Wednesday, November 27, 2013 - Evangelii Gaudium and Happy Thanksgiving

Evangelii Gaudium and Happy Thanksgiving

by Sinclair Noe

DOW + 24 = 16,097
SPX + 4 = 1807
NAS + 27 = 4044
10 YR YLD + .03 = 2.74%
OIL – 1.40 = 92.28
GOLD – 4.40 = 1238.60
SILV - .11 = 19.80

This has been a quiet week on Wall Street; the two major features have been record highs for the DOW and the S&P and 13 year highs for the Nasdaq, combined with light volume. Now normally, light volume on record highs would be an indication the market has run out of steam and is ready to roll over. But this is a holiday shortened week; the markets are closed tomorrow for Thanksgiving, and then just very, very quiet day on Friday. So, it's difficult to read much into the price and volume other than to say, there is a pause for the holiday.

Happy Thanksgiving.

Plenty to be thankful for; the S&P 500 has climbed 2.8 percent in November, poised for the third straight monthly gain. The S&P 500 is up 27% this year; the Nasdaq is up 33% year to date.

Economic data today shows fewer workers filed applications for unemployment benefits last week; that's a good report for the labor market. The Thomson Reuters/University of Michigan final index of consumer sentiment in November unexpectedly rose to 75.1 from 73.2 a month earlier, and came in higher than expected.

The Conference Board’s index of leading indicators, a gauge of the economic outlook for the next three to six months, rose for a fourth straight month in October.

A separate report showed the government shutdown hurt business confidence, with orders for durable goods dropping 2 percent in October. The MNI Chicago Report business barometer fell less than expected in November.

So, most of the economic data today is positive, but here's a scary little detail still lingering from the financial meltdown days; borrowers are increasingly missing payments on home equity lines of credit, HELOCs, they took out during the housing bubble, a trend that could deal another blow to the country's biggest banks. The loans are a problem now because an increasing number are hitting their 10-year anniversary, at which point borrowers usually must start paying down the principal on the loans as well as the interest they had been paying all along. More than $221 billion of these loans at the largest banks will hit this mark over the next four years, about 40 percent of the home equity lines of credit now outstanding.

Data from the credit agency Equifax shows that the number of borrowers missing payments around the 10-year point can double in their eleventh year. When the loans go bad, banks can lose 90 cents on the dollar, because a home equity line of credit is usually the second mortgage a borrower has. If the bank forecloses, most of the proceeds of the sale pay off the main mortgage, leaving little for the home equity lender.

What is happening with home equity lines of credit illustrates how the mortgage bubble that formed in the years before the financial crisis is still hurting banks. Even more so, it's a reminder of how everyday people are still digging out from negative equity, paying loans on properties that still are underwater and may be underwater for a long, long time. And of course, there's a ripple effect that keeps the entire economy from reaching escape velocity.

Between the end of 2003 and the end of 2007, outstanding debt on banks' home equity lines of credit jumped by 77 percent, to $611 billion from $346 billion, according to FDIC data, and while not every loan requires borrowers to start repaying principal after ten years, most do. These loans were attractive to banks during the housing boom, in part because lenders thought they could rely on the collateral value of the home to keep rising. Fitch Ratings calculates that after 10 years, a consumer with a $30,000 home equity line of credit and an initial interest rate of 3.25 percent would see their required payment jumping from $81.25 to $293.16. Yea, that's going to leave a mark.

Maybe the scariest news this week comes from former Federal Reserve chairman Alan Greenspan in an interview with Bloomberg TV claiming the stock market isn't in a bubble. Greenspan said: “This does not have the characteristics, as far as I’m concerned, of a stock market bubble.” Greenspan said that even with the rise in equities, the US economy is restrained by a “degree of uncertainty” that is reducing investment. Based upon past performance, which is not an indication of future results, Greenspan may be the ultimate contrarian indicator.

As a side note, Greenspan was asked about the major policy announcement from Pope Francis this week denouncing unfettered capitalism. Greenspan declined to comment.

The Pope's “apostolic exhortation” may be the most important news, not just of the week, but in a very long time. You don't have to be Catholic to understand the importance of this policy statement from the Pope, just look at the numbers. There are about 7.2 billion people in the world; about 2.4 billion are considered Christians, about 1.3 are Roman Catholics, and there are about 250 million more Eastern Orthodox. That makes Roman Catholics, by an overwhelming margin, the largest denomination of any religion on the planet. And Pope Francis is the leader of this massive flock.

And the Pope is now talking about the “new idolatry of money”, writing:

The worship of the ancient golden calf has returned in a new and ruthless guise in the idolatry of money and the dictatorship of an impersonal economy lacking a truly human purpose. The worldwide crisis affecting finance and the economy lays bare their imbalances and, above all, their lack of real concern for human beings.

His thoughts on income inequality are searing:

How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses two points? This is a case of exclusion. Can we continue to stand by when food is thrown away while people are starving? This is a case of inequality.

The pope's writing on "the economy of exclusion and inequality" might disappoint those who considers themselves free-market capitalists, but they would do well to listen to the message. And many of those free-market capitalists are Catholics. How can they reconcile their business with their faith?

Income inequality has been growing in the US since the 1970s. Nearly all of us are likely to experience it in some form or another. Income inequality is not someone else's problem. In the discussions of why the US is not recovering, economists often mention metrics like economic growth and housing. They rarely mention the metrics that directly tell us we are failing our economic goals, like poverty and starvation. Those metrics of income inequality tell an accurate story of the depth of our economic malaise that new-home sales can't. One-fifth of Americans, or 47 million people, are on food stamps; 50% of children born to single mothers live in poverty; and over 13 million people are out of work. And for the first time in our nation's history, children are now less likely to do as well as their parents.

The bottom line, which Pope Francis correctly identifies, is that inequality is the biggest economic issue of our time - for everyone, not just the poor. Nearly any major economic metric - unemployment, growth, consumer confidence - comes down to the fact that the vast majority of Americans are struggling in some way. You don't have to begrudge the rich their fortunes or ask for redistribution. It's just hard to justify ignoring the financial problems of 47 million people who don't have enough to eat. Until they have enough money to fill their pantries, we won't have a widespread economic recovery. You can't have a recovery if one-sixth of the world's economically leading country is eating on $1.50 a day.

