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 10^th, 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.

Friday, June 27, 2014 - Biscuits on the Table

Biscuits on the Table
by Sinclair Noe

DOW + 5 = 16,851
SPX + 3 = 1960
NAS + 18 = 4397
10 YR YLD  + .01 = 2.53%
OIL - .10 = 105.74
GOLD – 1.80 = 1316.10
SILV - .25 = 20.97

The major stock indices traded lower for most of the day, and only in the final minutes turned to positive territory. For the week, the Dow slipped 0.6 percent and the S&P 500 declined 0.1 percent, while the Nasdaq gained 0.7 percent. Volume spike today as the Russell Indices were reconstituted.

The Russell Indices are compiled by Russell Investments. The Russell 3000 is an index of the 3000 largest stocks in the US. The Russell 2000 is the 2000 smallest stocks in the Russell 3000. Once a year, the Russell indices are reconstituted, to reflect changes such as acquisitions, bankruptcies, or just changes in the size of the companies listed in the index. The reconstitution probably explains the increase in volume and the last minute increase in prices today.

Some things we need to know heading into the weekend; including Ukraine, Iraq, and Argentina. We’ll start with the situation in Ukraine. The European Union signed a free-trade pact with Ukraine today and warned it could impose more sanctions on Moscow unless pro-Russian rebels act to wind down the crisis in the east of the country by Monday. Georgia and Moldova signed similar deals, holding out the prospect of deep economic integration and unfettered access to the EU's 500 million citizens, but alarming Moscow which is concerned about losing influence over former Soviet republics.

EU leaders meeting in Brussels demanded that, by Monday, Ukrainian rebels agree to ceasefire verification arrangements, return border checkpoints to Kiev authorities, free hostages and launch serious talks on implementing Ukrainian president Poroshenko's peace plan.

EU leaders said they were ready to meet again at any time to adopt significant sanctions on Russia. Diplomats said they could target new people and companies with asset freezes as early as next week. More than 60 names are already on the list. Although it has drawn up a list of hard-hitting economic sanctions against Russia, the EU is still hesitating over deploying them because of fears among some member states of antagonizing their major energy supplier.

Meanwhile, leaders of the European Union's 28 member states voted on the next president of the European Commission, which serves as the EU's executive branch. The president sets the policy agenda, enforces rules and represents Europe abroad. They elected Jean Claude Junker on a 26-2 vote. The losing votes belonged to the United Kingdom and Hungary, and they really have a strong dislike for Junker; so much so that they may try to exit the EU. That probably won’t happen, but there is talk of an “in or out” referendum for the Brits.

A funny thing is happening in Iraq. The US is lining up support for Iraq from Iran and Syria. And the bombing has apparently started, but we’re still trying to figure out who is throwing the bombs. The first aerial bombing took place Monday or Tuesday, apparently carried out by the Syrian Air Force, acting at the behest of the Iranian government in support of the Iraqi government, which the US government supports, but only if the Iraqi’s purge the government of all the goofs who messed up over the past 10 years or so.

Which is to say, the war in Iraq is escalating. Already, the war involves Iraq, Syria, Iran, Turkey, Saudi Arabia, Qatar, ISIS or ISIL if you prefer, Israel, Lebanon, and of course the US. The Pentagon denied reports of US drone strikes along the Iraq-Syria border after reports by BBC of drone bombings. The Murdoch Street Journal reports Syrian airstrikes. Unidentified bombers have reportedly launched an air strike on ISIS positions in northern Iraq. Iraqi television has claimed they are US planes, but the Pentagon has denied responsibility.

US planes were identified by Iraqi television, but the Saudi Al-Arabiya network claims that the raid was carried out by Syria. Meanwhile, Iranian Special Forces sent in to help protect Baghdad and a few select holy sites, along with surveillance drones. And Israel has bombed Syria in retaliation for an attack from Syria that killed Israeli civilians in the Golan Heights.

And so with all this going on, the Pentagon admitted yesterday that armed US drones are now flying over Iraq, equipped with Hellfire missiles, deployed from a base in Kuwait, in addition to unarmed surveillance flights by drones and manned aircraft, and supplemented by US military advisers on the ground.

Meanwhile, the Pentagon says the United States has opened a "joint operations center" in Baghdad, boosting the total number of US service members to 500. And the New York Times reports that Iraqi government officials are saying that the US is planning to send more than 1,000 private security guards to Iraq to protect US troops, which amounts to far more than the US government has previous acknowledged.

For years Iraq has been a major oil producer; it kept Saddam in business all those years; back then Iraq produced about 2.5 million barrels a day; recently output has increased to more than 3 million barrels, and it’s estimated that production could easily top 6 million barrels. In a country of about 30 million, there should be enough natural resources for profound prosperity, but that is not the case. In recent years, none of this oil wealth trickled down to the grassroots, especially in Sunni areas of the country where signs of reconstruction, economic development, restored services, or jobs were hard to find. Instead, the vast new revenues disappeared into the recesses of a corrupt government, and from there – who knows?

So here’s where Iraqi oil, or the lack of its revenues at least, comes into play. Communities across Iraq, especially in embittered Sunni areas, began demanding funding for reconstruction, often backed by local and provincial governments. In response, the Maliki government relentlessly refused to allocate any oil revenues for such projects, choosing instead to denounce such demands as efforts to divert funds from more urgent budgetary imperatives. That included tens of billions of dollars needed to purchase military supplies including, in 2011, 18 F-16 jets from the United States for $4 billion. In a rare moment of ironic insight, Time magazine concluded its coverage of the F-16 purchase with this comment: “The good news is the deal will likely keep Lockheed’s F-16 plant in Fort Worth running perhaps a year longer. The bad news is that only 70% of Iraqis have access to clean water, and only 25% have clean sanitation.”

My grandmother used say, as long as we’ve got biscuits on the table, nobody should go hungry. I guess they never heard that saying in Iraq.

Nothing in today's complex world has a single cause, but you have to think that a major reason for all this is the oil.

Argentina is in trouble. They have until Monday to pay a group of hedge fund managers over $1.3 billion on defaulted bonds. If they don’t pay, they risk default. If it goes into default, investors lose faith in Argentina’s capacity to pay, interest rates on its bonds surge, and the country is forced to print money to pay creditors, the economy could collapse.

