Tuesday, August 12, 2014 - Hype is Hurting

Hype is Hurting

by Sinclair Noe

DOW – 9 = 16,560
SPX – 3 = 1933
NAS – 12 = 4389
10 YR YLD + .02 = 2.44%
OIL - .15 = 97.22
GOLD + .60 = 1309.50
SILV - .10 = 20.02

The Dow Industrial Average has now gone negative year-to-date. Seven of the 10 main groups in the S&P 500 declined, with energy companies dropping 0.7 percent to lead the slide as Brent crude settled at the lowest level since July 2013. The International Energy Agency said a supply glut was shielding the market against threats in the Middle East.

As we wrap up earnings season, 73% of companies have beaten earnings estimates, slightly above the 1-year average of 72%, but “beating estimates” this time doesn’t mean what it did in recent quarters. For the past few years, analysts have ratcheted down their estimates in the run-up to earnings season, setting the bar lower and lower—and setting up an easy beat. Companies are beating by an average of 4.2%, above the 1-year average of 3.2%. Q2 earnings growth is 8.4%, up from an expected 4.9% on June 30. This is the second-highest earnings growth rate since Q4 2011. Revenues are now up for 5 consecutive quarters and at all-time highs, and it now looks like revenues might be driving earnings. The strongest sectors for upside earnings surprises have been telecom services, health care (especially biotech), and information technology; while consumer staples is the weakest. US banks and thrifts had their second best quarter in 2 decades, with more than $40 billion in net income.

Profit margins have soared. Net profit margins more than doubled from 4.6% in March 2009 to 9.8% at the end of the first quarter. Margins could come in just shy of 10% when all the second-quarter results are in. The problem is that high margins tend to mark a peak rather than a normal level of profitability. In other words, it’s tough to keep the margins high, and there are several reasons: most of the fat has been cut and it is difficult to further improve labor efficiencies and that’s confirmed by last week’s productivity report showing that the real output of nonfarm business has been hovering around 3% year to year since Q2-2010, consistently higher than real GDP growth; capital spending has been low, but is likely to rebound; and with interest rates near all-time lows, companies will find it difficult to find better financing to boost margins. As margins stagnate or slip, the best defense is to look for companies that are growing revenues.

Actually, the best defense might be to discount analysts’ expectations; something that Wall Street is doing with greater frequency. The problem is that analysts issue glowing earnings growth expectations for the next few quarters, based on pro forma estimates, minus the bad stuff, and heavily adjusted; which in turn drives up share prices. Traders buy in. As the distant quarters get closer and closer, the analysts ratchet down expectations, making for a bar that is easy to hurdle, and again the traders buy in.

In its latest report on earnings expectations and reported earnings, FactSet found a startling change in how the market reacts to these fabricated earnings beats. Over the past five years, companies with upside earnings surprises saw their stock prices rise on average 1% from two days before the announcement to two days afterwards; and downside earnings surprises were punished with a 2.3% decline in stock price over the four-day window. So far in the second quarter earnings season, companies have been crushing earnings, and the market is languishing. FactSet found that this time around the market didn’t reward these juicy earnings surprises at all. Stocks of these companies actually dropped 0.1% over the four-day window. And downside earnings surprises got hit with a 3% decline. The hype is hurting.

The share of unemployed Americans competing for each open job hit a six-year low in June. The Labor Department's monthly Job Openings and Labor Turnover Survey, or JOLTS report, showed the number of unemployed job seekers per open job fell to 2.02 in June, the lowest level since April 2008. Job openings, a measure of labor demand, increased to a seasonally adjusted 4.67 million in June, the highest level since February 2001. At the same time, hiring reached its highest point since February 2008. Much of the increase in employment growth since the 2007-2009 recession ended had been driven by a sharp decline in the pace of layoffs, as opposed to a higher rate of hiring.