It's only surprising that it took so long for anyone - in this case, Pope Francis - to become the first globally prominent figure to figure this out and bring attention to income inequality. And it is an issue that is not going away.

Happy Thanksgiving, and don't forget all the things you are thankful for. 

If you would like to read the apostolic exhortation, Evangelii Gaudium, here is the link.

Tuesday, November 26, 2013 - The Best Question

The Best Question

by Sinclair Noe

DOW + 0.26 = 16,072
SPX + 0.27 = 1802
NAS + 23 = 4017
10 YR YLD - .02 = 2.71%
OIL - .60 = 93.49
GOLD – 9.60 = 1243.00
SILV - .39 = 19.92

Today we celebrate the Nasdaq. Yes, the Dow is at record highs, again, but the milk and cookies thing is getting old, kind of sickly sweet. Some might argue that you can never have too many cookies; that any day with milk and cookies is a good day. It's hard to dispute this argument. Still, it bears notice that the Nasdaq has closed above 4,000 for the first time in 13 years. The Nasdaq is up about 33% year to date, and counting. So, today we celebrate with chips and salsa.

If you're thinking the Nasdaq has had quite a run and it's starting to feel like 1999, you could be forgiven, but when you put it in perspective it's not quite the same. P/E ratios are around 19, compared with 29 just before the millennium. Price to book is now 2.6 compared to 5.1 back then. Basically, back in 1999, the Nasdaq was extremely overvalued. You can argue that it's overvalued today, but it isn't nearly to the old extremes.

Two economic reports on the housing market today. Permits for future home construction hit a near 5-½ year-high in October and prices for single-family homes showed big gains in September, suggesting a run-up in mortgage interest rates has not derailed the housing recovery.

The first report comes from the Commerce Department; building permits jumped 6.2 percent last month to an annual rate of 1.03 million units, the highest since June 2008. It was only the second time since mid-2008 that permits topped the 1 million-unit mark. Permits were up 13.9 percent from a year ago in October. Building permits are not counted toward GDP but they are a leading indicator, suggesting more construction activity in the coming quarters. Yesterday, we reported that pending home sales declined in October, likely some recalcitrance from buyers in light of the government shutdown; so maybe the permits indicate pent-up demand; or perhaps a shift away from single family residential.

Permits for the multifamily home sector jumped 15.3 percent in October and approvals for buildings with five units or more reached their highest level since June 2008. Single-family home permits, the largest segment of the market, rose 0.8 percent.

A separate report showed the S&P Case Shiller composite index of home prices in 20 metropolitan areas jumped 13.3 percent in September from a year ago, the strongest gain since February 2006. The Southwest continues to lead the housing recovery. Las Vegas home prices are up 27.5% year-over-year; in California, San Francisco, Los Angeles and San Diego are up 24.8%, 20.8% and 20.4% respectively. Phoenix posted 22 consecutive months of positive returns, up 18.9% in the past year. However, all remain far below their peak levels. As an example, since January 2000, home prices in Los Angeles were up 170% during the bubble days, dropped from those levels but are still up108% from 2000. Phoenix prices are up 41%, basically matching inflation.

Since April 2013, all 20 cities in the index are up month to month; however, the monthly rates of price gains have declined. More cities are experiencing slow gains each month than the previous month, suggesting that the rate of increase may have peaked.

As prices have rebounded, that has drawn REO properties out of the shadows and onto the auction block. Investors, including hedge funds and private equity firms, which acquire the lion’s share of homes at auctions, have raised about $20 billion to purchase as many as 200,000 homes to rent. Their purchases are spurring a rebound in property prices. As that speculative demand drives prices, that gives banks the chance to get foreclosures off their books.

Banks have reduced their collection of repossessed homes by 26 percent to $7 billion from a year earlier, according to the Federal Deposit Insurance Corp. That’s 50 percent of the level they held at the height of the foreclosure crisis at the end of 2010. Firms are motivated to sell these dwellings because they have to pay monthly outlays for maintenance and insurance. Banks have been eager to dispose of properties but they've been waiting for the right price. They may still take a hit on the sale, but it's a smaller hit and they are better able to absorb it; and waiting out the market, many properties will return a profit. Thanks in part to a Zero Interest Rate Policy, and the Fed buying up $85 billion a month in securities, and the stock market at record highs, the 6,940 FDIC-insured firms reported $42.2 billion in profit in the second quarter, up 23 percent from a year earlier.

Admittedly, third quarter bank profits dipped slightly, marking the first year-over-year decline since 2009. The Federal Deposit Insurance Corp. says the banking industry earned $36 billion in the third quarter, down $1.5 billion or 3.9 percent from the third quarter of 2012. The FDIC says the year-over-year earnings decline came primarily from a $4 billion increase in litigation expenses at a single institution. The FDIC did not name the institution.

Hmmm, I wonder which bank....

JPMorgan Chase of course, everybody knows that. We reported on their $13 billion penalty to settle charges of selling toxic mortgage bonds back in the day. Now that they have cleared that legal hurdle, the share price has jumped about 3%, raising the value of JPM shares by about $7 billion. Toss in a potential $4 billion in tax deductions, because profits are privatized but losses (and fines) are socialized, and the fine is almost paid.

The Conference Board's Consumer Confidence Index dropped in November to 70.4, down from 72.4 in October. The proportion of Americans who said jobs would become more plentiful in the next six months declined to 12.7 percent, the lowest since November 2011, from 16 % last month. The share of respondents who said they expected a pickup in their incomes declined to an eight-month low of 14.9 percent in November from 15.7 percent a month earlier. It should be noted that retail sales in October beat expectations, despite the drop-off in consumer sentiment. And the latest weekly chain-store sales snapshot for last week showed a solid increase, although it was driven by gains at discount and dollar stores. Consumers haven't gone into lock-down mode but we remain concerned about future finances because of weak gains in jobs and incomes.