Then again, if Argentina does pay this group of hedge fund managers over $1.3 billion worth of bonds by July 30, it opens itself up to lawsuits from other investors who also own those bonds, lawsuits that could cost the country up to $15 billion. That's over half the money it has in its central bank.

The story goes back to 2001, when Argentina was going through a financial crisis. Argentina issued bonds, and they defaulted on those bonds. After the default, hedge fund manager Paul Singer and some other hedge funds swooped in to buy the defaulted bonds for pennies on the peso. They knew they were buying defaulted bonds, but the idea was that things might improve or there might be a deal negotiated; that’s what usually happens, debt issuers restructure debt, and negotiate with creditors to pay less. Creditors usually take the deal because it is better to get something rather than nothing. Most of Argentina’s creditors have decided to accept 70 cents on the dollar.

But Paul Singer is demanding 100% face value of the bonds. And if he is not paid, there is a clause that says no other creditors can be paid. And if Argentina pays the full amount to Singer, the other creditors will likely not be satisfied with a 70% haircut. And the reason Argentina is in this jam is because Singer sued, and it went all the way to the US Supreme Court, and the Supremes sided with the hedge funds, and let stand a district court ruling.

The Supreme Court has been busy handing down decisions this week; and we will likely get a couple more decisions on Monday; I guess they don’t hand down decisions on Friday, and opt instead for an early happy hour. Anyway, the decisions of the past week were downright strange for one reason; several were unanimous. Wednesday, the court decided Riley v. California, which unanimously held that police cannot search the cellphones of people they arrest without a warrant. On Thursday, the court handed down two of its major opinions of this year: National Labor Relations Board v. Noel Canning, about the president's recess appointment power and McCullen v. Coakley, about abortion clinic buffer zones.

You will recall that the court is split ideologically, with 5 justices leaning right and 4 justices leaning left, so it’s a little surprising to see the twain meet. Unanimity is rare; a fractured court is the norm, and yet, we had three unanimous decisions among people who are inclined to disagree; and at a time when the House of Representatives is suing the president and people from one side can’t have a civil conversation with someone from the other side. Maybe this is an example of the rule of law being more important than politics. Before we declare a victory for compromise, maybe there’s a little more to how the court arrived at unanimity.

Even when the court agrees on a ruling, it can divide over the reasoning and even how the rule should be applied. In other words they take very different paths to arrive at the same place. It is possible that a 5-4 decision is not an indication of a polarized court. You have to read the decisions behind the vote. And conversely, a unanimous decision can mask deep divisions that appear down the road.

Thursday, June 19, 2014 - Market Hits Record Highs and Supreme Court Hands Down More Decisions

Market Hits Record Highs and Supreme Court Hands Down More Decisions

By Sinclair Noe

DOW + 14 = 16,921
SPX + 2 = 1959
NAS – 3 = 4359
10 YR YLD + .01 = 2.62%
OIL + .48 = 106.07
GOLD + 42.80 = 1321.30
SILV + .86 = 20.86

Taking a look at economic data, weekly claims for jobless benefits fell 6,000 to 312,000; the labor market still has plenty of slack but still shows signs of modest improvement. The Philly Fed manufacturing index was up to its highest reading since last September. And the Conference Board's index of leading economic indicators rose 0.5% to 101.7 in May.

President Obama said today that the United States would deploy up to 300 military advisers to Iraq to help its Iraqi government forces fend off Sunni militants. Obama emphasized again that he would not send combat troops to Iraq, although there seems to be a fine line between combat troops and advisers; he said the United States would help the Iraqis “take the fight” to the militants, who he said pose a threat to Iraq’s stability and to American interests, because Iraq could become a sanctuary for terrorists who could strike the United States or its allies.

Secretary of State John Kerry will go to Europe and the Middle East this weekend to build support among Iraq’s Arab neighbors for a multisectarian government in Baghdad.

Markets were in negative territory most of the day, nothing big, then we recovered near the end of the session, nothing big; the S&P 500 hit its 21^st record high close of the year. This market is just slowly scratching and clawing its way higher, and that’s a good thing. When the markets go on a sharp move higher, sometimes called a parabolic run, it usually ends with a nasty fall. For now, the markets are moving higher but staying within the channels of standard deviation.

There are plenty of geopolitical hotspots, and a boatload of economic uncertainty, but the US equity markets are as constant as you could want. The past 44 consecutive sessions of the Standard & Poor's 500 index have fluctuated upward or downward by less than 1 percent. To put that streak in context, the S&P 500 hasn't seen this little movement since 1995, when the index didn't change by a full percentage point for 95 days. All the while, stocks have been steadily ticking up. The S&P 500 is up 6% year-to-date.

There always seems to be a crisis somewhere and maybe investors and Wall Street traders are just crisis weary, even if it is a little dangerous to wait for the next hotspot to implode. Ukraine hasn’t resulted in disaster, at least not for the US. We’ve been dealing with a mess in Iraq for more than 10 years, so there’s no reason to freak out now. The full impact of recent world events is still unclear, so just keep trading. Compared with past conflicts in the Middle East, America has reduced its dependence on oil in the region and thus may not be feeling the effects of the current crisis as strongly.

The Federal Reserve’s QE policy has been a tremendous success for Wall Street, even if it hasn’t trickled down to Main Street. Impressive corporate earnings growth may be outweighing any effects that world events are having on the markets. Earnings of companies in the S&P 500 are expected to growth by a rate of 5.4% in Q2 2014, with nine of the ten sectors in the index projecting higher growth than last year.

Yesterday, Fed Chairwoman Janet Yellen dismissed inflation as nothing more than noisy. Wall Street traders loved the dismissal of rising prices as an indication that the Fed would not be swayed from their ongoing accommodative policy. Still, you have to wonder where the Fed is going as they try to oversee an uneven recovery and a benign exit from QE.

