a wider scale conflagration between Sunni and Shia sponsor states.

So, one of the indicators that things are getting better or worse will be reflected in the price of energy. Think of it this way: Everything you did this morning involved energy consumption: Waking up to your smart phone (charging overnight), putting on the coffee, pouring the cold milk from the fridge, taking a shower, driving the car to work and walking into your air-conditioned office. Likewise, the rest of your day will be one big consumption of energy. Anything that disrupts that supply of energy disrupts the work you do.

Right now there is probably a $5 to $10 fear premium built into the price of oil, and that seems to be acceptable. The signal from the energy market about the demand of energy and the risk of getting enough of it is clear: Prepare for less growth, less certainty and more geopolitical risk. The market, however, maintains a steady hand: Israel will be contained more or less, Russia and Ukraine will find a solution or just fade away. The non-acceptance of Black Swans is clear for everyone to see. The market is “perfect” in its information, zero interest rates will save us and we have all been fooled into believing that the real world no longer matters. Unemployment, social inequality, wars, innocents being killed, and TV images of people fighting to live another day are not relevant. Maybe, after 13 years of war, the US is just weary of any threat.

At some point the fear premium could pop and oil prices could jump to $150 or $200 a barrel, and if that happens the IMF forecast is way too high; if that happens the economy comes to a grinding halt; if that happens, everybody in the US and Europe will wake up and scream bloody murder, but for now, it’s just another day, another dollar.

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.