Pope Francis today published a major document, known as an apostolic exhortation, which establishes what might be considered an official platform for his papacy. Pope Francis called for renewal of the Roman Catholic Church and attacked unfettered capitalism as "a new tyranny", urging global leaders to fight poverty and growing inequality. In it, Francis went further than previous comments criticizing the global economic system, attacking the "idolatry of money" and beseeching politicians to guarantee all citizens "dignified work, education and healthcare".

He also called on rich people to share their wealth, writing: "Just as the commandment 'Thou shalt not kill' sets a clear limit in order to safeguard the value of human life, today we also have to say 'thou shalt not' to an economy of exclusion and inequality. Such an economy kills."

Economic inequality features as one of the issues Francis is most concerned about, and the pontiff calls for an overhaul of the financial system and warns that unequal distribution of wealth inevitably leads to violence, writing: "As long as the problems of the poor are not radically resolved by rejecting the absolute autonomy of markets and financial speculation and by attacking the structural causes of inequality, no solution will be found for the world's problems or, for that matter, to any problems."

Denying this was simple populism, he called for action "beyond a simple welfare mentality" and added: "I beg the Lord to grant us more politicians who are genuinely disturbed by the state of society, the people, the lives of the poor."

"How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses 2 points?"

That's the best question I've heard in a long time.

Monday, November 25, 2013 - A Record High, Barely

A Record High, Barely

by Sinclair Noe

DOW + 7 = 16,072
SPX – 2 = 1802
NAS + 2 = 3994
10 YR YLD - .01 = 2.73%
OIL - .75 = 94.09
GOLD + 7.90 = 1252.60
SILV + .38 = 20.31

The Dow and the S&P 500 indices have posted 7 weeks of gains. Today was flat, with the Dow up a few points and the S&P down a little. We'll have a holiday shortened week, with the market closed on Thursday (something retailers should consider).

Over the weekend, the big news was a nuclear agreement, of sorts between the US and Iran. The basic idea of the agreement is that we would lift some sanctions against Iran and they would not expand their nuclear program. The deal frees up some Iranian oil revenue that had been frozen in foreign banks. It's unlikely Iran will add much in oil exports in the six months covered by the agreement. Iran has been exporting oil to China, India, South Korea, and Japan; those countries were granted waivers on sanctions because they really wanted the oil.

The main benefit of the weekend’s deal with Iran may be the psychological impact on the market, which has long been propped up by fears of a supply disruption resulting from the standoff between Iran and the United States and its allies. Also, Iran may benefit from access to investment in oil infrastructure and equipment; but again, this is a 6 month deal for now. Many Middle Eastern countries have invested in infrastructure and need prices not to drop. Don't forget, a cartel controls a fair amount of the international pricing of oil. As sanctions kept Iranian oil out of the market, (kind of, sort of) many OPEC countries ramped up production and exports; they could easily cut exports if the price drops.

The US has been aggressively pursuing domestic oil and gas development, and there is currently a bit of a glut of production in the US. Don't expect a change in the price at the pump. The national average for gasoline is $3.26 a gallon compared with $3.43 a gallon a year earlier; and down about 60 cents just since early September. We may see a further decline, but very little that could be attributed to the deal with Iran at this time.

Meanwhile, a funny thing has happened as the price at the pump dropped, the wholesale price that refiners, banks, and traders pay before the gas reaches the consumer have jumped almost 20 percent over the last couple of weeks. While we've seen a boom in domestic production, we've also seen a boom in US exports of refined products; exports have more than tripled from about 1 million barrels a day to more than 3 million barrels a day. Yes, we have plenty of oil, a little less in refined petroleum products.

Also, this deal is still largely dependent on the cooperation of Congress, and Congress has been less than cooperative on almost everything, and especially anything to do with Iran. The White House has some discretion to rescind the Iran sanctions without Congress’s approval. The method for removing any given set of sanctions depends on how those sanctions were passed in the first place. If they’re the product of an executive order, as many of the existing sanctions against Iran are, removing them requires only that the White House decide to stop enforcing them. Removing sanctions that have been passed into law by Congress, however, is a much more difficult challenge.

Former Treasury Secretary Tim Geithner has a new job. He passed up a chance to work at megafund manager BlackRock. Geithner, who has landed a plum private-equity gig with Warburg Pincus, opted against joining CEO Fink’s BlackRock — with $4 trillion in assets under management — because he wanted to have a more involved role with any company he ended up joining.

Swiss voters overwhelmingly rejected an initiative that would have restricted executive salaries to 12 times that of the lowest-paid employee. Roughly 65% of Swiss voters Sunday opposed the 1:12 Initiative for Fair Pay.

How much should you pay to deposit money in a savings account at a bank? Not how much should you be paid, how much should you pay. Retail banks have warned they might need to start charging customers and companies for deposits if the US Federal Reserve cuts interest it pays on bank reserves. Not only has the Fed maintained a zero interest rate policy, but they have been paying banks to hold excess funds on deposit with the Fed. There is talk of the Fed not paying the banks; just talk at this point. The idea being that banks would be more inclined to put money to work with lending and other stuff that helps the economy. So, the banks are just talking about how they might have to charge you to make a deposit. The banks say that, without that interest payment, they might also be pushed to take ever-crazier risks with money that was once safely parked at the Fed.

Signed contracts for existing homes fell nationwide in October for the fifth straight month, further evidence the housing market has slowed after a frenzied rebound earlier this year.

The National Assn. of Realtors said its pending sales index, adjusted for seasonal swings, dropped 0.6% from September and was down 1.6% from its October 2012 level. The trade group said the government shutdown in early October, declining affordability and limited inventory curbed sales.  The index, which reflects signed contracts whose sales haven't yet closed, is at its lowest level since December of last year.

The world's biggest retailer, Walmart, announced that it is to replace its president and chief executive, Mike Duke, who is stepping aside after a year in which the company has struggled with sluggish sales and labour disputes.

