Tuesday, February 19, 2013 - Never more

Nevermore 

by Sinclair Noe

DOW + 53 = 14,035
SPX + 11 = 1530
NAS + 21 = 3213
10 YR YLD +.02 = 2.03%
OIL + .70 = 97.11
GOLD – 5.20 = 1605.60
SILV - .54 = 29.54

So, stocks have been moving higher, up for 7 weeks; the S&P 500 index is at a five year high. Every story I read talks about optimism in the markets. What that really means is that we're almost back to where we were in October 2007. Five years of risk and heartburn and having money tied up, and we're back where we were. WooHooo!

There's merger fever in the air. Last week we heard the announcements on USAirways and American Airlines, plus Berkshire Hathaway and 3 Brazilians buying an enormous quantity of ketchup. This week, the rumor du jour is Office Depot merging with Office Max. And when the M&A fever subsides, there is the stock buyback fever, the anti-dilution thrill that comes from watching corporate management buy high.

Of the 391 companies in the S&P 500 that have reported fourth quarter earnings results, 70.1 percent have exceeded analysts' expectations, compared with a 62 percent average since 1994 and 65 percent over the past four quarters. Fourth-quarter earnings for S&P 500 companies have risen 5.6 percent.

Of course, there is an ominous feel to this market rally, like a nasty black raven over the gate screeching out “Nevermore.” And this coincides with the impending sequester, which Congress will deal with, using all their energy and diligence, next week, after they get back from vacation. The purpose of the sequester was to threaten something so unthinkable that the two parties would come together to agree on an alternative, but the only thing they can agree on is vacation time. President Obama returned for a three-day golf holiday in Florida and he used the bully pulpit this morning to take a few jabs at the legislative branch in a White House auditorium surrounded by blue-uniformed emergency responders to illustrate some of the jobs threatened if the cuts were to take effect; Mr. Obama warned that military readiness and vital domestic services would be hurt “if Congress allows this meat-cleaver approach to take place.”

President Obama went on to say: “These cuts are not smart, they are not fair, they will hurt our economy, they will add hundreds of thousands of Americans to the unemployment rolls. This is not an abstraction — people will lose their jobs.”

President Obama tried to call the Republicans’ bluff in his State of the Union Address. “Deficit reduction alone is not an economic plan,” the president said. He didn’t come out against deficit reduction. He said it should not be given a higher priority than economic growth. There are many reasons why it is important to reduce the national debt. Short-term economic growth is not one of them.

The best chance of avoiding the sequester appears to be a miniature, watered down bill that might kick the can. Meaningful legislation by the deadline appears hopeless. And it is not good for the economy. It would hurt. It would slow growth. The market might look askance, right as we bump up on resistance. Funny how that times out.

Alan Simpson and Erskine Bowles, the Washington budget sages behind the ubiquitous Simpson-Bowles plan, have released a new version of their old plan to cut the federal deficit by trillions of dollars. The plan includes cuts to Medicare and Medicaid, “reforms” to Social Security, chained CPI, and the elimination or reduction of various tax deductions. Notably, many of the most significant cuts seem to fall on programs which benefit seniors. In the report, Simpson and Bowles argue that “the aging of the population represents a significant driver of our growing debt.”

All told, the new Simpson-Bowles plan is distinguishable from the old Simpson-Bowles plan largely by the fact that it sets a higher benchmark for how many cuts are needed.

The new $2.4 trillion figure seems to come from a recent report by the Committee for a Responsible Budget, the umbrella organization for Simpson and Bowles’ pro-cuts lobbying group, Fix the Debt, which is comprised of large corporations that want to Fix the Debt by having someone else pay, but still retaining their corporate loopholes. In the report, the Committee for a Responsible Budget calls cutting only an additional $1.5 trillion “dangerous,” because “it would leave no margin for error, would result in slower economic growth, would leave little fiscal flexibility, and would have little chance of stabilizing the debt beyond the ten-year window.”

“For these reasons,” the report goes on, “we believe the debt must be not only stable, but on a clear downward path by the end of the decade.”

