Tuesday, August 05, 2014 - Go Firgure

Go Figure

by Sinclair Noe

DOW – 139 = 16,429
SPX – 18 = 1920
NAS – 31 = 4352
10 YR YLD - .01 = 2.48%
OIL - .86 = 97.43
GOLD + .40 = 1289.60
SILV - .39 = 19.84

We start with a couple of economic reports: The Institute for Supply Management’s services index rose to 58.7 last month, the highest level since December 2005, from 56.0 in June. A reading above 50 indicates expansion. Orders jumped to a 9 year high. A sub-index gauging services industry employment also rose as did order backlogs, but export order growth moderated.

In a separate report, the Commerce Department said orders for manufactured goods increased 1.1% in June, more than reversing May's 0.6% decline. Orders for non-defense capital goods excluding aircraft hit a record high; this might indicate a renewal in business confidence and equipment spending plans. Factory orders rose across all categories, with bookings for electrical equipment, appliances and components recording their largest gain since November 2010. In another sign of strength, unfilled orders saw their largest rise in seven months.

So, a couple of good reports on the economy, and the stock market tumbles. Go figure.

The situation in Ukraine appears headed to a tipping point. Ukrainian forces have been pushing back against Russian backed separatists in eastern Ukraine. Meanwhile, Russia is massing troops on the border. Some 20,000 troops are now stationed about 50 kilometers from the border, closer than they had been stationed previously. In April, Russian President Vladimir Putin had briefly deployed about 40,000 troops at the border. The latest troops include Russian Elite forces, armored brigades, artillery and anti-aircraft units. Poland’s foreign minister thinks Russia is preparing to invade Ukraine; he didn’t flat out say an invasion was imminent, just that the Russians are getting ready.

Putin has ordered his government to prepare retaliatory measures against US and European economic sanctions imposed on Russia. We don’t know what Putin means by retaliatory measures. Russia may limit or ban flights over Siberia by European carriers bound for Asia as a response to sanctions levied against the country. Russia has also called for the UN Security Council to hold an emergency meeting on the humanitarian situation in Ukraine. It isn’t a humanitarian situation when the pro-Russian rebels shoot a plane full of civilians out of the sky, but it is a humanitarian situation when the rebels start getting their butts kicked.

One thing that hasn’t happened yet is a disruption in oil and gas supplies from Russia to Europe. Russia derives half its tax revenue from the oil sector; Europe relies on Russian supplies. As the weather changes and winter sets in, Europe’s resolve, which has already been soft, will weaken further. For now, energy prices are moving lower, despite violence in Eastern Europe, Libya, and Iraq. Global oil demand has been running below supply over the last few months, building up a glut of high quality crude oil in the West African, European and Asian markets. The US Energy Information Administration reported last week that gasoline supplies rose by 400,000 barrels at a time when market bulls hoped to see a reduction. Oil prices are at their lowest levels since February.

Yesterday we told you about the collapse of Portugal’s Banco Espirito Santo; today we report on the fallout. The French bank Credit Agricole held a 14% stake in Banco Espirito Santo and two seats on its board. Crédit Agricole's ties to the Portuguese group go back to 1986 when it helped the Espírito Santo Group set up Banco Internacional de Crédito. Over the years, the French bank raised its stake in the Portuguese group, as part of a larger international expansion plan in southern Europe.The French bankers say they never detected any “slip or difficulties” at Banco Espirito Santo. The collapse of the Portuguese bank nearly wiped out all the second quarter profits at the French bank.

Standard & Poors today announced that it was dropping its 10-year estimate of annual GDP growth in the US from 2.8% to 2.5%, which over a decade amounts to a pretty significant reduction. Why are they cutting the growth forecast? Here’s what S&P says: "Our review of the data, as well as a wealth of research on this matter, leads us to conclude that the current level of income inequality in the U.S. is dampening GDP growth, at a time when the world's biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population... At extreme levels, income inequality can harm sustained economic growth over long periods. The U.S. is approaching that threshold...."

