Friday, January 24, 2014 - Bulls, Bears, and Bonuses

Bulls, Bears, and Bonuses

by Sinclair Noe

DOW – 318 = 15,879
SPX – 38 = 1790
NAS – 90 = 4128
10 YR YLD - .04 = 2.73%
OIL - .41 = 96.91
GOLD + 4.40 = 1270.00
SILV - .11 = 20.01

The Dow has fallen every day this week, leaving it down more than 3%. That decline is the Dow's worst weekly performance since mid-May 2012. Meanwhile, the S&P 500 is down 2.5% since last Friday. That's the index's worst weekly slide since early November 2012.

All of the sudden, everybody seemed concerned about political and economic problems in Turkey, Argentina, and of course, China. The Turkish lira hit a record low and the South African rand fell to five-year low against the dollar. The Argentine peso had its sharpest decline in 12 years, going back to the 2002 financial crisis in that country; and the government abandoned its long standing policy of intervening to support the peso currency. Such moves are crucial factors for big, institutional foreign investors because exchange rate losses can easily wipe out any gains in stocks and bonds of emerging countries.

Right now, the losses haven’t turned into a rout, but there is concern that the turn may push big institutional investors to cut losses and run as the effect of falling currencies becomes too painful to bear. Every emerging market crisis is first-and-foremost a currency crisis. For example, South African government debt was slightly positive in rand terms in 2013. But in dollars terms, it lost more than 18%. Fund tracker EPFR estimates emerging equity and bond funds have seen outflows of almost $5 billion so far this year, on top of $58 billion of losses seen in 2013. EM equity funds have had 13 consecutive weeks of outflows, the longest run in 11 years.

What we haven't seen in emerging markets is major currency devaluation, a run on government debt or ratings downgrades. Any combination of those would suggest a major move where developing countries could experience sudden stops in their access to global capital, or some event that throws economies into a balance of payments or financial crisis. What we have seen and might continue to see is emerging market currencies falling, possibly big drops, as the yield on the 10 year Treasury note moves higher; which is expected to happen as the Fed cuts back QE3.

For several years, the world’s emerging markets seemed to be the main beneficiaries of two global trends: very rapid growth in China and the Federal Reserve’s various accommodative monetary policies, which injected huge amounts of capital into global markets. Since the Fed officially announced in December that it would ease its bond-buying stimulus, investors in emerging markets have been cautious. There are fears that rising interest rates will choke off growth in countries dependent on foreign lenders.

And for many years emerging markets have been able to sell resources to China, as China emerged as the world’s biggest producer and biggest market for everything from steel to coal to cars, the demand from China for raw materials soared year after year. Investors have committed tens of billions of dollars to emerging market projects aimed at meeting China’s voracious demand, and now Chinese demand is softening. Chinese economic growth slowed to 7.7 percent last year and the latest surveys of manufacturers in China show that with the exception of a few exporters, expectations about future sales are falling. The result in recent days have been waves of cash flowing out of emerging markets and into industrialized countries, notably the United States; but the  money has been going into the safe haven of Treasuries, rather than into the stock market.

It was just a few days ago that most people were bullish. Even the Fed’s taper at the December meeting was hailed as proof that the economy was improving. Earnings season has been less than exciting but we haven’t had massive misses, except for maybe IBM, Best Buy, Coach, Intel, Citigroup, and a few others; but nothing out of the norm. For the most part, Wall Street continues to pump up expectations, and there are still a few high flyers like Netflix, even if they are selling at 326 times earnings with almost zero in actual free cash flow. The Fed FOMC meets next week to determine their next moves on monetary policy and they are expected to continue with more tapering. Equities on Wall Street seem to have been shaken by the same fears that have hit the global equity markets; or maybe that’s just an excuse for a long overdue pullback. Your guess is as good as anybody.