Doug McMillon, currently CEO of Walmart's international division, will replace Duke as president and CEO of Walmart Stores on 31 January. Duke relinquishes the reins five years in charge, although he will stay on as chairman of the company's executive committee. Maybe a sign that Walmart will concentrate more on the international side of their business.

H&M the second largest clothing retailer, based out of Sweden has promised to pay workers In Bangladesh and Cambodia, a living wage. The pledge covers 850,000 workers. H&M said that because conditions varied between countries and factories, it would support textile workers in negotiating a living wage – a salary that enables a decent standard of living – instead of imposing a figure. It said paying more to factories that adopt a living wage would not push up the price of its goods.

The stock market will be closed Thursday, and a half day on Friday. Or, I should say Black Friday. Don't fall for it. Bargain hunters can — and, in some cases, should — avoid the Black Friday weekend crush. The shopping bonanza is mainly an expertly marketed ploy to capitalize on shoppers' fear of missing out. By dangling a small batch of irresistible savings, stores land hordes of hopeful shoppers all scheming to score the retail version of the golden ticket. Yet only a tiny percentage of customers end up with the most desirable deals. The rest, unwilling to leave empty-handed, walk away with lesser bargains arranged appealingly nearby.

The weekend is crowded with misleading promotions, including deceptive discounts off misstated "original" prices and deals that could have been had a year earlier. More than 90% of Black Friday ads this year feature items being sold at exactly the same price as they were last Black Friday. Retailers have been in a promotional mood for months as they try to attract wary shoppers. They're trying to make up for sales that have been weak through much of the year, damaged by volatile weather, shaky consumer confidence, the government debt stalemate and a payroll tax increase.

Forecasts for the Thanksgiving-to-Christmas period — which can sometimes account for 40% of a retailer's annual sales — are dour. Morgan Stanley predicted the worst holiday sales since 2008. Worried retailers may continue discounting well past Black Friday in an attempt to suck in last-minute stragglers

Friday, November 22, 2013 - Big Round Numbers

Big Round Numbers

by Sinclair Noe

DOW + 54 = 16,064
SPX + 8 = 1804
NAS + 22 = 3991
10 YR YLD - .04 = 7.74%
OIL - .60 = 94.84
GOLD + 1.30 = 1244.70
SILV - .16 = 19.93

Record highs for the Dow Industrials and the S&P 500; we also have Dow Transports confirming the movement of the industrials, and small caps, as represented by the Russell 2000 are looking strong, pricey but strong. This was the 41^st record high close for the Dow Industrials this year.

The S&P 500 is above 1800 and that round number now becomes support. The 1800 level is 17% above the record highs from the Spring of 2000. So, if you just followed the buy and hold, you made 17% over 13 ½ years; which is lousy; and even worse if you dig into the numbers. Adjusted for inflation, the 1800 level is 14% lower than the highs of 2000. Then you should also consider the S&P 500 is a capitalization weighted index, meaning the bigger companies have a bigger impact on the index. Back in 2000 there were 25 companies that accounted for 45% of the value of the 500 stock index; so, really back then it was more like a 25 stock index, and a 475 stock index.

And really, the S&P is a dynamic index; meaning, the companies change. Back in the day, the high flyers were Lucent, MCI Worldcom, AIG, Sun Micro, Dell. This year, we're seeing about 450 of the 500 stocks in the S&P are up; that is a broad based rally.

The Dow closes the week up; the seventh straight week of gains; the longest weekly winning streak since the 8 week rally of December 2010 to January 2011. The S&P finishes a seven-week winning run. Investors are pouring more money into US stock mutual funds than they have in 13 years. Morningstar reports stock funds took in $172 billion in the year’s first 10 months, the largest amount since they got $272 billion in all of 2000. Even with most of the cash going to international funds, domestic equity deposits are the highest since 2004. The move marks a reversal from the four years through 2012, when investors put $1 trillion into fixed income as the financial crisis drove many to redeem from stocks. Losses this year in bond portfolios, combined with 25% gains in the S&P, and suddenly everybody is pouring back into stocks. This is called performance chasing, and it is risky business.

Market investors now have about 57% of assets allocated to equities. We've seen high equity valuations before, in 1999, and in 2006-2007. Sentiment among individual investors grew increasingly positive as the S&P 500 set new highs. Bullishness in the American Association of Individual Investors’ weekly survey has averaged 43 percent this quarter, up from 29 percent in August and a long-term average of 39 percent.

Now normally, that kind of bullish optimism would be a contrarian indicator. But that doesn't always mean we're headed for a drop.  In ICI data going back to 1984, annual mutual-fund flows turned positive twice before: in 1989, preceding market gains in eight of the next 10 years, and in 2003, when the S&P kept rallying until October 2007.

And don't forget that December is a historically good month for stocks. With average returns around 1.4%, compared to 0.5% for all other months. June and July have even better average returns than December does. When ranked according to average returns, December is in third place.

Furthermore, there is not much consistency to December's return from year to year. In fact, December on average was one of the worst performing months during several of the decades in the early part of the last century.

Bottom line: stay alert and let the market tell you what it is doing.

The stock market reached several very important big round numbers this week and experts suggested that reaching these round numbers could mean that the stock market will reach other, larger round numbers in the near future. Maybe. Maybe not.

These same experts suggest you ignore the fact that these round numbers have almost no meaning for your own particular individual life and keep your focus on the round numbers themselves, because they are round, and also larger than previous round numbers the market has reached.

Why is this happening, you might be asking, if you are one of the 62% of Americans who think the economy is getting worse. It is partly due to the Federal Reserve pumping cash directly into markets to keep the economy from teetering back into a recession. It is also partly due to the fact that President Obama has been the least effective socialist dictator in history, overseeing record highs in corporate profits while wages stagnate, widening income inequality, in what has been an extremely uneven recovery. 