Job growth has topped 200,000 in each of the past six months, a stretch last seen in 1997. The unemployment rate has declined to 6.2 percent from 6.7 percent at the end of 2013. The JOLTS report shows some of the slack is coming out of the labor market, and the next sign of a tightening labor market is if we start to see wage growth. Meanwhile, a gauge of small businesses’ intentions to hire has also surged to a fresh post-crisis high, with 13% of respondents to a survey by the National Federation of Independent Business indicating their intentions to hire. That’s the largest percentage since September 2007. The problem is they aren’t actually hiring. The JOLTs hiring rate is nowhere near as buoyant as the job opening rates. The US hiring rate, hires as a share of total employment, hit 3.5% in June. You might expect businesses to intend to hire before they actually hire, but there is also a disconnect; and it might be in a skills mismatch or it might be in a wages mismatch.

During the Great Recession and its aftermath, the federal government acted to help victims of the severe downturn by funding programs that extended unemployment benefits—to up to 99 weeks in some cases, up from the standard 26 weeks. As the economic recovery continued, weak as it was for many in the working class, many lawmakers on the right began to believe that these extended benefits were a drag on employment—the theory being that government checks reduced the incentive for recipients to find a job, and that cutting off this lifeline would compel unemployed workers to look harder for work and perhaps take jobs they may not have accepted if the benefits had continued. Relying on this premise, Congress allowed the federally-funded Emergency Unemployment Compensation program to lapse last December.

Now, more than seven months later, data are available to test this idea. Coming from perspectives that diverge greatly along the ideological spectrum, scholars at both AEI and EPI, the Economic Policy Institute and the American Enterprise Institute, a couple of think tanks at opposite ends of the spectrum, have come to the conclusion that this “bootstraps” theory is incorrect—curtailing jobless benefits did not boost employment. Because unemployment benefits are contingent upon the people who receive them proving that they are looking for a job, receiving jobless benefits appears to make recipients at least just as likely, and certainly not less likely, to rejoin the ranks of the employed.

The US budget deficit was $95 billion at the end of July, down 3 percent from the same period last year. The fiscal year-to-date deficit at the end of July was $460 billion, the lowest level since the same period in fiscal year 2008, compared with a deficit of $607 billion for the same period in fiscal year 2013.

The National Association of Realtors released metro area home-price data for the second quarter, and it looks like growth in home prices is slowing, especially in the East. Nationwide, the median existing single-family home price in the second quarter was $212,400, up 4.4% from the second quarter of 2013. The median existing home price for the Phoenix area is $198,600, up 8.6% from one year ago.

The inventory of all existing homes for sale rose 6.5 percent in June from a year earlier to 2.3 million, an increase from a 13-year low of 1.8 million in January 2013. That’s a 5.5-month supply at the current sales pace, less than the six months that is considered equilibrium between buyers and sellers. Breaking it down further, inventory tightened at the market’s low end and grew at the top. The number of U.S. homes for sale in the bottom third of the market -- below $198,000 -- fell 17 percent in June compared with a year earlier, according to a Redfin analysis of 31 large U.S. metropolitan areas. The supply was up 3 percent in the middle market and jumped 15 percent at the top. The rising inventory of more expensive properties is giving a boost to sales. At the bottom of the market, first-time buyers, even those with the credit, savings and income to overcome tougher underwriting requirements, must face off against other bidders. First-time purchasers accounted for 28 percent of all sales of previously owned homes in June, down from about 40 percent historically.

A funny thing happened in New York yesterday; Manhattan prosecutors filed criminal charges against a dozen payday lending companies and their owner, accusing them of making payday loans that defied New York's limits on interest rates, or usury laws. The defendants in the case tried to cover their tracks with a maze of offshore corporations, to make it look like they weren’t doing business in New York. Under New York state law, the maximum interest rate that can be charged is 9 percent annually and the general usury limit is 16%, with a bunch of exemptions. The defendants in this case are accused of charging between 300% and 700% interest. Remarkably, most states still have usury laws on their books, but not all. In Arizona the legal rate of interest is 10%.

