Wednesday, April 02, 2014 - Speak Your Mind by Blowing Your Wad

Speak Your Mind by Blowing Your Wad
by Sinclair Noe

DOW + 40 = 16,573
SPX + 5 = 1890
NAS + 8 = 4276
10 YR YLD + .04 = 2.80%
OIL – 33 = 99.29
GOLD + 10.10 = 1290.90
SILV + .22 = 20.08

The S&P 500 closed at another record high.

The Commerce Department reported that orders to US factories rose 1.6% in February, the most in five months. January's durable goods orders were revised to show a larger drop of 1.0% instead of the previously reported decline of 0.7%. Yesterday, the Institute for Supply Management said its manufacturing index rose in March.

A private survey showed that US companies stepped up their hiring in March. Payroll processer ADP said private employers added 191,000 jobs. ADP also revised February's job creation up to 153,000 from the 139,000 figure reported earlier. The report comes ahead of the government's monthly jobs report, scheduled to be released on Friday; the over-under number for Friday is 200,000 net new jobs.

We know the Federal Reserve will be watching the jobs report. St. Louis Fed President James Bullard speaking to reporters at his branch of the central bank, said a formal rate rise is "still a considerable distance away." Federal Reserve Bank of Atlanta President Dennis Lockhart said today: “Based on my working medium-term outlook, I see the latter half of 2015 as the likely time frame for the first move to higher rates,” but if the economy doesn’t grow as he current expects, Lockhart thinks, “a later liftoff date… will likely be appropriate.”

Lately bad weather was cited as the reason that Walmart and FedEx and Delta’s earnings were disappointing.  If it isn't one-time charges that happen every quarter being removed from reported results, it's the weather being blamed. Of course, even if the weather truly was awful enough to prevent people from shopping, or buying a house, that demand should simply show up in a later month. A certain amount of productive capacity is lost, but pent up demand should rev things right back up again. The March jobs report won’t be the final word on the weather and the economy, but if we don’t see some sort of significant improvement, then we are running out of bad weather excuses.

Russian, American, and European diplomats continue to talk about settlement talks that might halt further Russian military action in Ukraine; Crimea is a done deal, but Ukraine is another matter. NATO will suspend "all practical civilian and military cooperation" with Russia because of its annexation of Crimea, saying it has seen no sign that Moscow was withdrawing troops from the Ukrainian border.

Meanwhile, Gazprom, the Russian energy company has fired a shot across the bow, raising the price it charges Ukraine for natural gas. The price jumped from $268 per 1,000 cubic meters of gas to $385, or about a 44% increase. Gazprom execs attributed the price increase to an unpaid debt for gas. This is not the first time energy has been used as an economic weapon, nor will it be the last.

The US has been undergoing an oil and gas renaissance; the White House has promoted exploration and drilling, and output has jumped. When it comes to natural gas, the US is being compared to Saudi Arabia, or Saudi America. Of course, that provided no advantage to thwart Putin’s aggression in Crimea. One reason Saudi America has failed to instill fear in Russia is that we lack the capacity to export LNG to Europe, and probably won’t be able to export in any significant quantities for a few more years; and then it would probably be a few more years before Ukraine could build facilities to receive such exports.

Meanwhile, we ran into a rash of reports in the past week or so, all telling us that our reliance on fossil fuels is killing us. The American Association for the Advancement of Society, the Intergovernmental Panel on Climate Change, and the World Meteorological Organization all confirmed that the planet is getting hotter; 13 of the past 14 years have been the hottest ever recorded. The Antarctic ice shelf is melting, Greenland too; the rain forests are dying and the Gulf Stream is collapsing. It’s not just the melting ice and the poor polar bears; the reports warn of very human problems of hunger, disease, drought, flooding, refugees, violence, and war.

Necessity is the Mother of Invention, and the time is now for innovation; and the good news is that there are inventors who have been working on these problems and have created solutions; the bad news is that the status quo and the powers that be are entrenched. This is a defining moment, and energy is being used as an economic weapon, and that weapon is pointed directly at our own foot.

And the entrenched powers just became more entrenched. The Supreme Court has struck down the aggregate campaign contribution limits, opening the gates for even more money to flood into the political system. The good news is we have the best politicians money can buy. The bad news is we have the best politicians money can buy. The 5-4 ruling in McCutcheon v. Federal Election Commission was penned by Chief Justice John Roberts and joined by justices Anthony Kennedy, Samuel Alito and Antonin Scalia; Justice Thomas went a step further and called for a complete end to campaign finance reform.

The decision relies heavily on the assertion in the 2010 Citizens United ruling that influence and access are not a corruption concern. This means that a single donor will soon be able to contribute millions of hard dollars in limited contributions, to political parties, candidates and political action committees.

Federal law sets certain limits, so you can't just go write a candidate a check for a million dollars and call it a day. That means you can't give more than $2,600 to any one candidate per election. Even if you were to donate once in the primary election and again in the general, the absolute most you could give to an individual candidate's campaign is $5,200. And you can’t, or couldn’t just spread money across the board. For the 2013-2014 election cycle, Federal Election Commission rules state that a donor can give no more than $123,200 to all political committees, with two sub-limits of $48,600 to candidates and $74,600 to political parties and political action committees. In other words, there was a limit, a cap on aggregate spending. Those limits are no more.

 Now, a single donor can now give more than $5 million in individually limited contributions to every House candidate, every Senate candidate, every state party committee, every national party committee and every leadership PAC connected to one political party. The McCutcheon ruling also did away with the aggregate limit on donations to political action committees, or PACs, which can give money directly to candidates. While there's a limit on how much PACs can give to each candidate, there's no limit on the number of PACs that can exist. Without the aggregate limit, one donor can now give $5,000 each to 1,000 different PACs. And those 1,000 PACs can turn around and funnel that money straight to one candidate. Which means that one candidate could haul in $5 million in direct contributions from one donor, funneled through a network of PACs.