S&P analysts say it basically boils down to the idea that high levels of income inequality cause more affluent households to save more of their increasing income rather than spend it, and as that cash is withdrawn the economy slows. At the other end of the economic scale, as income declines, households go into debt to try to maintain their standard of living, a strategy that is simply unsustainable over time. And when the unsustainable ceases to be sustained, you get a breakdown, much like that of 2008. In fact, S&P notes, as income inequality increases, an economic system becomes more and more vulnerable to a boom-and-bust cycle. It cites research demonstrating that income distribution plays a much more important role in sustaining long-term economic growth than any other factor.

Although the issue of income inequality is often addressed in moral terms, S&P concludes, at its foundation it is really an economic issue, saying: "A rising tide lifts all boats … but a lifeboat carrying a few, surrounded by many treading water, risks capsizing."

Earnings reporting season:

Retailer Target cut its second quarter earnings estimates due to higher promotions and more discounting; they also lost about $148 million related to that data breach, where hackers gained access to customer credit card info; that’s a small number compared to total sales at Target, but it apparently proved a costly distraction. Morgan Stanley reduced its second quarter earnings by 2 cents per share due to increased legal settlements. Disney posted better than expected earnings; shares moved just a smidge higher in after-hours trading. Cablevision cut back on its promotions and subscriber losses doubled in the second quarter. First Solar posted profits that missed estimates by a wide margin; they blamed project delays. Groupon fell in after-hours trading after posting a second quarter loss nearly triple the loss from a year ago. Zillow announced a second quarter loss, even as revenue increased; and they raised their full year revenue outlook. This was Zillow’s first quarterly report since they announced a $3.5 billion deal to acquire rival Trulia.

Time Warner and Fox both report earnings tomorrow, but the big news came today. Fox withdrew its offer for Time Warner. Game over. When Fox made the hostile bid, its stock dropped and Time’s stock soared; meanwhile Time’s board and management opposed the takeover and refused to discuss the offer. Now that Murdoch has dangled a huge windfall in front of Time Warner shareholders, only to take it away, one imagines that some of those shareholders may soon be venting their frustration to Time Warner's board and management.

Several America corporations have found a loophole in the tax code, which allows for a company to acquire a partial interest in a foreign company, and then change the address of its headquarters in order to evade US taxes; it’s called an inversion. There have been 22 such deals since 2011, most have been in the pharmaceutical industry, where overseas sales generate significant income that cannot be brought back to the US without suffering a major tax hit; but there have also been inversion deals in the media, consumer and manufacturing sectors. Some of those deals have collapsed, amid disputes over price and political scrutiny.

Walgreens was next on the list; closing in on a deal to buy the 55% of British pharmacy retailer, Alliance Boots; Walgreens already owns 45% of Alliance Boots. Walgreens will buy out Alliance Boots, but it won’t move its corporate headquarters abroad and it will not change its corporate citizenship to a lower tax country. They say they won’t do the inversion move because they would have had to renegotiate an existing agreement, and Alliance Boots wasn’t willing. There may also have been some political pressure.  President Obama has denounced tax inversions as unpatriotic and has urged Congress to stop them; which is like asking a Kleenex to stop a freight train. So, now the Treasury Department says there may be an executive order to provide a partial administrative fix, you know, until Congress gets back from its 5 week vacation.

As Ebola spreads, pharmaceutical giants are sitting this one out. That's mainly because treating a disease that affects a relatively small number of people who typically don’t have a lot of money doesn’t offer a great return on investment. It's unclear how much profit it would take to get Big Pharma interested in finding an Ebola cure, but right now such a project could well be a money-loser. Instead, small biotech firms, academics and government agencies are leading the search for an Ebola cure. And in a twist of fate, they may have found a way to treat the virus: tobacco.

A tiny San Diego-based company provided an experimental Ebola treatment for two Americans infected with the deadly virus in Liberia. The biotechnology drug, produced with tobacco plants, appears to be working. Mapp Biopharmaceutical produced an experimental drug called ZMapp, an antibody that had been tested only on infected animals; now it’s been given to human patients, and it seems to make a big difference. The antibody work came out of research projects funded more than a decade ago by the U.S. Army to develop treatments and vaccines against potential bio-warfare agents, such as the Ebola virus.