Like the Fed, the Bank of England has kept interest rates in the near zero range for the past 5 years. Last week, BOE Governor Mark Carney indicated that economic liftoff might come sooner than the markets think. Unemployment in Britain has been falling faster than expected, even though there is still considerable slack in the labor market. British GDP has steadily risen over the past year and is now just 0.6% below its pre-crisis peak. The improving picture could nudge the BOE toward a rate increase sooner rather than later. And so the BOE has its own form of forward guidance, stressing that the timing of the first rate increase is less important than the idea that once rates increase, the degree and pace of increases will be gradual and limited; in other words, a soft and gentle slope.

The Supreme Court is handing down decisions this week. Today they issued a unanimous ruling on Alice Corp v. CLS Bank International, a case that deals with patents. Alice Corporation, an Australian company developed a method for mitigating settlement risks among multiple parties. In its Supreme Court brief, the company said the method was eligible to be patented largely because it involved shadow records updated in real time that “require a substantial and meaningful role for the computer.”

The patents were challenged by CLS Bank International, which says it clears $5 trillion in foreign exchange transactions a day using methods to ensure that both sides performed. The bank said that Alice Corporation’s patents merely recited “the fundamental economic concept of intermediated settlement of escrow.”

A trial court invalidated Alice’s patents and then a court of Appeals affirmed the lower court ruling. Writing for the Supremes, Justice Clarence Thomas said that was “a patent-ineligible abstract idea,” and “Merely requiring generic computer implementation fails to transform that abstract idea into a patent-eligible invention.”

The case had been closely watched by the software industry. Patent claims over the way ideas are incorporated into computers, cellphones and other devices have become a challenge for many high-tech companies. Justice Thomas indicated that the decision posed no threat to the concept of software patents, writing: “There is no dispute that many computer-implemented claims are formally addressed to patent-eligible subject matter.”

The Supremes were also unanimous in ruling on United States v. Clarke; in this case the Court held that a taxpayer may conduct an examination of IRS officials in response to a summons for information and records if the taxpayer can point to facts or circumstances that could raise an inference of bad faith on the part of the IRS.

Another unanimous ruling says the First Amendment protected an Alabama whistleblower. In Lane v. Franks, the high court ruled that Edward Lane's First Amendment rights protected him from job retaliation when he testified in the public corruption trial of then state Rep. Sue Schmitz in 2010, who was accused of being on the payroll at the college but failed to actually show up for work. Schmitz’ bogus job was uncovered and detailed, along with many other cases of corruption in the state's two-year college system as part of a two-year investigation of the system by The Birmingham News in 2006-07.

 Lane was fired by the two-year college he worked after his testimony. Lower courts had ruled against Lane, finding that he was testifying as a college employee, not as a citizen. Writing for the court, Justice Sonia Sotomayor said Lane's testimony was constitutionally protected because he was speaking as a citizen on a matter of public concern, even if it covered facts he learned at work. The decision is a win for whistleblower advocates, who said it could encourage more government workers to cooperate with prosecutors in public fraud cases without fear of losing their livelihoods.

Meanwhile, there is still some fallout, and uncertainty surrounding a Supreme Court decision earlier this week involving sovereign debt of Argentina. Argentina defaulted on nearly $100 billion of debt in 2002. Because some of the debt was sold under New York law, it faced a court challenge after it settled with only some creditors in 2005 and 2010. A few “hold out” creditors sought better repayment terms, specifically, some hedge funds bought the debt after the 2002 default for pennies on the dollar and then demanded full payment. The president of Argentina has called the hedge funds, “vultures” The Supreme Court has given the vultures a victory.

In the next 10 days, we’ll see if Argentina will succeed in defying the United States courts. On June 30, there is a scheduled interest payment on a set of Argentine bonds that its government wants to pay. But the courts say that interest may not be paid unless the country pays all it owes on bonds it defaulted on years ago, something Argentina says it cannot and will not do.

Argentina’s plan is to convert the bonds on which it wants to make payment into new bonds that would not be subject to New York law. Several banks and other financial institutions were willing to accept a partial payment but now that might risk the ire of American courts.

There is no equivalent to bankruptcy law for sovereign debtors. There is no legal procedure to resolve debts of destitute countries. There is no court to approve a restructuring plan that will wipe out some debts and convert others to equity, as there is for companies. Instead, troubled countries negotiate with lenders to restructure the debts. That restructuring could involve reducing the amount owed, lowering the interest rate, extending the maturity of the debt or some combination of the three.

The IMF would typically work with poor countries by offering emergency money contingent on financial reforms for the country; the IMF money was understood to rank above the old debts. Bondholders could, and did, hold out for full payment, but they faced the risk that the restructuring would go through and those who agreed would get partial payouts, while the holdouts got none. Now it has changed, at least for countries that issue bonds under New York law. The hand of holdouts has been strengthened immensely. Financial market service providers are now sovereign debt enforcement agents.

What would happen then? In a brief submitted to the Supreme Court, Joseph Stiglitz, the Columbia University professor who was formerly chief economist of the World Bank, offered a warning: “Unable to restructure, governments that default would be permanently shut out from the debt market, with consequential adverse effects on development and economic growth prospects.” In other words, a modern day debtors’ prison for countries with oppressive debt.

We’ll see how this one unfolds.

Wednesday, June 18, 2014 - Forecasts Are Subject to Change

Forecasts Are Subject to Change

by Sinclair Noe

DOW + 98 = 16,906
SPX + 14 = 1956
NAS + 25 = 4362
10 YR YLD - .04 = 2.61%
OIL - .15 = 105.72
GOLD + 5.80 = 1278.50
SILV + .14 = 20.00

The Federal Reserve FOMC meeting wrapped up today. The Fed issued a statement that was almost a carbon copy of the April statement. The Fed said that growth “has rebounded in recent months” and the labor market indicators “generally showed further improvement.” The central bankers noted that business fixed investment had “resumed its advance” after saying that it “edged down” in April. The only negative comment was that the housing sector “remained slow.”

The Fed will hold interest rates steady for now, and probably well into next year; and they will continue to cut back on their large scale asset purchase program by another $10 billion per month. So, starting in July, the Fed will only buy $35 billion in Treasuries and mortgage backed securities.

The Fed statement was generally upbeat: "Economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually. Household spending appears to be rising moderately and business fixed investment resumed its advance."