So, if you have a big wad of money that you would like to waste on buying politicians, the Supreme Court has just ruled that you can blow your wad just a freely as you can speak your mind.

The new Michael Lewis book, “Flash Boys” looks at High Frequency Traders front running trades, using technology to jump in front of a trade and skim some profits. The uproar from Wall Street has been hilarious. There are claims that front running isn’t really bad; it doesn’t hurt ordinary investors; it may actually add to liquidity, blah, blah, blah. This is kind of like saying a mafia hit man is good for the neighborhood because he spends his money at the local grocery store and he hasn’t killed anybody on my street.

As we said the other day, High Frequency traders front running the market is not new; it has been going on for years, but the book and the 60 Minutes interview and the publicity finally caught the attention of otherwise somnambulant sleuths at the FBI who are investigating front running, which is a criminal offense. Where this could get interesting is that the High Frequency Trading firms set up shop in close proximity to the stock markets in New York, and they pay for high speed access to the exchanges’ computer systems and data.

The New York Stock Exchange calls it “fully managed co-location space next to the NYSE Euronext’s US trading engines in a new state of the art data center”. The NYSE is the landlord. And they can set up the “super high density” fiber optic connections for an initial fee of $7,000, or a onetime upgrade fee of $9,200. In other words, the New York Stock Exchange and the Nasdaq are complicit in the skimming operation. I didn’t hear Lewis or 60 Minutes talk about that, but that is the ugly truth.

The other funny thing about the Michael Lewis book and interview is the notion that some clever fellows, backed by hedge fund guru David Einhorn and a few other Wall Street big dogs, had come up with a clever technical fix in a new and better exchange called IEX.  Protected by a spool of fiber to ward off the high frequency traders like garlic against vampires. Free market triumphs, mission accomplished. Don't even think about a minimum transaction tax, a speed bump rule such as a minimum order duration, or anything more comprehensive than that.

Thursday, December 05, 2013 - 46664

46664

by Sinclair Noe

DOW – 68 = 15,821
SPX – 7 = 1785
NAS – 4 = 4033
10 YR YLD + .03 = 2.87%
OIL + .18 = 97.38
GOLD – 18.20 = 1226.10
SILV - .28 = 19.54

Nelson Mandela is dead. News reports say the former South African President died peacefully at his home. He was 95. Nelson Mandela will be remembered as the person who, more than any other, brought an end to apartheid, the heartless policy of “separate development” in which white, black and South Asian South Africans were obliged to live apart. It is part of his towering achievement that the very notion of racial segregation is anathema throughout the civilized world.

Yes, the stock market was down again today but the economy is doing better than you thought. Third quarter gross domestic product grew at a 3.6% pace, revised up from earlier estimates of 2.8%. Wow, sounds great, until you dig into the numbers. A large part of the revision, almost half, comes from an increase in inventories. Businesses were stocking the shelves. Were they predicting a gang-buster holiday shopping season or were they caught flat-footed by a lack of demand? We won't know with certainty until we get through the fourth quarter, but most indications are that the economy is still slogging forward, and there doesn't seem to be a need for such a large inventory buildup. We know businesses accumulated more than $116 billion in inventories in the quarter, the most since the first quarter of 1998.

Growth in consumer spending, which accounts for more than two-thirds of US economic activity, was revised down to a 1.4% rate, the lowest since the fourth quarter of 2009. That line about consumer spending is a bit misleading, and I always have to issue a caveat, because the economy is about much more than consumers, but still. Consumer spending had previously been estimated to have increased at a 1.5% pace. A sluggish start to the holiday shopping season offered another reason for caution on the economy's near-term prospects. Several big retailers reported disappointing November sales, with some relying on bargains to lure shoppers. And so, there is a strong possibility businesses will still have inventory on the shelves after the holidays, and there will be no need for new orders to replenish the stocks, and that will likely weigh down GDP growth in the fourth quarter and into the New Year.

Consumers are holding onto the purse strings. Some companies that reported sales gains had to offer more bargains to attract shoppers. The need to keep discounting, which stems from sagging consumer confidence and shoppers trained to wait for bargains, will persist through the remainder of the season. Retailers have created this expectation; just check your inbox; I'll bet you're getting more and more promotional e-mails from national chains. Why rush when there might be a better deal next week.

Meanwhile, the Commerce Department reported that after-tax corporate profits in the third quarter increased at a 2.6 percent pace in the third quarter, slowing from the prior quarter's 3.5 percent pace. So profits are still growing, quite nicely, but they are growing slower. Dividends decreased $179 billion in the third quarter, in contrast to an increase of $273 billion in the second; part of that decrease is from dividends paid by Fannie Mae to the federal government in the second quarter.

The knee jerk reaction on Wall Street was that the GDP number was stronger than estimates and Wall Street looks at good news as bad news, based upon the idea that the Fed will taper from Quantitative Easing; that speculation was enough to push treasury yields to 3-month highs, but a closer examination of the numbers shows the GDP numbers to be a little less than robust. Atlanta Federal Reserve Bank President Dennis Lockhart summed it up by saying: "I am not prepared to interpret the revised third quarter number as an indication that the economy is on a much stronger track."

Another number in the report was the price index for gross domestic purchases, which came in at 1.8%, up 0.2% from the second quarter. These measures of inflation are important because the Fed has repeatedly promised not to raise the so-called fed funds rate, now at nearly zero, until the jobless rate falls below 6.5% or inflation rises above 2.5%; those are the thresholds, rather than the targets. The Fed has targeted an inflation rate of 2%; that would be the sweet spot. And as long as inflation remains below target, that provides justification to keep the fed funds target rates in the zero range.

Why is that important? Markets are jittery about the Fed starting the process of ending some $85 billion in bond purchases each month. The purchases of Treasurys and mortgage-backed securities are meant to keep interest rates low and stimulate the economy. The tapering of bond purchases, however, is likely to trigger an increase in interest rates of all kinds and that could dampen economic growth. When the Federal Reserve first hinted during the summer that it would soon scale back, mortgage rates surged and interest rates also rose in many developing countries.