You may very well have a credit card that charges more than 10%, and the reason that is not considered usury is federal court decisions and statutes have virtually exempted credit card companies by allowing them to charge customers, regardless of their state of residence, the interest rates allowed by the state in which they are incorporated. This means that there are no limits on credit card interest rates in practice, even if certain limits remain on the books, the only exception being the 18 percent interest limit for federally chartered credit unions. And so it is a very rare event when anyone faces a criminal charge of usury.

Thursday, September 19, 2013 - Shine On You Crazy Dimons

Shine On You Crazy Dimons

by Sinclair Noe

DOW – 40 = 15,636
SPX – 3 = 1722
NAS + 5 = 3789
10 YR YLD +.06 = 2.75%
OIL + .04 = 106.43
GOLD - .20 = 1366.10
SILV + .13 = 23.19

No taper, despite hints and great expectations. Having announced the intention to taper, ultimately, a few weeks later, the proposal was shelved. The reasons given were concerns about the strength of the economic recovery and the impact of high rates on the ability of an over-indebted world to continue to meet its obligations. All these factors were largely unchanged between the time of the original announcement and the repudiation.

What did change was the taper tantrum, the unpleasant market reaction to the hint of taper. Bond yields rose sharply; the Fed's tough talk has already led to a 140 basis point rise in 10-year Treasury yields, which would be roughly equivalent to six rate increases; that in turn resulted in pushing mortgage rates higher, putting a crimp in the housing recovery. Today we learned home sales were up. Sales of previously owned homes unexpectedly rose in August to the highest level in more than six years as buyers rushed to lock in interest rates before they jumped even higher.

The labor "participation rate" dropped to 63.2% in July, the lowest level since the late 1970s. The rate for men is at an all-time low. The unemployment rate has been falling, but chiefly because so many people are giving up hope and dropping off the rolls.

Fed governors tried to pass this off as a structural problem; due to evolving technology, or a "skills mismatch", or that catch-all concept "demographics". No doubt this is half true. But half truths also go by another name. Chronic lack of demand is the real villain is this jobs slump. The problem is not that the labor market is under performing; it is that the recovery has been very slow.

The economy has weathered the most draconian fiscal tightening (2.5% of GDP this year) since the end of the Korean War remarkably well, helped by shale gas, but it is not yet at "escape velocity". The fiscal squeeze goes on. The International Monetary Fund has advised Washington to go easy, citing an "output gap" of 4.6% of GDP. The Dallas Fed's measure of core inflation was 1.2% in July. Growth of the M1 money supply is the slowest in two years, while growth of broad M3 has slowed to the point where it could turn negative without QE. The inflation threat is a fiction; it could be a problem at some point, but not today.

The US dollar rose sharply and stocks sold off, and emerging markets sold off even harder. The BRICS have been hit hard already and given the dangers of another euro-zone debt hemorrhage, which happened after the end of QE1 and QE2, it would be a globally rude gesture to taper.

Ultimately, most market prices, except interest rates, headed back to where they roughly started before the taper talk. Billions of dollars were gained and lost in the zero sum marketplace casinos that constitute the modern economy. And really that seems to be the determinant factor for the Fed. The Bernanke Fed has twice misjudged the global effects of premature tightening already, each time precipitating a credit and stock market crash within weeks, and each time forcing the Fed to capitulate. The exit from QE3 will be ugly, when it eventually arrives.

A paper by former Fed governor Frederic Mishkin, "Crunch Time", warns that the Fed will struggle to extract itself from QE if it delays until 2014. It may drown from losses on its $3.6 trillion of bond holdings as yields rise. The Fed's own balance sheet is at risk, and the risks may indeed outweigh the rewards. Certainly some Fed policymakers would like to head for the exits, but they would like to exit without imploding the Wall Street debt machine; and that may not be realistic.

If QE as conducted is causing asset bubbles, then we should deploy central bank stimulus more creatively, should it prove necessary. We know how to do it. The methods were pioneered by Takahashi Korekiyo, who pulled Japan out of the Great Depression early in the 1930s. His feat is now the model for what Japan is doing again under Abenomics.

