Wednesday, February 19, 2014 - Stake your Claim

Stake your Claim

by Sinclair Noe

DOW – 89 = 16,040
SPX – 12 = 1828
NAS – 34 = 4237
10 YR YLD + .02 = 2.73%
OIL + .81 = 102.91
GOLD – 11.40 = 1311.90
SILV - .43 = 21.64

This winter has been brutally cold for much of the country, the worst in 20 years. The harsh weather makes an easy scapegoat for slow economic growth and sickly earnings. Every bad bit of economic data and all ugly earnings reports can be buried under the snow and ice. Many companies and sectors aren’t really affected by the weather; while others were definitely slammed.

This is true of new construction. The Commerce Department reports housing starts dropped 16% to 880,000 in January from 1.05 million in December. For all of 2013, builders began work on 926,700 homes, up the most since 2007’s 1.36 million. The good news is that the weather related downturns will eventually melt away like so much ice on a warm sidewalk.

Another report today showed producer prices increased 0.2% in January, led by gains in goods such as food and pharmaceuticals. This follows a 0.1% increase in the PPI in December. Today’s data mark the debut of the PPI after its first major overhaul since 1978, which more than doubles its reach of the economy by including prices received for goods, services, government purchases, exports, and construction. The revamped PPI encompasses 75% of the economy, up from a third of all production for the old index, which reflected the costs of goods alone.

Since services represent the biggest part of the economy, the gauge will offer a broader look at inflation at the producer level. Goods will account for about 24% of the new PPI gauge; while service, including financial services, food wholesalers and transportation providers, make up 63%; prices of government purchases and exported goods represent 11%; construction is 2%. What this new methodology might do is to smooth out inflation at the wholesale level because goods are inherently more volatile than services. What the report reveals is that we are experiencing disinflation.

So, those were the two economic reports of the morning, and the Dow Industrial average was rolling along with about 50 points in gains, then we saw the minutes of the January Federal Reserve FOMC meeting. Fed officials agreed unanimously to continue to slowly reduce the pace of its asset-purchase program by another $10 billion to $65 billion per month and to pledge to keep rates low until “well past” the point where the unemployment rate fell below a 6.5% threshold. This was the first unanimous statement since 2011. And that’s about where the unanimity ended.

A few Fed hawks thought it might be good to increase short term rates within the next few months; a few Fed doves thought it might be good to slow down the pace of the taper; that brought a response that there should be a “Clear presumption in favor of continuing to reduce the pace of purchases by a total of $10 billion at each policy-making meeting, especially if there is no evidence of a change in the outlook.” The debate on changing the forward guidance, the pledge to the market about keeping rates low, was all over the map. Some want to lower the unemployment rate threshold, while others want a more descriptive or “qualitative” guidance.

And the Fed policy makers described the weak December jobs report as an “anomaly”. Now, remember that the FOMC meeting took place just a few days before the weak January jobs report; so I suppose we could describe that as a double anomaly. If there is a third consecutive weak jobs report for February, then I think we might call it egg on the face. The bottom line is that for now, the taper is on track, rates will remain low for at least a year, we’ll have plenty of forward guidance, and Janet Yellen’s job is something like herding cats.

There are a couple of interesting court cases; one involving Argentina and the other, Detroit.

The country of Argentina has asked the US Supreme Court to review a case that has unsettled the Argentinian markets and currency and might force the country to make payments on billions of dollars of defaulted bonds.

The dispute stems from Argentina’s 2001 default on $95 billion in debt. The country offered to substitute bonds worth 25 cents to 29 cents on the dollar in 2005 and made a similar proposal in 2010. Owners tendered about 92 percent of the outstanding debt. NML Capital, a fund run by billionaire Paul Singer, swooped in and bought about $1.5 billion in bonds for pennies on the dollar, and then they did not accept the swap, opting instead to go through the courts. NML sued to collect the full amount, citing a clause in the bond agreement bars Argentina from treating the restructured securities more favorably than the defaulted bonds.

Argentina challenged a lower court ruling that said the country must pay owners of the repudiated bonds in full before it can make payments on a separate $24 billion in restructured debt. The legal fight has put US courts in the unusual position of shaping another country’s financial future. Argentina says the dispute threatens to force a new default, and lower court rulings have led to credit ratings downgrades. The Argentines further argued that the lower court rulings “effectively reach into Argentina’s borders, coercing it into violating its sovereign debt policies and commandeering billions of dollars of core sovereign assets.”

The appeals court rulings in the case are on hold while the Supreme Court decides whether to get involved. Some decision is expected from the Supremes by around April. Argentina previously said it would never pay the funds, which the country’s leaders have called “vultures.” Its legislature passed a law in 2005 barring payment on the defaulted bonds. Another option under consideration is that the country will offer a new restructuring plan to defaulted bondholders and let investors who own the restructured notes swap them into debt subject to local law.

Meanwhile, Detroit is as broke as Argentina. Lawyers are arguing over how to split the money that’s left. A lawyer for the city says Detroit’s general obligation tax pledge doesn’t give bondholders priority over other creditors in its record $18 billion municipal bankruptcy. Bond insurers have sued Detroit, claiming a proposal by the city’s emergency manager to cut payments to general obligation bondholders is illegal. The insurers say that pledges the city made when the bonds were issued give bondholders certain rights over the taxes.

The dispute may require the judge to weigh in on a long-running debate among legal scholars about whether certain municipal bonds get priority over more traditional unsecured creditors, such as public employees or suppliers. The city’s lawyer argued the city’s pledges to bondholders are no different from those made to all unsecured creditors. Such general promises mean the municipal bonds in dispute are unsecured. Detroit didn’t set aside any property that could be used as collateral for the bonds, or create a special lien on the taxes. The current offer would pay public employee pensions 25 cents on the dollar and GO bond holders 22 cents. The bond insurers present their case in a couple of days.

The city may also try again to resolve a dispute over interest-rate swaps that cost taxpayers about $4 million a month. Detroit may present a new proposal for canceling the swaps in the next three or four days.

While historic winter storms have battered much of the US, California is suffering its worst drought on record. The reservoirs of California are just a fraction of capacity. In the dried-up fields of California's Central Valley, farmers are selling their cattle. Others have to choose which crops get the scarce irrigation water and which will wither.

California is the biggest agricultural state in the US - half the nation's fruit and vegetables are grown here. Farmers are calling for urgent help, people in cities are being told to conserve water and the governor is warning of record drought.

Meanwhile, the southern Imperial Valley, which borders Mexico, draws its water from the Colorado River along the blue liquid lifeline of the All American Canal. Farmers are making hay while the water flows, alfalfa actually; which is used as cattle feed and is being exported to China.  In effect, a hundred billion gallons of water per year is being exported in the form of alfalfa from California. It's a huge amount. It's enough for a year's supply for a million families.

Cheap water rights and America's trade imbalance with China make this not just viable, but profitable. We have more imports than exports so a lot of the steamship lines are looking to take something back. And hay is one of the products which they take back. It's now cheaper to send alfalfa from LA to Beijing than it is to send it from the Imperial Valley to the Central Valley.

Japan, Korea and the United Arab Emirates all buy Californian hay. The price is now so high that many local dairy farmers and cattle ranchers can't afford the cost when the rains fail and their usual supplies are insufficient. Hay trucks are a common sight heading north up the road from the Imperial Valley and despite the high prices, the cattle farmers have to buy what they can. Even with recent rains in northern California there's still a critical shortage of water. There will be many questions about who has claim to what, and this is just the early stages of the drought. Stay tuned.