A new research report by the Cleveland Fed indicates that when the inflation rate remains low, it would be justification for the Fed to maintain its Zero Interest Rate Policy. In other words, the Fed will try a balancing act; keeping the fed funds rate lower for longer, to ease the worries of investors and let the economy more gradually acclimate to a future that at some point, might include higher interest rates.

An interesting point to ponder is that inflation remains tame, perhaps even disinflationary, even as the stock market has moved to record highs. Now you might suspect that a rising stock market, even a frothy stock market, even a bubblicious stock market might have an inflationary impact on the economy; then again, maybe not. Here we are in a stock market boom, and deflation is a greater concern, and apparently a guide for Fed policy. Go figure.

Today, the European Central Bank and the Bank of England left interest rates unchanged. Deflation is a big concern in the Eurozone. Producer price inflation (PPI) fell to -1.4% in the eurozone in October. This is how deflation becomes lodged in the price chain. Prices are sticky for a while as you approach zero inflation, but once you break through the ice into deflation things can move fast; an example would be Greece.

We seem to have a glut of things, and you know the old story about supply and demand. China's fixed capital investment over the past year has been $4 trillion; that represents an 8 fold increase in the past 10 years, and it compare with $3 trillion for the entire EU and $3 trillion for the US. China is a vast new source of supply for a saturated global economy. Meanwhile, today's data on GDP suggests US businesses are a bit saturated as well. Europe's slide towards deflation is replicating what happened in Japan in the 1990s at the onset of its lost decade.

Japan is now fighting back with a strong monetary stimulus program called Abenomics, an easy money policy after the abject failure of a tight money policy. The result of tight money was that fiscal policy had to carry the entire burden instead. Budget deficits exploded as Japan battled the slump. Public debt ballooned to 245% of GDP. ECB President Mario Draghi says the central bankers are fully aware of downside risks of protracted low inflation. The ECB has been behind the curve for most of the past three years, needlessly causing a double-dip recession that caused havoc to public finances; so I guess its no surprise they took no action today.

In other economic news, the Department of Labor released its weekly jobless claims report this morning, and these results were also better-than-expected. Seasonally-adjusted claims fell by 23,000 to 298,000, significantly beating the 320,000 claims economists had predicted. Combined with yesterday's ADP payroll report, this would seem to bode well for tomorrow's monthly jobs report, but this weekly claims report was over the Thanksgiving holiday week, and the results might be slightly distorted. Still, it was the third straight weekly drop in initial claims. Not bad.

Look for 180,000 new jobs and the unemployment rate to go from 7.3% to 7.2%.

Regulators are reportedly ready to approve a tough version of what is known as the "Volcker Rule," part of the Dodd-Frank financial-reform act, which prohibits banks from proprietary trading, which is fancy talk for "gambling with their own money." Regulators were originally planning to leave a big loophole in the Volcker Rule by letting banks do what's known as "portfolio hedging”. This is basically proprietary trading by another name, because it lets banks claim that any kind of trading they do is hedging against losses somewhere in their massive, multi-trillion-dollar portfolios.

One reason why the Volker Rule might actually have teeth is the London Whale. Remember the $6 billion loss that was, according to Jamie Dimon, a portfolio hedge? Not exactly. Bankers warn that this version of the Volcker Rule means mega-banks will not be able to protect themselves from future economic calamities, which means they have no choice but to get smaller and take fewer risks.

Sounds about right.

Wednesday, November 13, 2013 - Cues for Yellen from Abe

Cues for Yellen from Abe

by Sinclair Noe

DOW + 70 = 15821
SPX + 14 = 1782
NAS + 45 = 3965
10 YR YLD - .07 = 2.70%
OIL + .84 = 93.88
GOLD + 16.10 = 1283.30
SILV - .09 = 20.71

Record high close for the Dow Jones Industrial Average. Record high close for the S&P 500 Index.

Janet Yellen starts her confirmation process tomorrow. Yesterday, a couple of Fed presidents, Dennis Lockhart of the Atlanta Fed, and and Minneapolis Fed President Narayana Kocherlakota both suggested that the current state of the economy still warrants aggressive monetary policy action.

Yellen is well known for her meticulous preparation, but it will be interesting to see how she handles questions from politicians looking for cheap shots and easy points. Political theatrics aside, Yellen is highly qualified with a very solid academic foundation, extensive policy experience, sound judgment over many years and the most effective researcher at the Fed. Her policy moves will likely be incremental and well communicated. Markets can look to a continuation of the Fed's current policy stance for now. When the time for taper comes, as it inevitably will, the central bank would partially compensate through more aggressive forward policy guidance.

None of that means much of a change and no guarantee the Fed can do much more than it is doing to help the economy break out of the doldrums of the past few years. Of course the Fed could do much more; adding $4 trillion to their balance sheet hasn't been enough to get the economy to escape velocity. There are all sorts of clever untried economic experiments that hold great promise, and then there are the tried economic experiments underway right now.

The S&P 500 has just hit a record high; it's up about 25% year to date. Very impressive, right? Ehh. The Nikkei 225 in Japan is up about 65% YTD. The yen has been devalued by about one-third. The Bank of Japan is printing more money than the Fed. Japanese companies have more cash and less debt than their American or European counterparts. Japanese manufacturing is making a comeback. And the third-largest economy in the world has rather suddenly switched from being a drag on global GDP to being one of the most potent players, and a significant net contributor to global growth. 

It's called Abenomics, after the Prime Minister Shinzo Abe, and the idea is kind of like the Fed's Quantitative Easing scheme, on steroids. And it looks like it's working, for now. Will it work in two years, five years, ten years? Who knows; but 20 years ago Japan tried to keep the yen strong, and avoid debt, and the Japanese economy was stuck and that went on for 20 years.