Fed Chairwoman Janet Yellen held a press conference and the topic of inflation was brought up. The feeling is that the Fed wants to see solid signs of recovery, and inflation isn’t a concern; those inflation numbers are just “noise”, according to Yellen. Yellen said: “The data we’re seeing is noisy, inflation is rising in line with expectations.”

 So, when you pay 7.7% more for hamburger, or 4.2% more for milk, or 5.8% more for airline tickets, or 5% more for car insurance; don’t worry, it’s just noise. You might want to wear ear plugs the next time you fill up at the gas station.

Yellen figures the stock market valuations are not out of historical norms, so even though the markets are trading around all-time highs, there are no bubbles forming. And the low volatility is not due to complacency, which is the actual definition of low volatility.

The Fed has been forecasting stronger growth right around the corner, and that is still the long range outlook, but the first quarter threw a monkey wrench into the forecast; blame it on the weather, or whatever. They now forecast GDP to rise 2.1% to 2.3%, down from the 2.8% to 3% forecast in March. Once again, strong growth is just over the horizon, like a carrot dangling just in front of a horse.

The markets just love an accommodative Fed. The S&P 500 hit a record high close, the Dow rebounded for nearly a hundred point gain, bond prices move higher, even small caps got dragged along for the ride.

Recessions are often considered to be over when there have been two quarters in a row of positive growth. The euro zone hit that mark when it squeezed out annualized growth of 0.5% in the third quarter after growth of 1.3% in the second quarter. Not so fast, at least according to economists at the Center for Economic Policy Research; they say the Euro-recession is merely hibernating; growth is still too weak and unemployment too high to declare the recession over.

The research group says that economists and policy makers should look more broadly at other indicators, like the sustainability of growth and unemployment. Joblessness in the euro zone is 11.7%, just below a record. The recession that began in mid-2011 is the longest since the group began keeping track in 1970. A committee of the group said in a statement: “Since early 2013 the euro area has witnessed a prolonged episode of extremely weak growth in economic activity. Labor markets have shown little change over that period.”

The International Monetary Fund is warning that the legal defeat Argentina suffered Monday in its decade-long fight against holdout bondholders could ricochet around the world’s sovereign debt markets, saying: “We are concerned about possible broader systemic implications.”

Last year, the IMF warned that if Argentina lost its case against creditors, the case could set a precedent that gives holdouts outsized power over nations struggling to pay back their debts. That, the IMF warned, could undermine sovereign debt restructurings around the globe. Cutting the amount of debt owed to creditors is a last-chance emergency measure sometimes needed to prevent the collapse of entire economies.

The IMF, the Group of Seven leading industrialized economies and others will have to rethink their reliance on sovereign immunity for getting restructurings done and courts around the globe will be forced to resolve conflicts between the Argentina legal case and their own law on sovereign debt. Financial markets are being forced to write new contracts that avoid complicated fights that leave creditors and borrowers in legal limbo for years.

For its part, the IMF is  reassessing how it handles the debt of countries in crisis. If a country can’t pay its debts, the IMF has traditionally only considered forcing a debt restructuring as a condition for an emergency fund loan. Now, it is considering offering an alternative: extending bond maturities.

In the past the IMF said that while bail-in measures would be voluntary (ranging from rescheduling of loans to bond exchanges that result in long maturities), creditors would understand that the success of such measures would be a condition for continued Fund support for the adjustment measures. Later this week, the IMF plans to post its latest policy musings on the issue.

Meanwhile, lawyers for Argentina say they will meet with hedge funds in New York, later this week to negotiate with hedge funds that held out on a partial payment for bonds. Argentine President Cristina Fernandez Kirchner has labeled the holdout investors "vultures" for picking over the carcass of the broken economy in the wake of the 2001-2002 default. In a televised address to the nation yesterday she said Argentina was the victim of "extortion" by the holdouts, but that she was still open to negotiations and insisted she would continue to pay the more than 90 percent of creditors who accepted the restructuring terms in 2005 and 2010.

Mary Barra, chief executive of General Motors, came under renewed attack today from lawmakers who were not satisfied with the company’s investigation into its delayed recall of millions of cars and challenged her on whether its most recent recalls should have been made earlier.

On congressman produced a string of internal emails from 2005 that showed that one GM employee had experienced a stalling problem in a Chevrolet Impala. The employee said in an email that the Impala she was driving had inexplicably shut off when she hit a bump in the road.

“I think this is a serious safety problem, especially if this switch is on multiple programs,” she wrote in an email to another GM employee. “I’m thinking big recall.”

As early as December 2000, drivers of the Chevrolet Impala and the other newly recalled cars began lodging complaints about stalling with the National Highway Traffic Safety Administration. That vehicle, however, was not recalled until this week, when the Impala was among 3.36 million cars worldwide recalled for a faulty ignition key. Those vehicles recalled were in addition to the 2.6 million Chevrolet Cobalts, Saturn Ions and other small cars with a defective ignition switch that the automaker has linked to at least 13 deaths and 54 crashes.

Barra testified that she did not believe that recalls were routinely avoided in the past. “If there was a serious safety problem, a recall would have been done,” she said.

In the end, the panel said it would continue to investigate G.M., including the role of safety regulators, and may hold more hearings on the subject.

Send in the drones. Iraq has asked the United States for air support in countering Sunni rebels. General Martin Dempsey, the chairman of the US military's Joint Chiefs of Staff, gave no direct reply when asked at a Congressional hearing whether Washington would agree to the request. ISIS has essentially taken over a major oil refinery in northern Iraq, but the Maliki government says they have not lost the refinery and government troops are still holding on; but if they are holding on, it’s by a thread. The big oil companies are evacuating some of their employees from refineries in the south. Iraqi troops are holding off Sunni fighters outside Samarra north of Baghdad.

The stunning and unexpected victories by the Islamists are very worrisome. In a region that is no stranger to conflict, this one is particularly frightening and has far-reaching consequences, including the threat of spin-off groups similar to ISIS taking root in surrounding nations.

A militarily successful Islamist force straddling over parts of Iraq and Syria will pose a real threat to the security and stability of those countries’ immediate neighbors. Even Syria, where government forces are fighting their own civil war, has offered to send troops to Iraq.