The tobacco plant production system was developed because it was a method that could produce antibodies rapidly in the event of an emergency. To produce therapeutic proteins inside a tobacco plant, genes for the desired antibodies are fused to genes for a natural tobacco virus. The tobacco plants are then infected with this new artificial virus. The infection results in the production of antibodies inside the plant. The plant is eventually ground up and the antibody is extracted. The whole process takes a matter of weeks.

Monday, August 04, 2014 - Giving Up the Ghost

Giving Up the Ghost
by Sinclair Noe

DOW + 75 = 16,569
SPX + 13 = 1938
NAS + 31 = 4383
10 YR YLD - .01 = 2.49%
OIL + .09 = 98.38
GOLD – 6.00 = 1289.20
SILV - .17 = 20.23

Let’s start with economic data; on Friday we had the monthly jobs report: 209,000 jobs and the unemployment rate ticked up to 6.2%. It was a decent jobs report but came in a little under expectations. Still the economy has been adding jobs at a strong clip this year. Early in 2014, the Conference Board’s employment trends index pointed to stronger job creation even though the economy temporarily contracted, and that’s exactly what happened. Hiring accelerated, the economy snapped back in the second quarter, and over the past six months the economy has added jobs at the fastest clip since 2006.

The Employment Trends Index increased in July to a reading of 120.31, up from 119.91; this represents a 6.6% increase from a year ago. The 6 month growth rate in the index is the strongest in over 2 years, and suggests solid job growth is likely to continue in the coming months. Job openings keep hitting post-recession highs. There were 4.64 million job openings in May, near an all-time high; and layoffs are extremely low, even compared to the prerecession period.

While there are some signs of strength in the jobs market, wages have been stagnant. Worker pay was a smaller piece of the US income pie than earlier estimated as some Americans collected significantly more in interest and dividend payments over the past two years.  According to revised data from the Commerce Department, employee compensation, including wages and benefits, was lower for each year from 2011 to 2013 than previously calculated. With the revisions, employee compensation was reduced by $9.5 billion in 2011, $5.1 billion in 2012 and $14.6 billion last year. It accounted for 52% of gross domestic income in the last quarter of 2013, down from a prior estimate of 52.2%.

More rank-and-file workers are participating in the recovery as companies report record profits and boost hiring. Compensation has accelerated this year, rising $134 billion after a $153 billion surge in the first quarter. It marked the biggest back-to-back gains since the six months ended in the first quarter of 2007. That’s because companies are hiring again and more people are returning to the workforce, not necessarily because paychecks are getting fatter. We’ve added millions of people to the payroll since the low point of the economy, but we haven’t added at all to the payouts that workers are receiving. Little has flowed to workers except as an increase in their employment rate.

The latest data on consumer credit is due out Thursday. It’s likely to show non-revolving debt like auto and student debt is continuing to grow rapidly. But credit-card debt has barely budged. Auto loans made up a big part of the growth in second quarter GDP. In the second quarter, motor vehicle and parts spending grew an annual 17.5% rate. Put another way, cars made up 3.7% of all consumer spending, the highest rate since the first quarter of 2008. Growth in subprime auto loans has climbed more than 130% in the past five years.

The New York Times recently reported that many subprime auto lenders are loosening credit standards and focusing on the riskiest borrowers, and then many of the subprime auto loans are bundled into complex bonds and sold as securities by banks to insurance companies, mutual funds and public pension funds, a process that creates ever-greater demand for loans. Subprime loans make up about a third of new car-sales and two-thirds of used cars; with many subprime loans carrying interest rates of 23% or more; the loans were typically at least twice the size of the value of the used cars purchased.

Now maybe you are thinking that there were financial reforms put in place following the downturn; reforms that would prevent subprime lending practices. The Dodd-Frank Act did create the CFPB, the Consumer Financial Protection Board, and you might imagine this would protect consumers from less- than scrupulous lenders. Auto loans were stripped out of the CFPB's jurisdiction by an amendment proposed by Representative John Campbell (R-CA), a former used car dealer. Ripping off poor people has become an art form, and one of the requirements is that the companies engaging in this performance art keep themselves outside regulation as much as possible.