One of the consequences of the BoJ’s policy shift has been to weaken the yen and boost the dollar. In recent years, dollar strength has been associated with soft commodity prices and weak pricing power in the traded goods sector. That has hurt emerging markets with their high exposure to commodities and global supply chains.

In short, the initial impact of Abenomics has been to export deflation to the rest of the world. This can also be seen in the lower-than-expected inflation rates in the US and eurozone. These are the unintended consequences of the BoJ’s actions. You may not want to invest in Japan, but you do have to understand that it matters enormously whether Abenomics succeeds or fails.

Last week the ECB cut rates, and now they're indicating they still have room to move Euro interest rates even lower. And the latest edict from the Euro Commission tells the bigger Euro economies to help support the entire union: “By virtue of their size in the European economy, Germany and France have a special responsibility to contribute to the recovery in the rest of the euro area.” Over all, the European Union has shrunk its average budget deficit by around half since a peak of almost 7 percent of gross domestic product in 2009 and has “created room” for a reduced emphasis on austerity, according to a report issued by the commission. It's more of a warning than an edict, but it seems to indicate the Eurozone is growing weary of austerity.

Yellen's testimony isn't until tomorrow, but this afternoon we got a look at the text of her prepared opening remarks; an advance copy. Yellen says the Fed has has "more work to do" to help an economy and labor market that are still underperforming. Her prepared remarks also say: "I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy." Yellen said the economy and labor market were performing "far short" of their potential, while price pressures remained muted. "Inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time." 

Nothing radical from Yellen.

About 106,000 people in the U.S. signed up for private health insurance through Obamacare last month, and 396,261 for Medicaid plans, according to data today that puts the U.S. government well behind its enrollment goals. While the government had an early target of about 800,000 sign-ups in private plans for the first two months, it has scaled back expectations as delays and software flaws plagued the online federal exchange. Only 26,794 sign-ups for private plans were through the federal marketplace serving 36 states.

While enrollment in private plans barely broke the 100,000 mark, state and federal exchanges received 846,000 applications in October, covering 1.5 million people, suggesting a large population in the pipeline if the government can get the website fixed. About 275,000 people who tried and failed to sign up for health plans are being asked this week to return to the website as the software flaws that initially shut them out are being corrected. Additional people who weren’t able to complete applications on the insurance exchange will be solicited later. The enrollment numbers include people who have already paid their first month’s premium and those who have only selected a plan without paying for it.

Last week, the U.S. Department of Agriculture released its annual survey of rural America, which puts the divergence in stark relief. Non-metropolitan areas experienced their first recorded period of population loss, and a decline in the labor force participation rate pushed unemployment down slightly (though the jobless rate surpassed the urban unemployment rate earlier this year). In other words, the cities slickers are doing better economically than their country cousins.

The Department of Agriculture has a whole division devoted to rural issues, which is aimed at fixing the jobs problem through initiatives such as farming cooperatives and infrastructure development. But the long-term problem might be more structural in nature, as the USDA suggests in its finding that suburbanization is slowing down:

The housing mortgage crisis slowed suburban development and contributed to an historic shift within metro regions, with outlying metro counties now growing at a slower rate than central counties. Similarly, nonmetro counties adjacent to metro areas that had been growing rapidly from suburban development for decades declined in population for the first time as a group during 2010-12. This period may simply be an interruption in suburbanization or it could turn out to be the end of a major demographic regime.

Of course, not all cities have been enjoying a robust economic recovery; some are better than others, and some just stink.

Tuesday, November 12, 2013 - Supremely Happy

Supremely Happy

by Sinclair Noe

DOW – 32 = 15750
SPX – 4 = 1767
NAS + 0.13 = 3919
10 YR YLD + .02 = 2.77%

OIL – 2.10 = 93.04
GOLD – 15.70 = 1267.20
SILV - .65 = 20.80

We've been hearing from Federal Reserve big wigs about their ideas for taper. Today, Federal Reserve Bank of Atlanta President Dennis Lockhart said he wants to see inflation accelerate toward the Fed’s 2% goal before the central bank reduces $85 billion in monthly bond purchases. Lockhart also wants to see economic growth pick up to around 3%.

In a speech, Lockhart said: “To achieve a faster pace of growth, it’s my opinion that we’ll need to see” greater consumer spending and a decline in “fiscal drag.” Even though those targets for inflation and growth are a long way off, Lockhart says the taper, reducing bond purchases, “ought to be on the table at upcoming meetings” by the FOMC, including the December 17-18 meeting.

There has been a common thread in mainstream economic forecasting lately. It goes like this: "Yes, 2013 has been rough. But growth should pick up in 2014." The latest example is from the OECD, the organization of leading developed nations projecting that improvement just around the corner, as its index of leading indicators rose.

The same story shows up in almost any mainstream forecasters' estimates. For example, in their last official forecasts, top Federal Reserve economists concluded that 2013 US economic growth was on track to be only 2 to 2.3 percent. But they forecast that would rise to the 3 percent ballpark in 2014 and as high as 3.5 percent in 2015.

The consistent pattern for the last four years has been to project improving growth in the year ahead, and then to mark down those projections when the rosier future does not arrive. 

Perhaps the US economy is gathering traction, or perhaps last week's rate cuts by the European Central Bank signal a global competition to cut the value of currencies; the result is that the dollar is bouncing off its lowest levels since February. Weak inflation readings offer the Fed a rationale to continue securities purchases; it also locks the Fed into securities purchases. Right now the PCE reading of inflation is just below one percent and there really isn't any indicator of a big increase in inflation; and if the Fed starts tapering now, they run the risk of increasing deflationary pressures.

When the Department of Justice blocked the American Airlines, US Airways merger, we told you it was probably a negotiating tactic. It was. DOJ has reached an agreement that will have the merged airline give up flight slots and gates at seven different airports, the big changes coming at Washington Reagan and New York La Guardia. So, now that a deal has been reached, the two airlines are expected to complete their merger in December, just in time for the holiday travel season.