What appears to be the most likely scenario at this point is that the rapid Sunni militant advance is likely to be stalemated at or north of Baghdad. They will probably continue to make some advances, but it seems unlikely that they will be able to overrun Baghdad and may not even make it to the capital. This scenario appears considerably more likely than the two next most likely alternative scenarios: that the Sunni militants overrun Baghdad and continue their advance south into the Shia heartland of Iraq; or that the Shia coalition is able to counterattack and drive the Sunnis out of most of their recent conquests. That’s what the markets are betting on right now, but forecasts are subject to change.

Monday, June 16, 2014 - Manic Monday

Manic Monday
by Sinclair Noe

DOW + 5 = 16,781
SPX + 1 = 1937
NAS + 10 = 4321
10 YR YLD - .01 = 2.59%
OIL - .12 = 106.79
GOLD – 4.20 = 1272.70
SILV un = 19.77

It’s Monday, and that means mergers. Today’s acquisition news comes from Medtronics, the medical device maker, announcing it will acquire Covidien for nearly $43 billion. Medtronics was founded in a garage in Minneapolis in 1949, but they will change their headquarters to Ireland, which is where Covidien has been headquartered since 2009. Covidien is actually a Massachusetts company, and they operate out of Massachusetts. Medtronics will continue to operate out of Minneapolis; the whole deal is about a lower tax rate, and for Medtronics, the ability to repatriate $20 billion in offshore profits, without paying tax.

Meanwhile, the IPO market remains white hot, and 14 companies will come to market this week. So far this year 124 companies have priced in the US, up 57% from a year ago. Total proceeds raised come to $25.8 billion, up almost 41% from 2013.

Data today showed industrial production climbed more than forecast in May. Output at factories, mines and utilities rose 0.6% after a revised 0.3% drop in April that was smaller than previously estimated. In a separate report, the New York Fed’s Empire manufacturing report rose to 19.28, better than expectations.

The Fed FOMC meets later this week to determine monetary policy. After their meeting concludes Wednesday, Fed officials will release their updated projections for interest rates, growth, inflation and unemployment, and also are likely to trim their bond-buying program by an additional $10 billion a month.

The latest report from the International Monetary Fund, the IMF, might suggest the Fed doesn’t need to be in a hurry to exit a Zero Interest Rate Policy. Of course, the IMF doesn’t set Fed policy, but the latest IMF forecast for the US economy cuts the outlook for growth to 2% from the 2.8% predicted back in April; the lower forecast is mainly a result of the weakness in the first quarter. The IMF kept if 2015 forecast unchanged at 3%. The forecast says the economy is starting to rebound but will remain below historical averages as the population ages and productivity growth slows. Their forecasts show we won’t return to full employment until the end of 2017, with inflation remaining low.

The IMF suggests the US raise the minimum wage as one way to boost the economy; other suggestions include more spending on infrastructure and education, plus changing parts of its tax system, including boosting the federal gasoline tax and reinstating the tax credit for research and development, to help spur growth. In the future, policymakers should also reform corporate taxes, introduce a carbon tax and move toward a federal value-added tax.

IMF Director Christine Lagarde says the oil shock that could result from the current tension in Iraq might affect the economy but for that to happen, the shock would have to be rather deep and rather long-lasting. You’ll probably start seeing the price increase at the pump, as prices hover just below $107 a barrel. And oil prices are being whipsawed by the headlines; if we see fighting in Baghdad, we could easily see prices pop up to $120 a barrel.

Iraq, excluding the Kurdish region, holds 150 billion barrels in proven crude reserves, the world’s fifth-biggest deposits. A pipeline from the Kirkuk region to Turkey has been shut down since March, and now Kurdish troops are defending the Kirkuk oilfields from ISIL rebels. Even if the rebels are turned back, the Iraqi government in Baghdad may have a hard time displacing Kurdish troops in the future.

Meanwhile, Ukraine said Russia cut natural gas supplies after demanding fuel payments be made in advance, the first time shipments have been affected in this year’s crisis in relations between the two countries. Tensions escalated over the weekend with 49 servicemen killed when pro-Russia fighters shot down an aircraft.

British climate change economist Lord Nicholas Stern says our current models “grossly underestimate” the economic damage that will be wrought by climate change. In 2006 Stern wrote a scientific paper that estimated the externalized costs of burning fossil fuels will impact the world economy by five per cent to 20 per cent of global GDP, which would work out to between $2.3 trillion and $9.1 trillion each year. Now, Stern says he “got it wrong on climate change; it’s far, far worse.”  So, Stern and a colleague, Simon Dietz just published a new preliminary paper that makes a few key updates, and now Stern believes that “climate change is the greatest markets failure the world has ever seen.”

The old model looks at any point in time, measures the economy’s productive capacity, and then gauges how much climate change will dampen that productivity in that moment. But climate change can also reduce that productive capacity itself. Stronger storms can damage infrastructure; sea level rise can force people to abandon homes, businesses or equipment; and climate damage can channel more investment into repairs and away from creating new capital. Stern and Dietz account for that, and the result is a double hit: at any given moment, the effects of climate change are reducing the economy’s ability to produce wealth, but they’re also reducing the economy’s overall capacity to produce wealth at future moments.

Other factors in modeling climate change’s economic effects are what scientists call “tipping points”; moments when global warming kicks off feedback loops in the planetary ecology that cause the effects to speed up. Examples of tipping points include the polar ice melting in a way that results in sudden huge collapses rather than gradual melting; or melting permafrost in the northern hemisphere releasing underground methane that in turn speeds up global warming even more. They can also include second-order social effects that damage economies: drought and food scarcity kicking off wars or mass refugee movements, for instance.

June is a big month for the Supreme Court and several major rulings are expected in the next few weeks, and some cases have already been decided.

Last Thursday, the Supremes announced opinions on only two of the 22 cases it has in front of it: POM Wonderful v. Coca-Cola which deals with whether a company can sue another one for unfair competition based on false or misleading product descriptions; and Clark v. Rameker, which weighs whether individual retirement account (IRA) inheritance can be exempted from Chapter 7 bankruptcy under the “retirement funds” exemption.