Takahashi turned the Bank of Japan into an arm of the treasury - "fiscal dominance" - and ordered it to finance the budget deficit. You can deploy QE in any way you want. It could be used to build houses, or to build infrastructure, or other ways of injecting the money directly into the veins of the economy, instead of the veins of hedge funds. There is no reason why it cannot be administered by an independent Fed, choosing the calibration level as they see fit.

Don't hold your breath. At this point, Bernanke seems content to leave the fuse burning on the financial weapons of mass destruction, as he rides off into the sunset.

Of course, the whole mess could implode, if the US decides it doesn't want to pay its bills. And that is looking more and more possible. The White House promised a veto of a Republican effort to gut President Barack Obama's health care law as part of a temporary funding bill in the House to prevent a partial government shutdown on Oct. 1.

The official policy statement said the GOP attempt to block Obamacare “advances a narrow ideological agenda that threatens our economy and the interests of the middle class" and would deny "millions of hard-working, middle-class families the security of affordable health coverage."

The veto threat was expected and wasn't going to stop House Republicans from pressing their effort to defund the health care law. Republicans in the House spent Wednesday talking about how hard they would fight to derail the health care law on the eve of its implementation and weren't conceding that their Senate rivals would undo their handiwork. A key force in the tea party drive against the law conceded the point even before the fight officially began, but urged the House to force a government shutdown rather than retreat.

The rhetoric will likely fade in the harsh light of an actual shutdown, but then again Congress is a hot mess. The Obama administration's budget director, Sylvia Burwell, issued a memo to department heads that said, "Prudent management requires that agencies be prepared for the possibility of a lapse" in funding.

In the years since the financial crisis, we may not have solved too big to fail, sent any bankers to jail, or done much to prevent another financial crisis, and we certainly haven't changed Wall Street's devotion to money-making at all costs.

But we at least have finally gotten a bank to admit it broke the law.

In what amounts to a relatively stirring triumph of justice on Wall Street, the SEC has convinced JPMorgan Chase to admit that it broke federal securities laws in its handling of the $6.2 billion "London Whale" trading debacle.

The SEC press release says: "JPMorgan failed to keep watch over its traders as they overvalued a very complex portfolio to hide massive losses..., While grappling with how to fix its internal control breakdowns, JPMorgan's senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company's problems and determine whether accurate and reliable information was being disclosed to investors and regulators."

Jamie Dimon in a separate statement said: "We have accepted responsibility and acknowledged our mistakes from the start, and we have learned from them and worked to fix them." Which is true, depending on what Dimon means by "from the start." When the London Whale story first broke in the spring of 2012, Dimon infamously dismissed it as a "tempest in a teapot." He has since repeatedly admitted that the bank erred, although this is the first time it has admitted breaking laws.

JPMorgan also agreed to pay $920 million to the SEC and other agencies to settle various London Whale charges. That is quite a lot of money to you and me, more than twice the size of the current Powerball jackpot. And for JPMorgan it amounts to little more than 13 days' profits, and nothing more than the cost of doing business.

But it does mark a turning point, finally there has been an admission of wrongdoing. Finally.

But wait, there's more. Today, bank regulators also ordered JPMorgan to  correct its debt collection and other credit card procedures and to refund more than $300 million to customers harmed by the bank's practices. In separate orders, regulators faulted the bank for errors in how it pursued credit-card debts in court, and for charging customers for credit-monitoring services they never received.

The Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency ordered the bank to refund $309 million to about 2 million customers charged for the credit-monitoring services. The orders also include $80 million in penalties. The OCC also ordered the bank to review past debt collections and compensate customers affected by errors. It did not provide details of how extensive the debt-collection problems were. That order did not include financial penalties, but left the door open to future fines.

At some point, you have to wonder how long a chronic offender can continue before we say, enough is enough.