In a settlement expected to be announced this week, Bloomberg reports Johnson & Johnson will pay more than $4 billion to resolve thousands of lawsuits over its recalled hip implants in the largest settlement of US legal claims over a medical device. The accord will resolve more than 7,500 suits filed in federal and state courts by patients who’ve already had defective hips removed. The company will likely pay an average of $300,000 for each of those removals. The agreement doesn’t bar patients whose hips fail in the future from seeking compensation from J&J; that means the settlement is uncapped in terms of its total value.

Timothy Massad is expected to be picked to head the Commodity Futures Trading Commission, replacing the retiring Gary Gensler. The CFTC is the regulator of the derivatives markets, estimated at more than $600 trillion on Wall Street; perhaps double that amount worldwide. It might be a misnomer to say the CFTC regulates the derivatives markets, because those markets are largely unregulated. The CFTC, long an unexciting agency overseeing agriculture futures, has only just been put in charge of the swaps markets, and has yet to write some of its planned rules. Massad worked as the head of the Troubled Asset Relief Program until 2011.

Six years after the collapse of a couple of Bear Stearns hedge funds and the fight continues over the cause of Bears' demise. Liquidators seeking to recover money for investors have filed a fraud lawsuit against three major credit rating agencies: Standard & Poors, Fitch, and Moody's. The suit accuses the credit rating agencies of assigning artificially high credit ratings to the mortgage bonds in the funds. When those bonds collapsed, the funds failed, resulting in more than $1 billion in investor losses.

The credit rating agencies made the mistake of allowing employees to communicate by email about the work they were sort of doing. “It could be structured by cows and we would rate it,” an S&P employee said to a co-worker in a text message from 2007. A Moody's employee wrote: “We sold our soul to the devil for revenue.” In an email, another S&P employee called the firm’s ratings practices a “scam.”

The lawsuit is not the first that seeks to hold the ratings agencies accountable for losses incurred during the financial crisis. The Justice Department filed a civil fraud action this year against S&P, the first federal enforcement action against a credit rating firm.  It is also not the first legal action related to the two Bear funds, which collapsed in July 2007. Federal prosecutors brought criminal securities fraud charges against the funds’ managers, Ralph Cioffi and Matthew Tannin. The two fought the charges and a jury found them not guilty after a trial.

A report by the Financial Crisis Inquiry Commission found the  credit ratings firms were “key enablers of the financial meltdown.”

Mortgage bond investors have had mixed results bringing civil lawsuits against the ratings agencies. S&P and the other agencies have argued that their ratings are speech that is protected by the First Amendment. A number of judges have agreed with the ratings agencies and tossed out these lawsuits. Others have said the ratings were not opinions, but misrepresentations that were possibly the result of negligence or fraud.

S&P also said its ratings were not to be relied on, in part because the investors had the same information as it did.

In July, a federal judge denied S&P’s motion to dismiss the government’s case and called its defense “deeply and unavoidably troubling.” The judge, David Carter of Federal District Court in Los Angeles, asked, “If no investor believed in S&P’s objectivity, and every bank had access to the same information and models as S&P, is S&P asserting, as a matter of law, the company’s credit ratings service added absolutely zero material value as a predictor of creditworthiness?”

This week, the operator of Japan's crippled Fukushima nuclear plant will begin removing 400 tons of highly irradiated spent fuel in a hugely delicate and unprecedented operation fraught with risk. Carefully plucking more than 1,500 brittle and potentially damaged fuel assemblies from the plant's unstable Reactor No. 4 is expected to take about a year. If the rods - there are 50-70 in each of the assemblies, which weigh around 660 pounds and are 15 feet long - are exposed to air or if they break, huge amounts of radioactive gases could be released into the atmosphere.

When the time comes, extracting spent fuel from the plant's other reactors, where radiation levels are much higher because of core meltdowns, will be even more challenging. Reactors No. 1 and No. 3 sustained heavier damage than No. 4 as a result of the March 2011 earthquake and tsunami, but Reactor No.4 is perched nearly 60 feet high in a building that has buckled and tilted and could collapse if another quake strikes. Also, if the pool housing the fuel assemblies is punctured and the water drains away, there could be a fire that releases more radiation than during the 2011 disaster

You've heard that some retailers are trying to kill Thanksgiving; they're moving Black Friday to Thursday, Thanksgiving Day; some are even starting sales at 6AM on Thanksgiving Day, so as to totally ruin any sense of the holiday. The big chain stores include: Old Navy, Kmart, WalMart, Target, Staples, Sears, Best Buy, Toys Rus, and others. We've been told that the reason behind the move is because of a calendar anomaly this year that resulted in 6 fewer shopping days between Thanksgiving and Christmas. The real reason is far more insidious and diabolical.

It is in fact, a socialist plot, and it started in Venezuela. About six months ago, Hugo Chavez, the Venezuelan president and dictator died; his replacement is a man named Nicolas Maduro, and Maduro has declared that Christmas should be celebrated earlier; he moved it to the first Saturday in November. So, I'm a little late with the story. And then he ordered government employees to be paid their Christmas bonuses in November, as he turned on the Nativity lights on the Presidential Palace. But why did the Venezuelan president decide to defy the calendar in such a bizarre manner? Well, Maduro announced that he simply wanted to bring “happiness for everyone.” And it's all part of a bigger plot.

Last week, Maduro sought to raise the level of happiness throughout the country by introducing the Deputy Ministry of Supreme Social Happiness. Maduro defended this cabinet-level creation, by remarking, “It’s provocative to make it a ministry, right?”

He then went on to add, “That’s the main message I wanted to give here. Let’s be happy and make others happy too.”