In the POM case, the court ruled that POM, a company that makes pomegranate juices, had the right to sue Coca-Cola for falsely advertising one of its juices as being made mostly of pomegranate and blueberry juice when it was actually made of apple and grape juices. POM, which makes a special pomegranate-blueberry juice blend, claimed it lost sales as a result of Cola-Cola’s false labeling. The ruling reversed a decision from the Ninth Circuit Court of Appeals, which essentially said POM lacked the legal standing to sue because of a conflict with state and federal law.

In Clark v. Rameker, the court ruled that IRA inheritance funds do not meet the “retirement funds” exemption and must be included as part of the estate in the bankruptcy process. Because an IRA is intended for the retirement of the person who originally put the funds into the account, and an inherited IRA functions essentially as a fund that can be used at any time and not just for retirement, the exemption does not apply.

Today, the Supreme Court handed Argentina two major defeats in cases brought by bondholders who refused to accept reduced payments after the country’s 2001 default. The Supremes decided against hearing Argentina’s appeal of an order requiring it to pay holders of defaulted notes from 2001 when making payments on its restructured debt. The next payment on those bonds comes due June 30. Shortly after the first decision, the Supremes handed down another ruling allowing the bondholders to issue subpoenas to banks in an effort to trace Argentina’s assets abroad.

The inaction by the Supreme Court is a victory for the minority of investors, led by a hedge fund controlled by billionaire Paul Singer, who have refused to exchange their defaulted bonds for about 30 cents on the dollar. Argentina calls those investors “vultures” because they bought many of the bonds post-default at a discount, angling to eventually collect a windfall; in other words, they bought the bonds for pennies on the dollar, refused to accept 30 cents on the dollar, and the Supremes say they now must be paid the full face amount of the bonds.

In response to today’s decisions, lawyers for Argentina wrote: “Since Argentina lacks the financial resources to pay the holdouts in full (what would amount to $15 billion) while also servicing its restructured debt to 92 percent of bondholders, Argentina will have to face, objectively, a serious and imminent risk of default.”

Argentina claimed that lower-court rulings misread Argentina’s bond agreements and violated its immunity as a sovereign nation. In court filings, the Argentine government has said it would comply with lower-court rulings. But in public pronouncements, Argentine President Cristina Fernández de Kirchner has vowed not to pay a group of creditors she has referred to as “predators.”

Also today, the Supremes dealt a rare blow to the gun lobby Monday by ruling that purchasers must report when they are buying firearms for other people.

Other rulings expected this week might include Sebelius v. Hobby Lobby, which deals with whether a for-profit company has to provide contraceptive care for its employees if the owner has a religious objection, even though the employees are entitled to it through the Affordable Care Act (ACA), also known as Obamacare.

Also, American Broadcasting Company v. Aereo, which should be of interest if you watch TV over the internet. Aereo is a Web startup company that allows consumers to pay an $8 or $12 subscription fee to watch their local TV networks live on any Internet-connected device. The major broadcasters say this amounts to theft of their product.

And a couple of cases that deal with the Fourth Amendment: Riley v. California, and United States v. Wurie; both cases are about whether the police have to obtain a warrant to search an individual's cellphone when an arrest is made.

Wednesday, February 19, 2014 - Stake your Claim

Stake your Claim

by Sinclair Noe

DOW – 89 = 16,040
SPX – 12 = 1828
NAS – 34 = 4237
10 YR YLD + .02 = 2.73%
OIL + .81 = 102.91
GOLD – 11.40 = 1311.90
SILV - .43 = 21.64

This winter has been brutally cold for much of the country, the worst in 20 years. The harsh weather makes an easy scapegoat for slow economic growth and sickly earnings. Every bad bit of economic data and all ugly earnings reports can be buried under the snow and ice. Many companies and sectors aren’t really affected by the weather; while others were definitely slammed.

This is true of new construction. The Commerce Department reports housing starts dropped 16% to 880,000 in January from 1.05 million in December. For all of 2013, builders began work on 926,700 homes, up the most since 2007’s 1.36 million. The good news is that the weather related downturns will eventually melt away like so much ice on a warm sidewalk.

Another report today showed producer prices increased 0.2% in January, led by gains in goods such as food and pharmaceuticals. This follows a 0.1% increase in the PPI in December. Today’s data mark the debut of the PPI after its first major overhaul since 1978, which more than doubles its reach of the economy by including prices received for goods, services, government purchases, exports, and construction. The revamped PPI encompasses 75% of the economy, up from a third of all production for the old index, which reflected the costs of goods alone.

Since services represent the biggest part of the economy, the gauge will offer a broader look at inflation at the producer level. Goods will account for about 24% of the new PPI gauge; while service, including financial services, food wholesalers and transportation providers, make up 63%; prices of government purchases and exported goods represent 11%; construction is 2%. What this new methodology might do is to smooth out inflation at the wholesale level because goods are inherently more volatile than services. What the report reveals is that we are experiencing disinflation.

So, those were the two economic reports of the morning, and the Dow Industrial average was rolling along with about 50 points in gains, then we saw the minutes of the January Federal Reserve FOMC meeting. Fed officials agreed unanimously to continue to slowly reduce the pace of its asset-purchase program by another $10 billion to $65 billion per month and to pledge to keep rates low until “well past” the point where the unemployment rate fell below a 6.5% threshold. This was the first unanimous statement since 2011. And that’s about where the unanimity ended.

A few Fed hawks thought it might be good to increase short term rates within the next few months; a few Fed doves thought it might be good to slow down the pace of the taper; that brought a response that there should be a “Clear presumption in favor of continuing to reduce the pace of purchases by a total of $10 billion at each policy-making meeting, especially if there is no evidence of a change in the outlook.” The debate on changing the forward guidance, the pledge to the market about keeping rates low, was all over the map. Some want to lower the unemployment rate threshold, while others want a more descriptive or “qualitative” guidance.

And the Fed policy makers described the weak December jobs report as an “anomaly”. Now, remember that the FOMC meeting took place just a few days before the weak January jobs report; so I suppose we could describe that as a double anomaly. If there is a third consecutive weak jobs report for February, then I think we might call it egg on the face. The bottom line is that for now, the taper is on track, rates will remain low for at least a year, we’ll have plenty of forward guidance, and Janet Yellen’s job is something like herding cats.

