Tuesday, July 22, 2014 - Curb Your Enthusiasm

Curb Your Enthusiasm

by Sinclair Noe

DOW + 61 = 17,113
SPX + 9 = 1983
NAS + 31 = 4456
10 YR YLD - .01 = 2.46%
OIL - .17 = 104.42
GOLD – 4.70 = 1308.50
SILV + .04 = 21.07

We start with a couple of economic reports. The National Association of Realtors reports existing home sales were up 2.6% in June to a seasonally adjusted rate of 5.04 million, compared to 4.91 million in May. Sales in June were 2.6% higher than last month, but were 2.3% below the June 2013 rate. Total inventory rose 2.2% in June to 2.3 million existing homes for sale; unsold inventory is up 6.5% from a year ago.

At June’s pace of sales, there was a 5.5 month supply of homes for sale. The Realtors’ group considers a 6-month supply to be a balanced market. Higher supplies favor buyers and lower supplies favor sellers. The Federal Housing Finance Agency says home prices in May rose 0.4% from the prior month and were 5.5% above their level of May 2013. Distressed sales accounted for just 11% of sales in June, down from 15% last year, 25% in 2012, and 30% in 2011. Fewer distressed sales probably explains why there were fewer sales than June of last year.

The Consumer Price Index, or CPI, measures inflation at the retail level; the CPI increased 0.3% in June. The core CPI looks at prices excluding food and energy, which is important for people who don’t eat food or drive cars or use electricity; core CPI was up 0.1% in June. On a year over year basis, CPI is up 2.1%, and the core CPI is up 1.9%. The big driver for the increase in June was higher prices for gasoline.

In earnings reports:

Quarterly profit at McDonald's fell more than expected. Second quarter net income fell almost 1% to $1.3 billion, or $1.40 per share. Sales at McDonald’s restaurants in the US dropped for a third straight quarter.

Coca Cola’s 2Q net income dropped to $2.6 billion from $2.68 billion a year earlier.

Verizon reported second quarter earnings nearly doubled, but it was a confusing report because Verizon paid for Vodaphone shareholders in the quarter, plus they sold some of their wireless spectrum to T-Mobile; cutting through the clutter, Verizon added 1.4 million devices; Verizon added three tablets for every new smartphone. Earnings were just a smidge above expectations.

Comcast reported net income of almost $2 billion for the second quarter, with total revenue of $16.8 billion, up 3.5% from the same period last year. The revenue increase came from high speed internet service. Comcast lost cable video customers, as more people bypass cable and satellite subscriptions in favor of cheaper streaming alternatives.

Credit Suisse reported a second quarter loss of $779 million, the largest loss since 2008; reflecting the charge of $2.6 billion related to the settlement with US law enforcement for a guilty plea to conspiring to aid tax evasion in helping American customers hide money in Swiss accounts. Or another way to look at it, they were one criminal conviction away from a $1 billion quarterly profit. Credit Suisse also announced it would exit the commodities trading business.

Meanwhile, it looks like bond traders are exiting the bond trading business. Trading in US government bonds has dropped 25% in the past few weeks compared to the same time period a year ago. Since the end of the second quarter, trading in investment grade bonds has dropped 17% and trading in junk bonds has dropped 8%.

Last week, Fed Chair Janet Yellen talked about overvaluation in the biotech and social media sectors. One of the most common measures of value is the P/E, or price to earnings ratio; there are certainly other measures of value, but PE is common. Generally, a low PE can point toward value, while a high PE might indicate overvaluation, or even an unprofitable company. Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share. So, you might think a PE of 165 would mean a stock was extremely overvalued, ready to crash; or not. In September 2003, Apple had a PE of 165; since then it has gained about 6,000%.

After the close of trade today, Apple posted fiscal third quarter results. Revenue came in at $37.4 billion versus $38 billion expected; EPS was $1.28 versus $1.23 expected; iPhone sales were on track; iPad sales were a little weak; Mac sales were a little better than expected. Apple posted profit of $7.75 billion, up from $6.9 billion in the year-ago period. Apple announced a new iPhone 6, not yet available, but ready to swamp stores before the end of the year; it will have a bigger screen. Curb your enthusiasm.