General Motors Financial said today it was served with a subpoena from the Department of Justice directing it to turn over documents related to underwriting criteria on subprime auto loans. The Financial Institutions Reform, Recovery and Enforcement Act, allows the Justice Department to sue over fraud affecting a federally insured financial institution.

A Federal Reserve survey of 75 domestic and 23 foreign banks shows that banks are seeing solid demand for loans, but the banks aren’t making it easy for borrowers. Banks reported stronger demand for prime residential mortgages for the first time since last summer and for home equity lines for the first time since October 2013. Credit standards on prime mortgage loans have eased somewhat, but mortgage standards still remain tighter than in 2005. The July survey also shows that new qualified mortgage rules has reduced approval rates on applications for prime jumbo home-purchase loans and nontraditional mortgages but have not impacted prime mortgages. Banks were somewhat more willing to make consumer-installment loans than they were in the April survey.

New research from the Federal Reserve and Northwestern University finds that expanding unemployment insurance benefits reduces the likelihood of mortgage delinquency. About 5 million foreclosures were completed between 2008 and 2012, but it could have been much worse. The survey says unemployment benefits prevented about 1.4 million foreclosures between 2008 and 2012.  

The researchers discovered there were other side benefits from jobless benefits. Banks who saw a lower default risk expanded credit access. Mortgage investors lost less than they otherwise would have. Local governments took a smaller hit. Also, more owners hanging onto their properties meant that homes stood a better chance of not falling into disrepair, which in turn would have sunk property values in their neighborhoods. And here’s one key finding for housing-policy wonks: Fewer troubled properties cut the government’s costs for expanding jobless benefits by narrowing the number of bad loans that would have been covered by federally controlled mortgage-finance giants Fannie Mae and Freddie Mac. Savings related to Fannie and Freddie decreased net costs for the federal government’s jobless-benefits expansion by about one-fifth.

Today’s bank failure comes from Portugal, and it was a big one. Banco Espirito Santo gave up the ghost; the bank will be shut down, and its healthy businesses transferred to a new bank. Portuguese officials were unable to find private investors to prop up the bank, and so the government will use 4.9 billion euro, or about $6.6 billion of its own funds to bail out the bank, or at least part of it. The bank will be spit in two, with the healthy part going to Novo Bank; the healthy part will include deposits and viable assets; so for now, the depositors and senior bondholders are safe.

Regulators are investigating possible accounting fraud and abuse of privileged information by the Espírito Santo family. Toxic loans, mainly to the Espirito Santo corporate parent and various subsidiaries, will be quarantined in a separate bad bank, which will be owned by shareholders and junior bondholders. Eventually, the new bank, or Novo Bank, will be sold in an attempt to recover the taxpayer loan. It is not clear whether even a sanitized version of Banco Espírito Santo will be worth enough to repay the loan.

Banco Espírito Santo provides something of a preview of what may happen in October when the European Central Bank discloses the results of an exhaustive review of bank holdings in the eurozone. The review is intended to uncover precisely the kind of hidden problems that have undone Banco Espírito Santo.

The central bank review is expected to expose an unknown number of other banks with problem loans or other woes that they have failed to disclose to regulators or shareholders. There has been concern that the central bank’s findings could destabilize the eurozone financial system. The European Union still lacks a comprehensive system for dealing with troubled banks, meaning countries must finance their own bailouts.

There is a new study taking a look at the state of banks in the US, the limits of Dodd-Frank reform, and what should be done with banks that are too big to manage. The study was requested by Democratic Senator Sherrod Brown and Republican Senator David Vitter, and the study finds that some institutions remain too complex and interconnected to be unwound quickly and efficiently if they get into trouble. That means that banks still would be able to force a taxpayer bailout in some form, and the banks are essentially receiving value in that implied guarantee. And the new study had the Government Accounting Office look at the value of that implied bailout. Turns out it was a tough calculation as the value of the implied guarantee varies, skyrocketing with economic stress (such as in 2008) and settling back down in periods of calm. If we were to return to panic mode, the value of the implied taxpayer backing would rocket. In other words, the threat of high-cost taxpayer bailouts remains very much with us.