Tuesday, August 13, 2013 - Metric Disconnects

Metric Disconnects

by Sinclair Noe

DOW + 31 = 15451
SPX + 4 = 1694
NAS + 14 = 3684
10 YR YLD + .11 = 2.71%
OIL + .42 = 106.53
GOLD – 15.90 = 1322.40
SILV + .03 = 21.56

Retail sales rose 0.2% in July, following an upwardly revised 0.6% increase in June; retail sales are now up for 4 consecutive months. The retail sales report is important because consumer spending accounts for about 70% of the economy. We've heard that so frequently that it sounds like a cliché, but when we spend, that money circulates through the economy and it is the vital life blood of the economy. Areas showing gains included restaurants and bars, grocery stores and sporting goods outlets. Within general merchandise, department stores showed a 0.6 percent increase in sales last month

Another Commerce Department report today showed inventories at US companies were little changed. Merchants had enough goods on hand to last 1.29 months at the current sales pace in June.

Atlanta Federal Reserve bank President Dennis Lockhart says he thinks policy makers should move cautiously this year to scale back its bond buying program. Lockhart says the Fed might make its first reduction before the end of the year, maybe as soon as September, and that it should be thought of as a cautious first step. So, Lockhart was a bit more dovish than other Fed policy makers of late, and as he made the comments, small losses on Wall Street gave way to modest gains.

The equity markets have come to play an outsized role in the US from a policy and practical level. It’s never a good idea to try to assess complex phenomena with a single metric, yet for much of the public and the officialdom, the level and trend of the stock market is a proxy for the health of the economy. Fed policymakers now have a vested interest in keeping the stock market up, both to boost confidence and maybe out of personal vanity; if the stock market were to fall, that would mean they’ve done a bad job. Can’t have that!

Equity is a residual claim: payments to shareholders come after paying suppliers and employees, bondholders, leases and licenses, legal claims, and taxes. But our new ideology is that the last should come first. And to achieve that, companies in the US have abandoned the model of sharing the benefits of productivity gains with workers. Once upon a time increases in productivity moved up in tandem with increases in wages, but that changed in the 1970s. Since the end of World War II, productivity has increased by 254%, but real hourly compensation has only increased by 113%. As I say, they used to move in tandem; the disconnect happened about 40 years ago.

According to Bloomberg data, trailing 12-month earnings per share for the S&P 500 are 16 per cent above their level of October 2007 (when both earnings and share prices peaked before the financial crisis). On the same basis, earnings for the MSCI EAFE index, covering the rest of the developed world, are down 37 per cent. Those for the FTSE-Eurofirst 300 are down 42 per cent.

Earnings for the MSCI emerging markets index are up since October 2007 – but by only 13 per cent, having peaked and started to decline two years ago.

Look closely at the raw numbers for the US and they turn out to be less inspiring. S&P 500 companies are on course to increase earnings by 3.6 per cent year on year for the second quarter. But they have declined by 1.3 per cent once financials are excluded. During those 12 months, bear in mind, the S&P gained 18 per cent, and its financials index gained 33 per cent.

Companies are not generating that much in revenues but, over the past 12 months, they returned a record amount of it to investors. This is an admission that they see few opportunities to invest for growth. But, in an environment where investors take little on trust and are desperate for a yield from anywhere, it has helped the rally keep going. This is not a strategy that can last forever. At some point, companies must start generating more revenues and profits with which to make these payouts.

And if you still think its safe to jump back in;Apparently FINRA is looking into whether sell-side research analysts are doing some naughty things, which is an evergreen topic. It’s hard to tell if the analysts are doing naughty things but, probably, right? Basically the analysts are meeting with potential issuers before those issuers’ IPOs, which is fine. But at those meetings, which tend to be arranged by “so-called I.P.O. advisers” they might be talking about the IPO and the analysts’ views of the issuers, which is not fine. 

Yep, the IPO market is back in a big way. Initial public offerings are up 40% from a year ago; 126 companies have raised $27.1 billion, on track to $43 billion for the full year. Mark Hulbert at Marketwatch writes: "When companies are rushing to sell their shares, it often means that the overall stock market has become not just fairly valued, but actually overvalued.”

As Hulbert points out, companies aren't selling you stock out of the goodness of their hearts, but to make their executives, employees and bankers rich. What better time to get rich than when you think your stock is probably overpriced? The last big IPO boom featured dumb money chasing quick riches on first-day stock pops, a game that was heavily rigged in favor of insiders.

Hulbert's own inflation-adjustment of the IPO data suggests the market is on pace for the biggest dollar amount of IPO issuance since 2000, just at the popping point of the dot-com bubble. Estimates like these are going to vary depending on what sort of method you use to adjust for inflation; suffice to say there are a lot of IPOs these days.

IPOs may be back in fashion but mergers just took a hit.

The Department of Justice and several states has sued to block the proposed merger of American Airlines and US Airways. Arguing the combined airline would reduce competition for air travel in key markets. European regulators recently approved the deal after the companies agreed to give up two daily slots at London’s Heathrow Airport.

The airlines claim the merger would cut costs by streamlining operations and scaling back on unprofitable routes. They claim this would be good for customers because it could result in lower costs. However, the merger would also create a monopoly in several areas, such as nonstop service between Miami and Philadelphia or Nashville and Washington DC. The combined airline would also dominate some key hubs.

If not challenged by DOJ, the merged American would surpass United to become the largest U.S. passenger airline by several measures. While US Airways and American overlap on only 12 nonstop routes, no other nonstop competitors exist on 7 of those 12. The merger would also mean less competition along 1,665 other routes within the United States, while boosting competition along just 210 routes. According to the Justice Department, If the US Airways-American merger went through, the four biggest airlines would control more than 80 percent of the domestic air-travel market.

This doesn't mean the merger won't happen; it is still a possibility, but there would likely be some major concessions as talks continue.

Have you experienced a power outage lately? We had one at the studios about a week ago. It happens, and it is happening with greater frequency. The Department of Energy has a new report that shows the power grid is suffering more blackouts, a lot more over the past 20 years.