And most of the gain in stocks seems to go right back to Federal Reserve policy. This week we had Bernanke saying the U.S. economy is getting better and, as per incoming data, the Fed will at some point slowly start to pull back support. But for right now, they aren't pulling back support because the economy is still too weak to stand on its own two feet. And you've got the OECD doing what all forecasters do these days: marking down their estimates for future growth and warning of various headwinds.

Meanwhile, mixed in with all this near-term analysis, many in my world are mulling over Larry Summers' warning that whatever the cycle is doing, the underlying problem is one of structural slog.

Barring new fiscal break-downs, like the failure to come to some kind of an agreement on the budget that expires mid-January, there will be less fiscal drag in 2014 than this year, and that should add to growth.* But don't mistake less fiscal headwinds for tailwinds. The optimistic view is that lousy, austere fiscal policy is sucking about 1.5 points off of real growth this year and will take 0.5 of a point off of next year's growth.

The fact that less growth is reaching the broad middle class and lower wage workers is a constraint on consumption, which remains 70% of the US economy. During the housing bubble years, (dangerously) cheap credit and the wealth effect from inflated home prices offset this drag, but that's behind us. Looking at inflation and average compensation, we see that there is no pressure from wages or prices on inflation and real compensation growth is flat, flat-lining in fact.

Meanwhile, we know that the economy's been growing and that company profits have been high. There's nothing wrong with profits, but there's definitely something wrong when they fail to lead to employment and earnings gains for the broad majority. 

Uneven consumer spending along with fiscal drag/austerity and political dysfunction have contributed to a weaker investment climate, not just in the US but in most economies. You keep hearing about "trillions on the sidelines." Again -- that's also a symptom of high profitability amidst weak demand, along with low inflation. Investors just don't see enough domestic projects with high enough prospective returns to get them back in the biz of investing in structures, equipment, software, at least not at rates that would give us the growth pop we need.

Of course, this begs for a strategy of investment in public goods, but that runs into the austerity buzzsaw. And besides, who needs infrastructure when you can just chase performance up to the next big round numbers in the stock market. We just might get there, or not.

Thursday, November 21, 2012 - Size and Composition

Size and Composition

by Sinclair Noe

DOW + 109 = 16,009
SPX + 14 = 1795
NAS + 47 = 3969
10 YR YLD - .01 = 2.78%
OIL + 1.59 = 95.44
GOLD - .40 = 1243.40
SILV + .14 = 20.09

Intraday, the Dow industrials were higher last Friday and last Monday, but this was a record high close, and that is what we look at – the close. The reason we look at the close is largely arbitrary, and the reason we celebrate the Dow record high close as opposed to the S&P 500 record high close, is again arbitrary. The significance of a close above 16,000 is not a big deal; it's just a number. Earlier in the week the market looked at the round number and could not close above; there was a pause; then today, a move above. Test, retracement, breakout; that's bullish.

We have discussed that there is a disconnect between the markets and the broader economy. We have discussed that the trickle down effect or the wealth effect has been less than satisfying for. Still, some of that money will filter into the broader economy; and the bottom line is that it's better than a poke in the eye with a sharp stick.

At some point the Fed will taper; the easy money party will end; until then, well, enjoy the milk and cookies.

Initial claims for state unemployment benefits fell 21,000 to a seasonally adjusted 323,000. Meanwhile, prices at the wholesale level dropped 0.2%. The PPI core rate, excluding gas and food rose 0.2%; so the lesson is that we can all get lower prices if we just stop driving and eating; and, we are seeing disinflation at the wholesale and retail levels. Also this morning, the Philadelphia Federal Reserve Bank reported its business activity index fell to its lowest level since May. Wall Street's pretzel logic saw this bad economic news as a positive, indicating the Fed will continue to be accommodative. Just how long the Fed can keep pumping easy money into the stock market is the big question. Japan may serve as a playbook. Today the Bank of Japan left its massive stimulus policy, known as Abenomics, in place. So, with Japan as a guide, the Fed could do much, much more. The dollar rose to its highest against the yen in more than four months.

Today, European Central Bank President Mario Draghi said the ECB would not cut the deposit rate into negative territory. Draghi tried to dispel talk the ECB was considering charging banks to deposit cash overnight in a bid to boost economic activity. The Federal Reserve pays banks to deposit funds, and there has also been talk that they might consider not paying to get that money out of the vaults and into circulation. Draghi said the central bank did not see deflation materializing, but clearly deflation is a greater concern than inflation, and deflation may force the ECB to reach deeper into their tool belt.

It's generally accepted that central banks monetary policies implemented in response to the global financial crisis prevented a deeper recession and higher unemployment than there otherwise would have been. These measures, along with a lack of demand for credit as a result of the recession, contributed to a decline in real and nominal interest rates to ultra-low levels that have been sustained over the past five years.

A new report from the McKinsey Global Institute examines the distributional effects of these ultra-low rates. Over the past 5 years, governments in the eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion both through reduced debt-service costs and increased profits remitted from central banks.

Nonfinancial corporations benefited by $710 billion as the interest rates on debt fell, however this did not result in higher levels of investment. The impact that ultra-low interest rates have had on banks has been mixed. They have eroded the profitability of eurozone banks, resulting in a cumulative loss of net interest income of $230 billion between 2007 and 2012. But banks in the United States experienced an increase in effective net interest margins and a cumulative increase in net interest income of $150 billion. The experience of UK banks falls between these two extremes.

Meanwhile, households in these countries have lost a combined $630 billion in net interest income; that's not total losses from the economic downturn, that's just net interest income.

There are limits to central bank monetary stimulus schemes. The Federal Reserve has been buying mortgage backed securities at a rate of $40 billion per month and they now hold an estimated 26% of the total of mortgage backed securities outstanding. Each month the Fed continues buying, they increase their stake by 0.8%. Even if the Fed were to taper in March and stop all MBS purchases by the end of 2014, Fed holdings of MBS would rise to about 34% of the total MBS market.

