Wednesday, April 30, 2014 - Record Highs in First Gear

Record Highs in First Gear

by Sinclair Noe

DOW + 45 = 16580.84 (record close)
SPX + 5 = 1883
NAS + 11 = 4114
10 YR YLD - .04 = 2.65%
OIL – 1.59 = 99.69
GOLD – 4.60 = 1292.30
SILV - .29 = 19.25

Back on December 31^st, we finished the old year with a record high close on the Dow Industrial Average at 16,576; since then the index has bobbed up  and down, briefly hitting an intraday high of  16,631 on April 4^th, but on that day we finished in negative territory. Today, a record high close. The S&P 500 is closing in on the record high close of 1890, but not today.

Now, when you hear the Dow is breaking records, you might think the economy is roaring, cruising along the highway in fifth gear. You would be wrong; the economy is stuck in first gear and the clutch is slipping. The Commerce Department reports the economy expanded at a mere 0.1% annual pace in the first three months of the year, one of the weakest rates of growth in the nearly 5-year-old recovery.

A slowdown had been expected due to the harsh winter weather that froze business activity across a large swath of the country, but this report was worse than expected. The gross domestic product had been expanding at a 3.4% pace in the second half of last year. No worries, the weather has warmed and everything is returning to normal. Yeah, not exactly.

There has been a rebound in the monthly data for March but there have been some disappointments as well. On the positive side, households have pared down some of their debt, credit is a little more available, and consumer spending should bounce back. Even the 2% growth in consumption spending is not all that encouraging; 1.1% of that consumption growth, more than half, was attributed to higher household expenditures on health care.

Home construction is likely to pick up speed as the weather improves, but the housing market seems to be slowing down, with reports this week on new home sales turning soft and existing home sales turning negative in many areas. Residential investment has been negative for 2 quarters. The housing market probably won’t deliver much horsepower as the engine of economic growth but it should be a little better than the winter months, when many parts of the nation were frozen.

An area of concern is business investment, as company spending on equipment fell in the first quarter, and the 3 quarter average is barely positive. The change in inventories subtracted 0.57 percentage points from growth in Q1, exports subtracted 0.83 percentage points. The outlook for trade is soft; the US is not immune to weakness overseas; China’s economy has slowed; there are problems in the Eurozone; and emerging markets are still struggling. Meanwhile, incomes have flat lined and unemployment remains unpleasantly high.

On Friday we’ll get the monthly jobs report. Today, we got a preview from ADP, the human resources firm, and their data shows the economy added 210,000 jobs in April. The ADP report showed hiring picking up in nearly all industries and company sizes; it just isn’t picking up at a real fast pace.

The Federal Reserve FOMC wrapping up their policy meeting and they issued a statement that they will keep policy on the same track; interest rate targets are unchanged and the taper continues with another $10 billion in large scale asset purchases cut this month, to a mere $45 billion a month. The central bankers said that economic activity “slowed sharply” earlier in the year but noted it has “picked up recently.” And “The committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.”

The disappointing reading on economic growth earlier in the day underscored how bumpy the road back to normal can be. The FOMC statement repeated language from its last meeting in March stating that it will consider the country’s realized and expected progress toward full employment and 2% inflation in determining when to increase rates. The Fed also reiterated that it will take into account “a wide range of information,” including the health of the labor market, inflation pressures and financial developments. In some ways, you could look at the continuation of the taper as a vote of confidence from the Fed. Fed policymakers have said that the phaseout of bond purchases is not on autopilot; the Fed can speed it up or slow it down, depending on how the economy progresses, but apparently the weak GDP number today was not convincing enough to alter expectations; or maybe GDP falls outside the Fed mandate of price stability and maximum employment, and maybe it isn’t something they should specifically pinpoint. Of course, if the economy turns south, they will have to deal with it.

Many Americans are still wondering when the recovery is going to start, but by economic measures, the economy stopped shrinking and started growing in June 2009, the official start of the recovery. That was 58 months ago. Since 1945, the average length of a business-cycle expansion has been 58 months. So if the current recovery continues, it will end up being longer than average, not to mention much weaker. And today’s GDP number was right on the edge of recessionary. The cold weather excuse only goes so far. Already in the second quarter we’ve had deadly and damaging tornadoes, and as the weather continues to warm, we’ll deal with the effects of drought. You have to wonder if the economy was plagued by more than just weather last quarter.

That doesn’t mean we are now entering a recession; we may be close but we aren’t there yet, and we may still rebound, but this affords a good opportunity to think about how you might handle the next downturn in the business cycle. The stock market was up today, and in light of the GDP report, you have to wonder about stock valuations; the earnings reports haven’t afforded much to cheer. Are you still buying or are you looking to sell into strength.

Since Q4 2011, the average peak-to-trough pull-back on the Dow has been roughly -6%, with no correction exceeding -10%. One may ascertain that a "buy-on-the-dip" mentality remains pervasive among equity investors. So why not add to long, risk-on positions once again? Could this pull-back be different? Aren't stocks "the only game in town" with the excessively accommodative Fed monetary policy?

And while you consider market risk, don’t forget the old idea of the best and worst six months in the stock market; we’re entering the worst six months by the way. The old adage "Sell in May and Go Away", warning investors of a seasonal decline in equities, is often attributed to summer vacations and decreased investment flows relative to winter months. According to the Stock Trader's Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period. 

When we look at the 13 cases since 2001, the strategy of selling out just before May would have given rise to successful trades in 9 cases, or about 70 % of the time. Moreover, we observe that the "Sell in May" strategy has not failed in two consecutive years since 1992-1993. Given that "Sell in May" failed in 2013, we estimate the odds for a seasonal decline are even higher for 2014. This is not a perfect indicator, but there are not perfect indicators. You have to think that anybody who doesn’t recognize the odds is just trying to sell you something.