The nation’s economy shrank in the last quarter of 2012. Economists attribute it to cutbacks in defense spending in anticipation of the sequester. More cutbacks will give us exactly what the country doesn’t need right now — austerity. Of course, we dealt with a fiscal cliff to start the year, and all that uncertainty amounted to nothing more than a can of beans. The markets seemed to love it. More precisely, the Federal Reserve was so worried about the fallout that they juiced the markets, and pushed us to an outstanding January. This is apparently the third mandate: jobs, inflation, juiced equities. They're batting .333, which is great for baseball; lousy for economics.

How long can the Fed keep the markets happy in the face of zany politicians? Longer than you might guess. Tomorrow, we'll hear the Fed's minutes from the last FOMC meeting, but don't expect any revelations. One possible topic that might have been discussed: backlash from paying billions of dollars to commercial banks when the time comes to raise interest rates. The growth of the Fed's balance sheet means it could pay $50 to $75 billion a year in interest on bank reserves at the same time it makes losses and has to stop sending money to the Treasury. Yep, that will be a topic for the FOMC.., someday.

(Wolf Richter had this on the latest corporate welfare queen) The sequester is scheduled to kick in on March 1. An artificially constructed national disaster, it would threaten everything from national security to preschool programs for low-income kids. It would cause hundreds of thousands of jobs to evaporate, or whatever. So, as the drama with all its lurid theatrics was playing out in Washington, Facebook filed its first 10-K annual report with the SEC, containing its financial statements for 2012 along with a host of small-print footnotes which presumably no one would ever look at. But the recalcitrant nonpartisan research and advocacy group, Citizens for Tax Justice, took a look anyway.

And it found “an amazing admission”: despite $1.1 billion in pre-tax profits from its US operations in 2012, Facebook didn’t pay any federal or state income taxes in the US—in fact it will collect net tax refunds totaling $429 million.  Facebook is relying on a single tax break in our glorious corporate tax-dodge code to obtain its negative tax rate: the deductibility of executive and employee stock options. It cut Facebook’s federal and state income taxes by $1.03 billion last year—but that was just part of it. As Facebook said in its footnote under “Share-based Compensation,” on page 68 of the 10-K: “during the years ended December 31, 2012, 2011, and 2010, we realized tax benefits from share-based award activity of $1.03 billion, $433 million, and $115 million respectively.”

Another $2.17 billion of this US tax break is carried forward. To rub it in, COO Sheryl Sandberg giddily pointed out during the earnings call that the company “ended the year with a total of $5.8 billion in NOL, net operating loss, tax loss carry forwards created by stock compensation”—to be used in future years.

Given Facebook’s anemic “profits” in the US, it’s unlikely that it will have to pay federal or state income taxes anytime soon. Instead, taxpayers will have to continue showering tax refunds on what has become the cutest, coolest welfare queen of them all.

On its financial statements, Facebook claimed that it had a federal tax liability in 2012 of $559 million, that it would somehow pay $559 million in taxes in the coming year. But the number was wiped out by its infamous footnote on page 68 of the 10-K. And suddenly, that “federal tax liability” of $559 million had, like so many things on financial statements, no graspable relationship to reality.

Unknown hackers infected the computers of some Apple workers when they visited a website for software developers that had been infected with malicious software. The malware had been designed to attack Mac computers. The same software, which infected Macs by exploiting a flaw in a version of Oracle Corp's Java software used as a plug-in on Web browsers, was used to launch attacks against Facebook, which the social network disclosed on Friday. Twitter, which disclosed that it had been breached February 1 and that hackers might gave accessed some information on about 250,000 users, was hit in the same campaign. It's possible that hundreds of companies, including defense contractors, had been infected with the same malicious software. This is apparently different than the Chinese hacking attacks. Today, a security company issued a detailed report that places the Chinese hacks at the very doorstep of the Chinese military.

If you've been behind the wheel recently, you already know gasoline prices are up. The national average price for regular gas rose to nearly $3.75 a gallon. Retail prices have gone up for each of the last 33 or so days.  prices rise near the end of winter every year. As refineries switch to summer blends to reduce smog, they shut down units and work on maintenance. Traders worry there won't be enough supply, so they start bidding up prices. This time around it's happening a few weeks earlier than typical. One reason is refiners are catching up on maintenance and repair work they weren't able to do late last year because Hurricane Sandy.