Also after the close, Microsoft posted profit of $4.6 billion, or 55 cents a share, on revenue of $23.4 billion. During the year-ago period, the world's largest software company earned $4.97 billion, or 59 cents a share, on $19.9 billion in sales. So, sales were up, profit was a slight miss, due to the Nokia acquisition. Bing search ad revenue is up 40%, and Bing now has about 20% of the market share for search engines. Microsoft is big in the cloud, where revenue is up almost 150%, topping 4 billion.

Hedge fund manager Bill Ackman went on CNBC yesterday and promised he would deliver the death blow against Herbalife. Ackman has been shorting the stock for about a year, a $1 billion bet the company will crash. Then he delivered a 3 hour diatribe with 250 slides in his PowerPoint presentation, alleging that Herbalife is not just a multi-level marketing nutritional club, it is a pyramid scheme preying on minorities, and the biggest fraud since Enron. Ackman didn’t present a great deal of evidence. Today the stock was up 15%, for no apparent reason, other than surviving an Ackman death blow.

There were two rulings from two federal appeals court panels on Obamacare today. The question was whether the government could subsidize health insurance premiums for people in states that use the federal insurance exchange; 36 states use the federal exchange, while the other states set up their own state exchanges. This goes back to wording in the original law that says subsidies can be applied to state exchanges.

 The United States Court of Appeals for the District of Columbia Circuit said that the government could not subsidize insurance for people in states that use the federal exchange. That decision could potentially cut off financial assistance for more than 4.5 million people who were found eligible for subsidized insurance in the federal exchange, or marketplace.

A couple of hours later, the United States Court of Appeals for the Fourth Circuit, in Richmond, upheld the subsidies, saying that a rule issued by the Internal Revenue Service was “a permissible exercise of the agency’s discretion.”

For now, nothing changes, with the exception that there will be many more billable hours for the attorneys.

Bloomberg reports that regulators are ready to label Metlife a potential threat to the financial system, subjecting the insurer to oversight by the Federal Reserve. MetLife, the biggest US life insurer, could be subjected to stricter capital, leverage and liquidity requirements as a result of Fed supervision. A decision by the Financial Stability Oversight Council may come as early as July 31, and MetLife would have 30 days to request a hearing before the FSOC to contest the decision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now 4 years old, even though it isn’t really in effect; just 52% of the rules mandated under Dodd-Frank have been finalized by regulators; Another 23% have been proposed but they’re still working out details, and regulators haven’t even gotten around to 24% of the rules. A recent report by consumer watchdog Public Citizen called out the Securities and Exchange Commission as a particularly egregious delayer, noting that it had pushed back the deadlines for 13 of the 23 rules it was supposed to finalize this year.

City workers and retired city workers in Detroit have agreed to pension cuts to help bailout the city from bankruptcy. General retirees would get a 4.5% pension cut and lose annual inflation adjustments. They accepted the changes with 73% of ballots in favor. Support for the pension changes triggers an extraordinary $816 million bailout from the state of Michigan, foundations and the Detroit Institute of Arts. The money would prevent the sale of city-owned art and avoid deeper pension cuts.

Most people travel to or from Israel by air, and the major airport, really the only airport is Ben Gurion in Tel Aviv; last year, 14 million people went through Ben Gurion Airport, in a country with a population of 8 million.  Yesterday a rocket from Gaza landed about one mile from the airport; we don’t have further details on that rocket; it didn’t hit the airport; it was a mile away. When news spread, Delta diverted a flight to Paris. United airlines cancelled flights. The Federal Aviation Administration banned all US passenger and cargo flights to and from Tel Aviv for at least the next 24 hours. European airlines cancelled flight to Israel. The possibility of a passenger jet being shot down over a war zone is a very realistic and fresh memory.