Thursday, July 10, 2014 - If It’s Not One Thing…

If It’s Not One Thing…
by Sinclair Noe

DOW – 70 – 16,915
SPX – 8 = 1964
NAS – 22 = 4396
10 YR YLD - .01 = 2.53%
OIL + .59 = 102.88
GOLD + 8.70 = 1336.30
SILV + .32 = 21.52

We start today with the hottest stock in the world: CYNK Technology, ticker CYNK.  It is a one person company, which has something to do with a website, with headquarters in Belize, maybe. There is no indication of revenue, possibly about a million in losses. It had been trading for a couple of pennies, and then for no apparent reason it started trading higher. After closing at 6 cents on May 15 it began its surge with a 3,650% jump to $2.25 on June 17. The stock climbed as much as 49% to $21.95 earlier today in over-the-counter trading on volume of more than 380,000 shares before erasing its gain to close down 5.5% to $13.90, and a market cap of a little more than $4 billion. How and why did this happen? Nobody seems to have an answer, but I think it would be a very, very bad idea to do anything with this stock, just to be clear.

Se nao e uma coisa e outra coisa.

Which is Portuguese for “if it’s not one thing, it’s another thing.”

I’m sure somebody in Lisbon was fully aware of what was going on, and they were waving their arms and screaming about the bank that was ready to implode; and nobody paid any attention because there was so much else happening around the world. Iraq is fractured, bombs are flying in Israel, Germany is expelling a US spy, the Italian economy looks wobbly, Libya, Ukraine, Nigeria, Thailand, China. Pick a global hot spot, pick ten global hotspots, and I bet Portugal is not on the list.

Here’s the story: Espirito Santo International is a big conglomerate in Portugal; they missed a payment on some short-term debt this week. So, a couple of subsidiaries got clobbered, Espirito Santo Financial Group shares down 9%, and Banco Espirito Santo shares down 17%. Trading was halted.  The credit rating agency, Moody’s, cut the corporate credit rating to junk status, which is basically closing the barn gate after the cow gets out.

While I make no claim to any particular knowledge of the Portuguese banking system, the consensus is that this problem should not create a meltdown scenario; however, there has been a singe factor. Borrowing costs for Greece, Spain, and Italy bounced a bit higher. Again, this is not earth shaking, but it did cause a brief flash of realization that the banking problems of the past few years have not been corrected.

A couple of years ago the European Central Bank developed a plan for dealing with sovereign debt crises, the OMT or Outright Monetary Transactions program, but it has never been used and it probably wouldn’t apply even if the situation in Portugal started to create a meltdown scenario. So the fear out of Portugal is something called the “doom loop”; that’s the cycle in which weak banks lean on governments for support, draining public finances, which in turn drags down the banks with them.

A couple of years ago,ECB President Mario Draghi bought some time when he declared the central bank would do “whatever it takes”, and then they did nothing. So it was like a whiff of smoke that reminds you that never bought fire extinguishers, even after that little explosion in 2008, and the Greece fire in 2011.

And so, European stocks took a hit today, and that spread over to Wall Street, where the Dow Industrials started the day with a 180 point dip, until traders remembered – it’s Portugal. And then they decided that a little pullback following a 6 week rally was to be expected and Banco Espirito Santo is nothing to fear, even if you don’t have a fire extinguisher.

So, with the long-term memory of a dog chasing a squirrel, we move on to our next topic. After all, we live in a mobile-first and cloud-first world. So says Satya Nadella, the CEO of Microsoft; no he’s not the guy trying to buy the LA Clippers, he’s the guy who replaced Steve Ballmer. Nadella has sent out a really long email to all Microsoft employees outlining his vision for Microsoft. Over the years, Microsoft made a very large amount of money serving the PC world. Its Windows operating system and Office software generated the vast majority of its sales and profits, but now the personal computer is going the way of the typewriter. Microsoft used to talk about “a computer on every desk and in every home,” a vision it clearly succeeded in delivering. But what do you do when you’ve delivered that vision?