In a TV interview today, Attorney General Eric Holder said no American financial institution is too large to indict and no bank executive immune from criminal prosecution. Holder cited the case of JPMorgan, which in November agreed to a civil settlement under which it would pay $13 billion to end a series of government investigations into its sales of toxic mortgage backed securities. It was an interesting case for Holder to cite because you may recall JPMorgan was not indicted and no major JPMorgan bank executives have faced criminal prosecution.

In December, Holder said the Justice Department plans to bring civil mortgage fraud cases against several financial institutions early in 2014, using the JPMorgan case as a template. Civil not criminal. Today, Holder said: "There are no institutions that are too big to indict," and "There are no individuals who are in such high level positions that they cannot be indicted, criminally investigated." Holder’s timing is delicious.

Jamie Dimon, JPMorgan’s chief executive, just got a big raise. Dimon’s pay increased to $20 million for 2013, up from $11 million the year before. The bank’s board of directors approved the increase even though a steady stream of scandals and a raft of regulatory actions have in recent months cast doubt on Dimon’s leadership at the nation’s largest bank. The big raise for 2013 came in the face of opposition from a vocal minority of board members.

Over the course of the year, the bank agreed to a series of high-cost legal settlements, including the $13 billion claim. Dimon led JPMorgan while it committed what government investigators have identified as over 15 frauds, most of them massive. These frauds represent the greatest financial crime spree the government has ever identified. In January of last year, the Federal Reserve and the Office of the Comptroller of the Currency imposed sanctions on the bank for weak risk and financial controls, as well as deficient safeguards against money laundering and violations of the Bank Secrecy Act, over the 2012 derivatives loss; total legal expenses topped the $20 billion mark.

The bigger the frauds committed by JPMorgan under Dimon’s watch, and the larger the settlements, the greater the value that Dimon brings by way of getting the government to settle cheap, and not tear down the bank and put people in jail. JPMorgan’s board must be really satisfied with Dimon’s ability to negotiate a deal with regulators. The directors don’t bear the cost of Dimon’s bonuses. Dimon negotiations with the government ensure that the shareholders bear all the losses of the obscenity of giving Dimon a raise to reward the crime spree that occurred while he was both the CEO and chairman of the board of JPM.

The regulatory and prosecutorial response to JPM’s crime spree has failed to hold a single senior officer or director personally accountable either civilly or criminally. The officers who control the bank are delighted to use bank funds to negotiate deals in which there are large fines, but the government does not prosecute the officers or seek to claw bank their compensation and seek damages from them. The DOJ treats JPM as “too big to fail.” This means that the DOJ will never require JPM to pay the full cost of its frauds and disgorge the full extent of its fraud proceeds if doing so could even come close to creating a concern that JPM would lack adequate capital. This gives Dimon a crushing negotiating leverage.

Holder has zero prosecutions of the elite bankers whose frauds drove the worst financial crisis since the Great Depression. Holder has zero civil cases, and the banking regulators have zero enforcement actions, that bankrupted an elite bank officer or director whose frauds helped drive the crisis. JPMorgan, Washington Mutual, and Bear Stearn’s boards of directors made the officers who led the frauds wealthy for over a decade through their compensation and bonus deals.

So, I’m not sure what Attorney General Holder was really talking about. There are no criminal indictments; JPMorgan has violated multiple laws with impunity; Jamie Dimon gets a big bonus.

Meawhile, the Financial Stability Board, which coordinates regulation for the Group of 20 leading economies, is reported investigating manipulation in the foreign exchange markets, or Forex, and is working on a reform of interest rate benchmarks after the Libor interbank rate-fixing scandal. Britain's Financial Conduct Authority (FCA) and the US Department of Justice have been investigating allegations that traders at some of the world's biggest banks manipulated the largely unregulated $5 trillion-a-day foreign exchange market. In the foreign exchange probe, groups of senior traders are alleged to have shared market-sensitive information relevant for London fix, which is set at 4 p.m. London time, using actual trades.

Just a reminder that so far, we haven’t fixed anything, and everything, every market is rigged.