There are a couple of interesting court cases; one involving Argentina and the other, Detroit.

The country of Argentina has asked the US Supreme Court to review a case that has unsettled the Argentinian markets and currency and might force the country to make payments on billions of dollars of defaulted bonds.

The dispute stems from Argentina’s 2001 default on $95 billion in debt. The country offered to substitute bonds worth 25 cents to 29 cents on the dollar in 2005 and made a similar proposal in 2010. Owners tendered about 92 percent of the outstanding debt. NML Capital, a fund run by billionaire Paul Singer, swooped in and bought about $1.5 billion in bonds for pennies on the dollar, and then they did not accept the swap, opting instead to go through the courts. NML sued to collect the full amount, citing a clause in the bond agreement bars Argentina from treating the restructured securities more favorably than the defaulted bonds.

Argentina challenged a lower court ruling that said the country must pay owners of the repudiated bonds in full before it can make payments on a separate $24 billion in restructured debt. The legal fight has put US courts in the unusual position of shaping another country’s financial future. Argentina says the dispute threatens to force a new default, and lower court rulings have led to credit ratings downgrades. The Argentines further argued that the lower court rulings “effectively reach into Argentina’s borders, coercing it into violating its sovereign debt policies and commandeering billions of dollars of core sovereign assets.”

The appeals court rulings in the case are on hold while the Supreme Court decides whether to get involved. Some decision is expected from the Supremes by around April. Argentina previously said it would never pay the funds, which the country’s leaders have called “vultures.” Its legislature passed a law in 2005 barring payment on the defaulted bonds. Another option under consideration is that the country will offer a new restructuring plan to defaulted bondholders and let investors who own the restructured notes swap them into debt subject to local law.

Meanwhile, Detroit is as broke as Argentina. Lawyers are arguing over how to split the money that’s left. A lawyer for the city says Detroit’s general obligation tax pledge doesn’t give bondholders priority over other creditors in its record $18 billion municipal bankruptcy. Bond insurers have sued Detroit, claiming a proposal by the city’s emergency manager to cut payments to general obligation bondholders is illegal. The insurers say that pledges the city made when the bonds were issued give bondholders certain rights over the taxes.

The dispute may require the judge to weigh in on a long-running debate among legal scholars about whether certain municipal bonds get priority over more traditional unsecured creditors, such as public employees or suppliers. The city’s lawyer argued the city’s pledges to bondholders are no different from those made to all unsecured creditors. Such general promises mean the municipal bonds in dispute are unsecured. Detroit didn’t set aside any property that could be used as collateral for the bonds, or create a special lien on the taxes. The current offer would pay public employee pensions 25 cents on the dollar and GO bond holders 22 cents. The bond insurers present their case in a couple of days.

The city may also try again to resolve a dispute over interest-rate swaps that cost taxpayers about $4 million a month. Detroit may present a new proposal for canceling the swaps in the next three or four days.

While historic winter storms have battered much of the US, California is suffering its worst drought on record. The reservoirs of California are just a fraction of capacity. In the dried-up fields of California's Central Valley, farmers are selling their cattle. Others have to choose which crops get the scarce irrigation water and which will wither.

California is the biggest agricultural state in the US - half the nation's fruit and vegetables are grown here. Farmers are calling for urgent help, people in cities are being told to conserve water and the governor is warning of record drought.

Meanwhile, the southern Imperial Valley, which borders Mexico, draws its water from the Colorado River along the blue liquid lifeline of the All American Canal. Farmers are making hay while the water flows, alfalfa actually; which is used as cattle feed and is being exported to China.  In effect, a hundred billion gallons of water per year is being exported in the form of alfalfa from California. It's a huge amount. It's enough for a year's supply for a million families.

Cheap water rights and America's trade imbalance with China make this not just viable, but profitable. We have more imports than exports so a lot of the steamship lines are looking to take something back. And hay is one of the products which they take back. It's now cheaper to send alfalfa from LA to Beijing than it is to send it from the Imperial Valley to the Central Valley.

Japan, Korea and the United Arab Emirates all buy Californian hay. The price is now so high that many local dairy farmers and cattle ranchers can't afford the cost when the rains fail and their usual supplies are insufficient. Hay trucks are a common sight heading north up the road from the Imperial Valley and despite the high prices, the cattle farmers have to buy what they can. Even with recent rains in northern California there's still a critical shortage of water. There will be many questions about who has claim to what, and this is just the early stages of the drought. Stay tuned. 

Friday, January 24, 2014 - Bulls, Bears, and Bonuses

Bulls, Bears, and Bonuses

by Sinclair Noe

DOW – 318 = 15,879
SPX – 38 = 1790
NAS – 90 = 4128
10 YR YLD - .04 = 2.73%
OIL - .41 = 96.91
GOLD + 4.40 = 1270.00
SILV - .11 = 20.01

The Dow has fallen every day this week, leaving it down more than 3%. That decline is the Dow's worst weekly performance since mid-May 2012. Meanwhile, the S&P 500 is down 2.5% since last Friday. That's the index's worst weekly slide since early November 2012.

All of the sudden, everybody seemed concerned about political and economic problems in Turkey, Argentina, and of course, China. The Turkish lira hit a record low and the South African rand fell to five-year low against the dollar. The Argentine peso had its sharpest decline in 12 years, going back to the 2002 financial crisis in that country; and the government abandoned its long standing policy of intervening to support the peso currency. Such moves are crucial factors for big, institutional foreign investors because exchange rate losses can easily wipe out any gains in stocks and bonds of emerging countries.

Right now, the losses haven’t turned into a rout, but there is concern that the turn may push big institutional investors to cut losses and run as the effect of falling currencies becomes too painful to bear. Every emerging market crisis is first-and-foremost a currency crisis. For example, South African government debt was slightly positive in rand terms in 2013. But in dollars terms, it lost more than 18%. Fund tracker EPFR estimates emerging equity and bond funds have seen outflows of almost $5 billion so far this year, on top of $58 billion of losses seen in 2013. EM equity funds have had 13 consecutive weeks of outflows, the longest run in 11 years.