The Fed has already distorted the housing market, and if QE continues much longer, they could corner the market. What would that look like? I'm not sure, I'm just asking. Another question is whether the asset purchases have really done the job. The Fed might want to look at buying something else. Quantitative easing can be targeted at all kinds of assets and with the Fed swallowing up the entire MBS market, maybe it's time to look elsewhere. There is probably nothing to prevent the Fed from jumping into the corporate bond market, or maybe they could start buying up municipal bonds; they could start with Detroit, Riverside, and Stockton.

Regardless of whether you agree with the idea or not, or whether you appreciate the irony or not, the point is that the Fed can not only make adjustments to the size but also the composition of its asset purchases.

Today marked a big change in the Senate. I'm still trying to figure how it will affect business and the economy but a friend asked me to speak on it today, so I'll say a few words.

Senate Majority Leader Harry Reid pulled the trigger today, deploying a parliamentary procedure dubbed the "nuclear option" to change Senate rules to pass most executive and judicial nominees by a simple majority vote. The Senate voted 52 to 48 for the move, with just three Democrats declining to go along with the rarely used maneuver.

From now until the Senate passes a new rule, executive branch nominees and judges nominated for all courts except the Supreme Court will be able to pass off the floor and take their seats on the bench with the approval of a simple majority of senators. They will no longer have to jump the hurdle of 60 votes, which has increasingly proven a barrier to confirmation during the Obama administration.

Reid opened debate in the morning by saying that it has become "so, so very obvious" that the Senate is broken and in need of rules reform. He rolled through a series of statistics intended to demonstrate that the level of obstruction under President Barack Obama outpaced any historical precedent.

Half the nominees filibustered in the history of the United States were blocked by Republicans during the Obama administration; of 23 district court nominees filibustered in U.S. history, 20 were Obama's nominees; and even judges that have broad bipartisan support have had to wait nearly 100 days longer, on average, than President George W. Bush's nominees. There has been gridlock; that's true. Changing the rules can come back to bite you at a later date; that's true, too.

I have no problem with the filibuster, at least the old fashioned filibuster. I hate the modern filibuster, where a senator just says: “I filibuster” and everything grinds to a halt. If you want a filibuster, then stand up on the Senate floor, (like when Mr. Smith Goes to Washington) talk until your voice or your bladder gives out. Read from Dr. Seuss of actually try to display intelligence. We know this is possible because every time a Senate committee calls an expert witness to testify at a hearing, we never hear the witness, just the various Senators, bloviating on without end.

And if they ever did bring back the old fashioned filibuster, the could set up a wind farm on the steps of the Capitol to capture the never-ending torrent of hot air.

Wednesday, November 20, 2013 - Fed Minutes, Fed Conundrum

Fed Minutes, Fed Conundrum

by Sinclair Noe

DOW – 66 = 15,900
SPX – 6 = 1781
NAS – 10 = 3921
10 YR YLD + .09 = 2.79%
OIL - .01 = 93.33
GOLD – 32.40 = 1243.80
SILV - .49 = 19.95

The Federal Open Market Committee, Federal Reserve policy makers, met October 29-30, and to no one's surprise they did not change monetary policy. Today, minutes of that meeting were released. The policy makers “generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months.”

They think the economy is improving, despite the government shutdown and ongoing political dysfunction, the economy is getting better and the FOMC is considering how and when they can exit Quantitative Easing; they would like to scale back $85 billion per month in purchases of Treasuries and mortgage backed securities without triggering a rise in interest rates that could slow economic growth and wipe out gains in the labor market. That is not to say they are ready to raise their Fed Funds target for interest rates. That target has been right at zero and will likely remain at zero for at least a year or more.

They want to get out of the bond buying business without the market noticing, and independently pushing interest rates higher. It'll be a fine trick if they can pull it off.

In a speech to the National Economists Club, Ben Bernanke said: "I agree with the sentiment, expressed by my colleague Janet Yellen at her testimony last week, that the surest path to a more normal approach to monetary policy is to do all we can today to promote a more robust recovery," and he says, "The FOMC remains committed to maintaining highly accommodative policies for as long as they are needed."

Exactly how long the accommodative policies will remain in place is the $85 billion dollar question; the market is now guesstimating the Fed won't taper till March or maybe January. The idea is that they will wait for signs that the economy is strong enough to finally reach escape velocity. We're not there yet.

The National Association of Realtors reported that home re-sales fell 3.2 percent last month from September to a seasonally adjusted annual pace of 5.12 million. That's down from a 5.29 million pace in September and the slowest since June. A healthy pace is around 5.5 million. Sales of single family homes declined 4.1 percent, while condominium sales rose 3.3 percent. The median sales price of an existing home was $199,500 in October, up 12.8 percent from a year earlier and the 11th straight month of double-digit annual increases.

The 16-day partial government shutdown pinched home sales last month by creating uncertainty about the economy and slowing loan approvals: 13 percent of real-estate agents reported that transactions had been delayed. Now, that might just mean that sales were postponed, and they'll pick up in the next report, or it might signal a plain old slowdown.

The Fed's bond purchases have kept long-term interest rates low. Mortgage rates are still low by historical standards, but interest rates began to rise in late May on speculation the Fed would slow its bond purchase program. Add to that the idea that many younger potential home buyers, or first time buyers saw the carnage of 2006 and 2007 and they just aren't interested. In this past month's report, first time buyers accounted for 28% of sales, down from around 40% in healthier housing markets.

Cash purchases made up 31 percent of October's sales. This might indicate that the Fed's easy monetary policy has only been easy between the Fed and the banks. So, this gets right to the Fed policy makers' conundrum; how can they withdraw easy money from the markets without creating a slowdown; if the Fed stops buying mortgage backed securities, that would almost certainly make it even tougher to get a mortgage and the housing market would surely suffer.

One idea is to counter any taper of asset purchases by reducing the interest rate on funds that banks keep on deposit with the Fed. That's right, the Fed not only buys mortgage backed securities from the banks, but then they pay the banks to keep funds on deposit with the Fed, essentially discouraging the banks from taking the money and lending it out in the community and into the economy. This is something that might be a small step, worth considering, but the reality is that any Fed taper from QE will be met with a taper tantrum, and for now the Fed doesn't want to rile the markets.