US and United Nations diplomats are in Israel, trying to broker a ceasefire of some sort. Israel continues to pound targets across the Gaza Strip. It does not appear a ceasefire is near. If there is any light at the end of the tunnel, the tunnel will be destroyed.

The European Union today threatened Russia with harsher sanctions if Russia doesn’t cooperate in the investigation of the downing of the Malaysian flight 17 and if Russia doesn’t stop sending weapons to Russian backed separatists in Ukraine. But it was just a threat, and they’ll get together later in the week to draft proposals for sanctions.

Wednesday, March 12, 2014 - The Next 25 Years

The Next 25 Years

by Sinclair Noe

DOW – 11 = 16,340
SPX + 0.57 = 1868
NAS + 16 = 4323
10 YR YLD - .04 = 2.72%
OIL – 1.96 = 98.07
GOLD + 17.70 = 1368.20
SILV + .43 = 21.42

Let’s run through some of the economic and business news and then we’ll get to today’s anniversary.

Stocks were flat. People are still trying to make heads or tails of this mixed up world. The situation in Ukraine is not improving. The EU agreed a framework for its first sanctions on Russia since the Cold War. Protesters battled soldiers in the streets of Caracas, Venezuela; two more protesters were shot; dozens were injured. Riot police clashed with demonstrators in several Turkish cities for a second day as mourners buried a teenager wounded in protests last summer.

The Senate Banking Committee announced an agreement on legislation to wind down the government-owned mortgage financiers Fannie Mae and Freddie Mac. Share price cratered.

Herbalife says the Federal Trade Commission has opened an inquiry into the company. The FTC confirms the inquiry, but not the nature of the inquiry. Share price cratered.

Copper prices dropped to the lowest level in almost 4 years; this goes back to China, and is a canary in the coal mine for industrial demand. China is one of the metal’s biggest customers and there has been recent poor trade data out of China. Two Chinese solar companies have defaulted in the past week. The general risk from here is that this move in metals prices further destabilizes the Chinese financial system and will raise concerns of a hard landing in China if the authorities can’t get ahead of the pressures and potential contagion effects this move is generating.

A Senate subcommittee plans to hold a hearing in early April on GM's recall last month of more than 1.6 million vehicles with the faulty ignition switches which have been linked to 12 deaths. Most of the affected cars were sold in the United States. Even after the long delayed recall, GM says drivers should not use big, heavy key rings. Not a good repair job.

It is illegal for Tesla to sell cars in New Jersey, other than traditional auto dealerships, which is not the Tesla business model. Guess who pushed that law through the New Jersey legislature; this, even though Tesla does not limit the number of keys you can safely have on a key ring.

Citigroup recently discovered they had made $400 million in fraudulent loans to a company in Mexico, now they’ve uncovered three new sets of problems loans, each at about $10 million.

Fabrice Tourre, the Goldman Sachs trader convicted of defrauding investors in a subprime mortgage product that failed during the financial crisis has been ordered to pay a fine of $825,000. The SEC accused Tourre of concealing from investors how Paulson & Co, the hedge fund of billionaire John Paulson, had helped put together a fund of subprime mortgages called Abacus, and had bet it would fail.  Paulson made a cool $1 billion by shorting Abacus, while investors lost the same amount. Goldman, the company, in July 2010 reached a related $550 million settlement with the SEC. It did not admit wrongdoing but acknowledged and expressed regret that its marketing materials were incomplete. Tourre resigned from Goldman in December 2012, and is pursuing a doctorate in economics at the University of Chicago.

Boeing says the missing 777 Malaysia Airlines jetliner was not subject to a new US safety directive that ordered additional inspections for cracking and corrosion on certain 777 planes. They still have no idea where the jet is.

This week, we’ve been looking at anniversaries: the 5^th anniversary of the bull market, the 14^th anniversary of the bear market, the 3^rd anniversary of the Fukushima disaster. Today marks the 25^th anniversary of the World Wide Web. This is actually a somewhat questionable anniversary; not because of the malware, the misinformation, the internet trolls, the time wasting, and the tedious social media that passes as actual human interaction.