What we haven't seen in emerging markets is major currency devaluation, a run on government debt or ratings downgrades. Any combination of those would suggest a major move where developing countries could experience sudden stops in their access to global capital, or some event that throws economies into a balance of payments or financial crisis. What we have seen and might continue to see is emerging market currencies falling, possibly big drops, as the yield on the 10 year Treasury note moves higher; which is expected to happen as the Fed cuts back QE3.

For several years, the world’s emerging markets seemed to be the main beneficiaries of two global trends: very rapid growth in China and the Federal Reserve’s various accommodative monetary policies, which injected huge amounts of capital into global markets. Since the Fed officially announced in December that it would ease its bond-buying stimulus, investors in emerging markets have been cautious. There are fears that rising interest rates will choke off growth in countries dependent on foreign lenders.

And for many years emerging markets have been able to sell resources to China, as China emerged as the world’s biggest producer and biggest market for everything from steel to coal to cars, the demand from China for raw materials soared year after year. Investors have committed tens of billions of dollars to emerging market projects aimed at meeting China’s voracious demand, and now Chinese demand is softening. Chinese economic growth slowed to 7.7 percent last year and the latest surveys of manufacturers in China show that with the exception of a few exporters, expectations about future sales are falling. The result in recent days have been waves of cash flowing out of emerging markets and into industrialized countries, notably the United States; but the  money has been going into the safe haven of Treasuries, rather than into the stock market.

It was just a few days ago that most people were bullish. Even the Fed’s taper at the December meeting was hailed as proof that the economy was improving. Earnings season has been less than exciting but we haven’t had massive misses, except for maybe IBM, Best Buy, Coach, Intel, Citigroup, and a few others; but nothing out of the norm. For the most part, Wall Street continues to pump up expectations, and there are still a few high flyers like Netflix, even if they are selling at 326 times earnings with almost zero in actual free cash flow. The Fed FOMC meets next week to determine their next moves on monetary policy and they are expected to continue with more tapering. Equities on Wall Street seem to have been shaken by the same fears that have hit the global equity markets; or maybe that’s just an excuse for a long overdue pullback. Your guess is as good as anybody.

In a TV interview today, Attorney General Eric Holder said no American financial institution is too large to indict and no bank executive immune from criminal prosecution. Holder cited the case of JPMorgan, which in November agreed to a civil settlement under which it would pay $13 billion to end a series of government investigations into its sales of toxic mortgage backed securities. It was an interesting case for Holder to cite because you may recall JPMorgan was not indicted and no major JPMorgan bank executives have faced criminal prosecution.

In December, Holder said the Justice Department plans to bring civil mortgage fraud cases against several financial institutions early in 2014, using the JPMorgan case as a template. Civil not criminal. Today, Holder said: "There are no institutions that are too big to indict," and "There are no individuals who are in such high level positions that they cannot be indicted, criminally investigated." Holder’s timing is delicious.

Jamie Dimon, JPMorgan’s chief executive, just got a big raise. Dimon’s pay increased to $20 million for 2013, up from $11 million the year before. The bank’s board of directors approved the increase even though a steady stream of scandals and a raft of regulatory actions have in recent months cast doubt on Dimon’s leadership at the nation’s largest bank. The big raise for 2013 came in the face of opposition from a vocal minority of board members.

Over the course of the year, the bank agreed to a series of high-cost legal settlements, including the $13 billion claim. Dimon led JPMorgan while it committed what government investigators have identified as over 15 frauds, most of them massive. These frauds represent the greatest financial crime spree the government has ever identified. In January of last year, the Federal Reserve and the Office of the Comptroller of the Currency imposed sanctions on the bank for weak risk and financial controls, as well as deficient safeguards against money laundering and violations of the Bank Secrecy Act, over the 2012 derivatives loss; total legal expenses topped the $20 billion mark.

The bigger the frauds committed by JPMorgan under Dimon’s watch, and the larger the settlements, the greater the value that Dimon brings by way of getting the government to settle cheap, and not tear down the bank and put people in jail. JPMorgan’s board must be really satisfied with Dimon’s ability to negotiate a deal with regulators. The directors don’t bear the cost of Dimon’s bonuses. Dimon negotiations with the government ensure that the shareholders bear all the losses of the obscenity of giving Dimon a raise to reward the crime spree that occurred while he was both the CEO and chairman of the board of JPM.

The regulatory and prosecutorial response to JPM’s crime spree has failed to hold a single senior officer or director personally accountable either civilly or criminally. The officers who control the bank are delighted to use bank funds to negotiate deals in which there are large fines, but the government does not prosecute the officers or seek to claw bank their compensation and seek damages from them. The DOJ treats JPM as “too big to fail.” This means that the DOJ will never require JPM to pay the full cost of its frauds and disgorge the full extent of its fraud proceeds if doing so could even come close to creating a concern that JPM would lack adequate capital. This gives Dimon a crushing negotiating leverage.

Holder has zero prosecutions of the elite bankers whose frauds drove the worst financial crisis since the Great Depression. Holder has zero civil cases, and the banking regulators have zero enforcement actions, that bankrupted an elite bank officer or director whose frauds helped drive the crisis. JPMorgan, Washington Mutual, and Bear Stearn’s boards of directors made the officers who led the frauds wealthy for over a decade through their compensation and bonus deals.

So, I’m not sure what Attorney General Holder was really talking about. There are no criminal indictments; JPMorgan has violated multiple laws with impunity; Jamie Dimon gets a big bonus.

Meawhile, the Financial Stability Board, which coordinates regulation for the Group of 20 leading economies, is reported investigating manipulation in the foreign exchange markets, or Forex, and is working on a reform of interest rate benchmarks after the Libor interbank rate-fixing scandal. Britain's Financial Conduct Authority (FCA) and the US Department of Justice have been investigating allegations that traders at some of the world's biggest banks manipulated the largely unregulated $5 trillion-a-day foreign exchange market. In the foreign exchange probe, groups of senior traders are alleged to have shared market-sensitive information relevant for London fix, which is set at 4 p.m. London time, using actual trades.

Just a reminder that so far, we haven’t fixed anything, and everything, every market is rigged.