This is not to suggest the economy is horrible; the Fed's assessment of a growing economy was reinforced with a report this morning that consumer spending rose in October, despite the shutdown, and suggesting upside momentum heading into the fourth quarter. Retail sales excluding automobiles, gasoline and building materials increased 0.5 % last month after advancing 0.3% in September. Overall retail sales rose 0.4% after being flat in September. Core retail sales last month were bolstered by gains in receipts at clothing, furniture, electronics and sporting goods shops, among others. Sales at electronics and appliance stores rose by the most since April.

Meanwhile, the Labor Department reported that inflation is a bit less than optimal; the Consumer Price index dipped 0.1% last month as gas prices dropped, after rising 0.2% in September; this was the first decline in 6 months. In the 12 months through October, the CPI increased 1.0%, the smallest gain since October 2009.

Stripping out the volatile energy and food components, the core CPI edged up 0.1%, rising by the same margin for a third consecutive month. Over the past 12 months, the core CPI increased 1.7%, matching the previous month's rise. A reminder that the Fed targets inflation at 2%; that's the level they want; less than 2% indicates a greater concern that disinflation could lead to deflationary pressures. All the more reason for the Fed to continue with its easy money policies.

The other target, or guidance, offered by the Fed is that they will stick with easy money until the unemployment rate hits a target of 6.5%; in last night's speech, Fed Chair Ben Bernanke, indicated that it is still a target but it doesn't mean that if the target is hit, it will automatically change anything. Bernake said:

“In the judgment of the Committee, the unemployment rate--which, despite some drawbacks in this regard, is probably the best single summary indicator of the state of the labor market--is sufficient for defining the threshold given by the guidance. However, after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation. In particular, even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.”

Bernanke went on to say:

“When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently for the Committee to rely more heavily on its rate policies, the associated forward guidance, and its substantial continued holdings of securities to maintain progress toward maximum employment and to achieve price stability. In particular, the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.”

The Dow just skirted 16K and virtually the entire run-up of the stock market is based on one thing, and one thing only, the Fed pumping money into the markets.  That is it, that is all.  Since the market bottom the market has more than doubled, but jobs aren’t even close to recovering as a percentage of the population, Europe is still in crisis, and oil prices are still ludicrously high. You cannot have profits higher than actual productivity increases plus inflation plus population increase.  Anything more than that is not profit, it is fraud, underinvestment in real capital or it is diverting future profits to the present.

 The problems the economy has cannot be fixed by giving more money to banks and rich people and attempting to turn the housing market into a cash cow again. The economy requires targeted spending, to get off oil, to break up the big banks and other oligopolies, to open up the economy to actual competition, and to increase the pricing power of labor and reduce the pricing power of employers while making sure they don't run up against supply bottlenecks.  It does not require giving money to people who will simply use that money for more leveraged financial plays or to bury bad assets on balance sheets at mark to make believe.

To the extent a market works it must be regulated to be competitive, and assets must not be allowed to pile up in a few hands.  Financial profits cannot be allowed to be higher than non-financial profits, and the labor market must be tight, so that people are free to move away from jobs they hate (if your employees hate their jobs they should either be very well paid because the job is absolutely necessary, or it shouldn’t exist at all.) And the employees who are actually working need enough to actually live on. Did you hear about the Wal-Mart in Ohio that held a Thanksgiving food drive – for their own employees?

Whatever the Fed is doing or thinking about doing, the first step should be acknowledgment that the trickle down wealth effect from the housing market and the stock market is limited, very limited. As for the stock market, it is in fantasy land, entirely a creature of the Federal Reserve, almost completely divorced from the actual economy. Of course, the stock market can remain irrational longer than you can remain solvent. 

Tuesday, November 19, 2013 - Too Good To Be True

Too Good To Be True

by Sinclair Noe

DOW – 8 = 15,967
SPX – 3 = 1787
NAS – 17 = 3931
10 YR YLD + .04 = 2.70%
OIL + .31 = 93.34
GOLD - .80 = 1276.20
SILV - .06 = 20.44

No record high today; not a surprise; it can't happen every day. So, we'll see if this is a pause or whether we have to wait six years till we have milk and cookies again. Likely the former, but you never know.

JPMorgan Chase and the Justice Department have reportedly finalized a $13 billion settlement and resolves an array of state and federal investigations into JPMorgan’s sale of troubled mortgage securities to pension funds and other investors from 2005 through 2008. The government accused the bank of not fully disclosing the risks of buying such securities which, as we know, failed.

JPMorgan had to acknowledge a statement of facts that outline the bank’s wrongdoing in the case. JPMorgan also backed down from demands that prosecutors drop a related criminal investigation into the bank and largely forfeited the right to try to later recoup some of the $13 billion from the Federal Deposit Insurance Corporation. The $13 billion deal also comes just days after the bank struck a separate $4.5 billion deal with a group of investors over the sale of toxic mortgage-backed securities.

The breakdown of the money includes a $2 billion fine to prosecutors in Sacramento and $4 billion in relief to struggling homeowners in hard hit areas like Detroit and certain neighborhoods in New York. Half of that relief will go to reducing the balance of mortgages in foreclosure-racked areas and offering a so-called forbearance plan to certain homeowners, briefly halting collection of their mortgage payments. For the remaining $2 billion in relief, JPMorgan must reduce interest rates on existing loans and offer new loans to low-income home buyers. The bank also will receive a credit for demolishing abandoned homes in an effort to reduce urban blight.

So, for about $6 billion of the deal, it appears JPMorgan is getting off quite easy; they were unlikely to see much or any of this, with or without a deal. Also, in the past, we've seen how loan mods have tended to favor the banks over the homeowners. And it'll be interesting to see what kind of terms they offer for low-income home buyers.

The government earmarked the other $7 billion as compensation for investors. The largest beneficiary is the Federal Housing Finance Agency. JPMorgan will pay the remaining compensation to a credit union association and state attorneys general in California and New York as well as the Justice Department’s own civil division.