The report notes that “thunderstorms, hurricanes and blizzards account for 58 percent of outages observed since 2002 and 87 percent of outages affecting 50,000 or more customers.” The rest are caused by things like “operational failures, equipment malfunctions, circuit overloads, vehicle accidents, fuel supply deficiencies and load shedding — which occurs when the grid is intentionally shut down to contain the spread of an ongoing power outage.”

The report estimates that over the past 10 years, weather-related outages have cost an average of about $18 billion to $33 billion per year, adjusted for inflation. So, is severe weather the cause of the blackouts, or is the problem related to old infrastructure? Yes. The grid is old; there's been almost no new construction in the past 25 years, and that makes it vulnerable to severe weather. Grid resilience is increasingly important as climate change increasesthe frequency and intensity of severe weather. Greenhouse gas emissions are elevating air and water temperatures around the world. Scientific research predicts more severe hurricanes, winter storms, heat waves, floods and other extreme weather events being among the changes in climate induced by emissions of greenhouse gasses.

The Energy Department report says the grid should be modernized and made to tougher standards especially where severe weather may be a problem. Yes, it would be expensive to upgrade the grid, and it would be more expensive to wait.

Yesterday, we reported that a couple of lower-level traders at JPMorgan might face the possibility of arrests in connection with the London Whale trades. It doesn't look like Bruno Iksil, the actual London Whale will be arrested; he's cooperating with the investigators.

Almost everyone, from President Obama to his ideological foes in the Republican Party, wants the government out of the business of guaranteeing almost every mortgage loan made in the U.S. That's all well and good, but there is no reason to think that private investors will be willing to fund the types of mortgages people expect at rates they consider "affordable" in the absence of government guarantees. The government could help assuage investor fears by proving that it is committed to upholding the rule of law and punishing individuals who commit financial fraud.

The government, in turn, has shown almost no interest in charging individuals with criminal conduct. Somehow one of the most destructive and widespread frauds in recent history happened without anyone causing it; except for Fabrice Tourre, and that was a civil suit, not criminal. Bank shareholders have certainly spent money on settlements, but the actual perpetrators, whoever they were, have gone unscathed. Given this backdrop, who would pour money into a rejuvenated "private-label" MBS market in sufficient size to offset a large decline in government support?

From the perspective of investors, lying about the quality of the loans they were packaging into securities wasn't even the worst thing the banks did. In many cases, banks failed to ensure that the securities they were selling were even legal. And it now appears that many of the mortgage backed securities weren't really backed by mortgages, maybe more than $1 trillion dollars worth of the stuff.

Of course, the lack of proper documentation didn't prove much of an obstacle to banks that wanted to foreclose on delinquent (and current) borrowers -- they just forged the paperwork they needed.These fraudulent foreclosures harmed investors and the broader economy, although they boosted the earnings of the big banks.

State attorneys general and the Department of Justice eventually settled with the big banks over this practice. None admitted wrongdoing, and no individuals were punished. Far less money actually reached the victims of these fraudulent practices than was expected -- and many had to endue long delays before getting what little they were owed, and then many people received a check in the mail and it bounced; yep, the settlement checks sent out by the banks, bounced. As if that weren't bad enough, the court-appointed settlement monitor says that many of the banks are still breaking the rules. 

The government's failure to prosecute wrongdoing has created an environment of legal doubt that keeps investors away. Not only are investors unable to trust the government to enforce the law -- they can't even trust the government to tell them how bad a job it has done enforcing the law. It all leaves you wondering why anyone would buy private-label MBS until that changes. 

Tuesday, August 06, 2013 - Dog Days

Dog Days

by Sinclair Noe

DOW – 93 = 15,518
SPX – 9 = 1697
NAS – 27 = 3665
10 YR YLD + .02 2.63%
OIL - .86 = 105.70
GOLD – 21.20 = 1283.60
SILV - .23 = 19.58

If the markets are boring you this summer, you just aren't paying attention. August trading in this post-financial crisis landscape has been anything but boring. For the past four years, the market has offered tremendous gains and harrowing losses during the month of August. The boring, flat market many of us have grown to expect just hasn't materialized.

Investors were treated to big gains in August 2009 and August 2012. But in August 2010 and 2011, the broad market coughed up about 5%. In 2010, August ended up marking the final lows of a summer correction. In 2011, the eurozone crisis pulled stocks underwater by as much as 12% during the month of August, only to claw their way back from the brink of a new bear market. So much for the dog days of summer. This time around, nothing should surprise you. 

The US trade deficit declined in June to its lowest level in more than 3-1/2 years as imports fell and exports touched a record high. The Commerce Department says the trade gap fell 22.4 percent to $34.2 billion, the smallest since October 2009. The percentage decline was the largest since February 2009.

May's shortfall on the trade balance was revised to $44.1 billion from the previously reported $45.0 billion. Exports of goods and services increased 2.2 percent to a record $191 billion. The gain in exports was broad based, with food, industrial supplies, capital goods and consumer goods rising. Motor vehicle exports, however, fell in June. The increase in export growth may point toward slightly stronger second half GDP growth for the economy.

I mentioned yesterday that we were expecting some Federal Reserve officials to give some speeches this week. Yesterday, Dallas Fed President Richard Fisher called for an end to QE; no surprise because it's well known that Fisher opposes ongoing QE. Today, Dennis Lockhart, President of the Federal Reserve Bank of Atlanta spoke as part of a panel discussion; and Charles Evans, President of the Chicago Fed Bank spoke to reporters.

Lockhart said continued improvement in the labor market would be key: "If we see the growth pick up in the second half and if we see a continuation of the job gains that we - not (the) 162,000 number that we saw last month but at a higher range, say 180-200,000 - I think with other fundamentals improving we probably are in a position to remove ... the extraordinary policy program over the medium term - that being the asset purchase program." Lockhart also said that if the economy deteriorates then the exit from QE is not a foregone conclusion.