So Nadella writes: “Computing is ubiquitous and experiences span devices and exhibit ambient intelligence. Billions of sensors, screens and devices – in conference rooms, living rooms, cities, cars, phones, PCs – are forming a vast network and streams of data that simply disappear into the background of our lives. This computing power will digitize nearly everything around us and will derive insights from all of the data being generated by interactions among people and between people and machines. We are moving from a world where computing power was scarce to a place where it now is almost limitless, and where the true scarce commodity is increasingly human attention.”

There are a couple of interesting phrases in the mission statement from Nadella; he writes, “computing is ubiquitous” and also “ambient intelligence”. The idea that computers are ubiquitous is fairly easy to understand; just look around you; you probably have a smart phone close at hand; if you are in an office, you still have PCs, and don’t forget the computers in the printers and telephones, and thermostat, and electric meter. If you are driving right now, your car is a computing marvel. And if you are at home, check out the computer in your refrigerator, and dishwasher, and a dozen other gadgets and appliances. Another name for ubiquitous computing is the “internet of things”.

And the idea here is to connect machine to machine, and machine to human, and then human to human. We’ve been talking about that for a long time. The computers would be embedded in almost everything and everything would communicate seamlessly with everything else. We’re not there yet, but if you have questions about the internet of things, just ask Siri or Cortana.

All that computing power means we are surrounded by an ocean of data. The exploration of that data constitutes what Microsoft researchers call the “fourth paradigm”, exploration of data to discover new and interesting results to power a new generation of artificial intelligences. Microsoft Research head Peter Lee recently talked about some of the AI breakthroughs that were powering the new tools. Discussing the concept of “transfer learning,” he revealed that by training a speech recognition neural net on multiple languages, its performance improved with each new language, even on previously trained languages.

There are already apps that can infer context from our emails and documents and then deliver information we need, or might need, when we need it. We’ve already seen this in marketing and advertising; based upon your searches, the data programs can figure out whether you are getting married, pregnant, planning a vacation, or looking for a job; and then they deliver advertising that should grab your fancy and even calculate the probability of a purchase, putting the supply chain in motion, ready to send out drones to deliver your package with same day delivery, or even within the hour. It’s a little like the waiter anticipating when you want a coffee refill; that sounds like a simple task but it is incredibly complex and requires understanding the differences between correlation and causation. Computers are not good at that, but they’re getting better, or maybe they’re getting smarter.

As computing becomes more and more ubiquitous all those little computers, embedded in almost everything, are gathering data; and the neural networks are analyzing the data – watching and learning, and the data eventually becomes information, and the information becomes knowledge. And we end up with collective wisdom. At least that’s the idea.

We’re closer than you think. We already know that computing power grows exponentially. Moore’s Law basically says that technology performance indicators double every 18 months, which leads to incredible innovative applications only slightly bogged down by social acceptance. Not every innovation makes it into common usage because of concerns about privacy, lack of trust, reliability, or just information overload. Somewhere there is a huge scrapyard of abandoned apps.

There is an even larger ocean of smaller and more powerful embedded computers monitoring our actions and data and trying to figure out where we want to go, and then trying to figure out how to help us get stuff done. That’s the benign version. The version will a little less sugar coating involves a complete loss of privacy and subjugation before the robot overlords. Then again, in a world of CYNK Technology and Portuguese doom loops, maybe we deserve robot overlords.

Microsoft will have an earnings call next week, and we’ll likely learn more then. Today’s six page memo was big on building productivity, but that might also mean pink slips for many Microsoft employees; after all there are bound to be some redundancies following the Nokia acquisition. Nadella writes that "We will reinvent productivity to empower every person and every organization on the planet to do more and achieve more." But for all the talk of a brave new mobile first, cloud first world, don’t expect Microsoft to abandon the Xbox game console; it’s a money maker. Still, it is a fairly bold new direction for Microsoft, maybe the biggest vision change since Bill Gates ran the place.