The $13 billion settlement represents the largest amount that a single company has ever paid, even though they won't really “pay” the full amount, and it represents about a half year of profits for JPMorgan. While the deal put numerous civil cases to rest, it would not save JPMorgan from any criminal inquiries into its mortgage practices. Under the terms of the deal, the bank would also have to assist prosecutors with an investigation into former employees who helped create the mortgage investments. So, the biggest settlement ever, and it looks like JPMorgan will be able to hand pick a few lower level executives to throw under the bus for criminal charges.

How the hell is Jamie Dimon still in charge of this vast criminal enterprise? Well, for shareholders, it's just the cost of doing business.

MF Global, the collapsed brokerage firm that was run by former New Jersey Sen. Jon Corzine, must pay back $1.2 billion to ensure customers recover losses they sustained when it failed in 2011. The restitution is being levied following a complaint filed by the Commodity Futures Trading Commission earlier this year that alleges MF Global unlawfully used customer funds to meet the firm's needs in its final weeks; at least that's the quick explanation; more on that point in a moment.

MF Global Holdings, the New York-based parent company, imploded in October 2011 after making big bets on bonds issued by European countries that later fell in value. When it collapsed, more than $1 billion in customer money was reported to be missing. It was later determined the money was used to pay for the company's own operations. It was the eighth-largest corporate bankruptcy in US History. MF Global also faces a $100 million civil penalty due after it has fully paid customers and certain creditors.

MF Global admitted in the consent order that it is liable for some of the allegations pertaining to the acts and omissions of its employees as set forward by the CFTC. The commission is still involved with litigation against MF Global Holdings Ltd.

So, where did the money for restitution come from and where did the money go to when it just sort of vanished two years ago? When the music stopped on Halloween 2011, properly segregated customer funds were dispersed in the custody of a large number of financial institutions (such as JPMorgan), exchanges, clearinghouses, and other third parties in the form of investments and margin accounts and other perfectly permissible uses. Following the collapse, a trustee was appointed and one of the trustee's first tasks was to recover those moneys.

And according to the trustee, the banks were "quite cooperative" when it came to returning properly segregated customer accounts. JP Morgan, for instance, returned more than $1 billion in such funds within weeks of the trustee's appointment, as did BMO Harris Bank. Accordingly, such funds were never counted as composing any part of the $1.5 billion shortfall. The bank funds that took longer to retrieve, were different. These were the funds the banks received during, for the most part, that wild final week of October 2011, when money was being wired all over the place without much to discern what was being wired for what purpose. The origins of those transfers were hard to trace. Many of MF Global's banks handled its proprietary transactions as well as customer transactions, and without satisfying distinction.

So, in a way, the money wasn't exactly missing, it was just a matter of sorting out between assets on hand and outstanding claims against those funds. There were two categories of commodity customer at MF Global, each covered by slightly different CFTC rules. Those trading on domestic exchanges were protected by laws and regulations that very clearly required the broker to maintain segregated customer accounts and to perform certain daily calculations to ensure that sufficient moneys would always be available on hand to liquidate fully each account if needed.

When MF Global began to feel a liquidity crunch in the summer of 2011, its officials inquired into whether they could dip into the regulatory excess to find cash to prop up the proprietary end of their business. And technically speaking, they were allowed to dip into the “regulatory excess” in the foreign exchange accounts but only to the extent that there was an equal amount of “excess segregated funds” on hand for the domestic exchange accounts to make up for it.

On October 26, 2011 the technical line for segregated funds was crossed as MF Global officers dipped into regulatory excess funds, trying to right the ship before the end of the trading day, but that didn't quite work out and MF Global slipped into oblivion, and the funds slipped into oblivion; a shadowy ether not quite in segregated accounts, and somewhere between domestic and international, and nowhere to be found; or rather, the money was found, it just took about two years to find it.

And so the lesson here is that the money in that brokerage account is not quite as safe and secure as you might imagine.

The largest category of victims in the Bernie Madoff Ponzi Scheme will be first in line for compensation from a $2.35 billion fund collected by the Justice Department; this includes clients who lost cash through accounts with various middleman funds.

These so-called indirect investors represent about 70 percent of all the claims filed after Madoff’s arrest in December 2008, and about 85 percent of the claims for out-of-pocket cash losses. But because they were not formal customers of Mr. Madoff’s brokerage firm, they are not eligible to recover anything from the federal bankruptcy court, where the Madoff trustee has so far collected $9 billion to apply toward eligible claims. However, the indirect investors — at least 10,000 people and possibly many times that — are eligible for compensation from the federal Madoff Victim Fund.

Generally, anyone who withdrew less from their Madoff-related account than they paid in will be eligible to recover from the Madoff Victim Fund, even if they invested indirectly through the hundreds of “feeder funds,” investment groups and other pooled investment vehicles that poured cash into Madoff’s hands during his decades long fraud. Apparently, the use of feeder funds is a common tactic of Ponzi schemes, a way of building a network of fresh clients to be funneled into the scheme.

Unfortunately, there are some people who didn't live long enough to get their money back.

And the other connection here is the Madoff/JPMorgan link. JPMorgan was Madoff's banker and there is an ongoing criminal investigation that the bank turned a blind eye to Madoff's Ponzi scheme. The investigation centers on whether JPMorgan failed to alert federal authorities to Madoff’s conduct.

The trustee trying to recover funds for Madoff's victims says the bank generated handsome sums by allowing Madoff’s brokerage firm to “funnel billions of dollars” through its account with JPMorgan, “disregarding its own anti-money laundering duties.” The bank, starting around 2006, also pursued derivatives deals linked to Madoff’s so-called feeder-fund investors, the hedge funds that invested their clients’ money with him.

The case will most likely hinge on a series of e-mails that suggest JPMorgan continued to work with Madoff even as questions mounted about his operation. In one e-mail that surfaced in a separate lawsuit, a JPMorgan employee acknowledged that Madoff’s outsize returns seemed “a little too good to be true.”