No, this is a questionable anniversary because the world wide web must be differentiated from the internet and even after we had the web, we waited until 1993 to actually have a web page. The web was built on top of the internet. On the internet, the connections are between computers using cables and other physical links; on the web, connections are hypertext links. The web is a way to present information from a software application known as a web browser using Hypertext Markup Language or Hypertext Transfer Protocol, HTML or HTTP. The web was based on a proposal written on March 12, 1989 by Sir Tim Berners-Lee, and then we had to wait until December 1990 for Berners-Lee to release the first web browser, called the WorldWideWeb.

So, what will the web look like in the next 25 years? That is part of the question posed on this anniversary by none other than Berners-Lee in an interview published today in the Guardian; he believes the web should be "accessible to all, from any device, and one that empowers all of us to achieve our dignity, rights and potential as humans." He hopes to re-invent the Web through the "Web We Want" initiative, which would create a universal "Internet Users Bill of Rights"; think of it as an online Magna Carta.

The initiative would build support for national and regional campaigns to create a world where everyone is online and free to participate in the flow of knowledge, ideas, collaboration and creativity over an open Web. Without an open, neutral Internet, we can't have an open government, good democracy, healthcare, connected communities and a diverse culture. And Berners-Lee says: "It's not naive to think we can have that, but it is naive to think we can just sit back and get it."

Among the obstacles to an open, neutral internet, Berners-Lee cites principles of privacy, free speech, responsible anonymity, the impact of copyright laws, and the overhaul of how security services are managed especially in light of American and British spy agency surveillance of citizens.

The web has become an indispensable tool for communications, science, education, health, democracy, entertainment, finance, advertising, and commerce. It has been well argued that the internet is the most significant contribution to spreading knowledge since the introduction of Gutenberg’s printing press, but this web is much faster; Martin Luther’s 95 theses can now be pinned on someone’s Facebook wall and travel round the world in the blink of an eye. The growth of the web has been exponential; actually that is not a strong enough word to describe the growth.

The Web has brought tremendous innovation, but how do we measure innovation’s impact on our standard of living? We can look at the web and easily see that it has been very profitable for many; fortunes have been made, and lost. The most recent fortune will likely go to the innovators behind the Candy Crush game, King Digital; today they announced an initial public offering that values the company at $7.6 billion; and Wall Street analysts immediately started whining that the valuation was low based on trailing 12 month PE of 13.3. This is for a video game. What is the net contribution to economic growth from a video game?

Another way of looking at innovation is price. It is fairly easy to assess the value of innovation if it lowers the price of something, such as a car or food. How do we measure an improvement in quality for something that already exists? The internet has provided people with tremendous information on health and medicine; surgery is more likely to be successful now than before this information was available. How do we measure that?

The financial industry has claimed to embrace innovation. Yes, you can get your bank statement online and businesses can accept digital payments online, but it also led to bankers devising better ways of manipulating markets and the so-called innovation of the vast world of ticking time bombs known as derivative. You can also make the case that the net social contribution from so-called financial innovation was negative.

And for all the good things that we get from the internet, you have to wonder if we’ve squandered this gift of technology. So much effort has gone into advertising and marketing and targeting customers; this makes sense because you have to make money in order for the technology to be viable, but has this emphasis detracted from directing our efforts to improve our standard of living? How can we compare Facebook and Twitter and Candy Crush with the invention of powered air flight, the development of the interstate highway system, the polio vaccine?

This is not to say that social media has a negative social contribution (I’ll leave that distinction to the bankers). Social media can do amazing things: a spike in Twitter posts about upset tummies can alert the doctors to a salmonella outbreak, an amber alert on my phone may save a child’s life, there are massive online campuses that can provide an education comparable to the best universities, great thoughts abound on Redditt, the libraries of the world are now available at the click of a button, and the great cacophony of millions of voices may someday come together in crowd sourced harmony to create beautiful music.

In the past 25 years, we’ve seen some amazing innovation, lots of cool stuff, lots of silly stuff, and a fair amount of bad stuff on the internet. In the next 25 years, maybe we’ll do better.