Chicago Fed President Charles Evans said much of the same: "We are quite likely to reduce the flow of purchases rate starting later this year - I couldn't tell you exactly which month that will be - and it's likely to wind down over time in a couple or few stages."

Both Fed officials think the Fed will stick to a Zero Interest Rate Policy for quite some time. Evans said he expects the economy to grow about 2.5 percent in the second half of this year, and more than 3 percent next year. That rate of growth should generate about 175,000 to 200,000 jobs a month and will probably bring the unemployment rate down to about 7.2-7.3 percent by the end of the year. So, the outlook is rosy, the current conditions, not so much. The Fed doesn't always nail economic forecasts.

All told, Evans said, the Fed's third round of quantitative easing, or QE3, will likely total at least $1.2 trillion since January 2013, double the size of the Fed's prior round of purchases. So, we might question whether we got our money's worth and also if the economic forecasts are good enough. Even if the economy starts averaging 200,000 net new jobs per month, is that good enough, considering the quality of jobs? Is 6.5% unemployment good enough? Remember, the Fed hasn't seen much in the way of fiscal policy to improve the situation.

Another regional Fed policymaker, Narayana Kocherlakota, president of the Minneapolis Fed, has called for the Fed to spur the economy further by lowering its threshold for considering a hike in rates to 5.5 percent unemployment, near the economy's long-term normal rate.

So, the markets were down today, even with good news on the trade deficit because the market is focused on free money from the Fed and fearful they will take away the punch bowl, or the Bernanke “put”, or whatever you want to call it; the Fed has been pumping $85 billion a month into the markets and they would hate to see it go. For the rest of us, that money doesn't seem to filter down from Wall Street to Main Street, but it is turning into the lifeblood of Wall Street, and when it's gone Wall Street will likely respond poorly, and today was just a small indication.

The government filed two civil lawsuits against Bank of America for what the Justice Department and securities regulators said was a fraud on investors involving $850 million of residential mortgage-backed securities.

The Justice Department and the Securities and Exchange Commission filed the parallel suits in US District Court in Charlotte.

The securities date to about January 2008, putting them just at the beginning of the global financial crisis.

Bank of America responded to the lawsuits with a statement: "These were prime mortgages sold to sophisticated investors who had ample access to the underlying data, and we will demonstrate that.

Bank of America had warned in a securities filing on Thursday about possible new civil charges linked to a sale of one or two mortgage bonds.

The two suits accuse Bank of America of making misleading statements and failing to disclose important facts about the mortgages underlying a securitization named BOAMS 2008-A.

"These misstatements and omissions concerned the quality and safety of the mortgages collateralizing the BOAMS 2008-A securitization, how it originated those mortgages and the likelihood that the 'prime' loans would perform as expected," the Justice Department said in its statement. A "material number" of mortgages in the pool "failed to materially adhere to Bank of America's underwriting standards."

Bank of America has announced a series of settlements with investors and the government, including an $8.5 billion settlement with investors in mortgage-backed securities and a $1.6 billion deal with bond insurer MBIA Inc.

Last week, a jury in New York City convicted former Goldman Sachs trader Fabrice Tourre on six civil counts of securities fraud, for selling a toxic mortgage-backed bond to investors without disclosing that an architect of the deal, hedge fund Paulson & Co., also bet on its failure. This victory for the Securities and Exchange Commission signifies a long-awaited measure of justice for the unbridled greed and dirty dealing that sparked the financial crisis, but an exceedingly small one. Tourre was a young, mid-level employee, listed as a “vice president,” but so are hundreds of people at Goldman, not a decision-maker in executive suites throughout Wall Street. The conviction means he’ll pay a fine and probably get barred from the securities industry, an industry he’s already left to pursue a doctorate. This is hardly the level of accountability that practically the entire country demanded to see, especially when you consider that it represents the sum total of legitimate crisis-related convictions, and a non-criminal one at that. The SEC must stop chasing minnows while letting the whales of Wall Street go free.

Despite this, the Tourre case matters. It should lead Washington to rethink the conventional wisdom that financial regulators and Justice Department officials have spread about these cases: that they’re impossible to prosecute. It’s not just critical for how we remember the last crisis; it also shapes how we should think about the next one, whenever it comes to pass.

If you look at all the excuses for the total absence of prosecutions of major bank executives for their roles in nearly crashing the global economy, you find two major themes. First, the financial industry’s conduct was perhaps unethical but not technically illegal, especially since the peculiarities of securities law ensure that well-heeled bank executives will find some loophole to exculpate themselves from guilt. Second, juries will not be able to understand the hopelessly complex intricacies of the law, and will simply punt before agreeing beyond a reasonable doubt on the guilt of the bankers.

The Tourre case proves these both wrong. To say the case discredits a silly argument gives that argument too much weight. There were numerous convictions of accounting fraud in the Enron and WorldCom era, in cases that were at least as complex as the 2008 crisis. Ultimately fraud is fraud. Juries are more sophisticated than people give them credit for. They take their job seriously.

That appears to be the result of the trial of Fabrice Tourre. The jury, which has been interviewed extensively, fully understood that Tourre was something of a scapegoat and not the central decision-maker at the firm. They recognized that senior executives at Goldman Sachs approved the deal, known as Abacus. And they generally discounted the damning emails from Tourre, bragging about selling the toxic bonds to “widows and orphans.”

Instead, they bore down into the details, asking simple questions about whether Tourre’s lack of disclosure to investors about the designed-to-fail quality of Abacus represented securities fraud. They saw through the allegation that the industry generally did not disclose the participation of hedge funds like Paulson in derivatives deals, and focused on whether that constituted a material misrepresentation. And Tourre’s participation in the scheme, not his place on the totem pole at Goldman, was the determinative factor. One juror summed it up this way: “They portrayed him as a cog, but in the end a machine is made up of cogs and he was a willing part of that.” While Toure faced civil charges with a lower burden of proof, these core insights from the jury could have been employed even in criminal financial fraud cases.