And on the question of valuations, at 18 times forward earnings for the S&P 500 and 36 times forward earnings for the Nasdaq, US stocks are generally closer to the high end of their range; that seems a bit pricey compared to emerging markets with 12 times forward earnings. Still, somebody was buying today, at least enough to push the Dow to a record high close. Investor optimism for US stocks has been trending up since the end of 2011, reaching an extreme level in January. Of course that would be a contrary indicator. There are plenty of voices telling you to stay the course, or even buy, and then buy some more. I’m just saying it is important to consider the possibility of selling into strength. 

Tuesday, April 29, 2014 - Lowering the Bar

Lowering the Bar
by Sinclair Noe

DOW + 86 = 16,535
SPX + 8 = 1878
NAS + 29 = 4103
10 YR YLD + .02 = 2.69%
OIL - .12 = 100.72
GOLD - .40 = 1296.90
SILV - .13 = 19.54

The S&P/Case-Shiller home price index for February showed prices up 12.9% from February a year ago, that’s down from the 12-month advance of 13.2% reported in January. The index tracks existing home sales in 20 major metropolitan areas, and this economic report tends to lag, plus it is a 3-month moving average of prices; so maybe we could be seeing one of the last reports to reflect bad winter weather.

Home prices fell in 13 of the 20 cities in February compared with the previous month, and it wasn’t just cold weather cities; prices in Las Vegas dipped 0.1% in February from the previous month, the city's first monthly decline in nearly two years; home prices fell 1.6% in Cleveland and 0.7% in Tampa, Florida. Las Vegas still posted the biggest 12-month gain, with an increase of 23.1%.

The Conference Board said its index of consumer attitudes dipped to 82.3 from an upwardly revised 83.9 in March; still, very near a 6-year high.

A new report today from the National Employment Law Project finds that as the economy has inched toward recovery, low-wage jobs have returned far more quickly than middle- or high-income work. The report’s finding shows how the housing sector in particular is a key middle-income employer that has failed to rebound.

Employment among specialty trade contractors, who earn a median wage of $20.03 an hour, is still down 22%. The number of workers who manufacture wood products, with a median pay of $14.94 an hour, is down 27%. Jobs working in rental and leasing services, with a median wage of $14.17 an hour, are down 16.3%. Employment in “credit intermediation and related activities,” which includes mortgage lending, is down 7.1%. Those jobs pay a median wage of $18.51 an hour.

Homebuilders have been slow to pick up the pace of construction, which in turn is squeezing the housing market. Without good job growth among younger and middle class workers who would be first time home buyers, builders are focusing on higher-end projects, which is a smaller market. It’s the old idea that workers need to be paid enough to buy the products they make, otherwise, the market falters, and it becomes harder and harder to break out of the downward cycle.

The Federal Reserve FOMC is meeting today and tomorrow. The outcome is expected to be rather boring; more of the same; reduce the amount of money it is pumping into the economy by another $10 billion per month. The Fed’s purchases of long-term bonds, known as quantitative easing, are widely expected to end in the fourth quarter of this year. The steady phase-out has become routine and predictable. It will only become interesting if the Fed goes off script.

The US treasury reports the biggest debt paydown in 7 years. The drop in net marketable debt will be $78 billion in the April-June period, $38 billion more than the paydown projected three months ago, with an end-of-June cash balance of $130 billion. That trend may be temporary. A faster pace of hiring and soaring corporate profits are lifting tax receipts while spending increases at a slower pace. That’s helping shrink a budget deficit projected this year to be the smallest as a share of the economy since 2007. (Considering what followed, maybe we shouldn’t rush to paydown.)

The majority of S&P 500 companies are reporting better than expected earnings, albeit on lowered expectations; that’s the plan, lower the bar and step right over it.  Easy, right? Not always.

Twitter stumbled today, posting a first quarter loss of $132 million or 23 cents per share, compared to a loss of $27 million or 21 cents per share a year earlier. Revenue more than doubled to $250 million but it wasn’t enough. Shares were hit by 9% in after-hours trade.

EBay posted a loss of $2.3 billion compared to profit of $677 million a year ago. Revenue rose 14%, but shares dropped nearly 4% in after-hours trading.

A number of health-care related companies reported earnings today. Here’s a quick summary. Merck beat estimates by 9 cents; share price was up about 3%. Bristol Meyers Squibb beat earnings estimates but revenue missed expectations; shares down 3%. Cubist Pharmaceuticals posted a 30 cent per share profit, while analysts had expected a loss; shares up 4%. HCA Holdings’ earnings came in one penny short and then they lowered guidance; shares down 4%.

Pfizer has bid $100 billion for AstraZeneca, the biggest and latest in a series of proposed big pharma mergers. Traders and investors love big mergers because it represents a possible liquidity event, mainly for the party being acquired. Earlier this month, Valeant Pharmaceuticals offered to buy Allergan in a deal valued at more than $45 billion, while Novartis sold and exchanged business units with Eli Lilly and GlaxoSmithKline. And Mallinckrodt bought Questcor Pharmaceuticals for $5.6 billion. On Monday, Forest Laboratories, which has been offered $25 billion by Ireland's Actavis PLC, said it would offer up to $1.5 billion for Furiex Pharmaceuticals.

What does this mean for the industry and consumers? Not much good. The Pfizer-AstraZeneca deal is mainly about taxes. Pfizer would become a British company by combining with AstraZeneca, lowering the new company's tax rate dramatically. There's even a euphemism for this kind of move. It's called a tax inversion in the trade. Pfizer's tax rate was about 27% last year. In the UK the corporate tax rate stands at 21% and will fall to 20% in 2015. The tax code provides an incentive for US-based companies to move overseas, often times taking good jobs with them. That also means there might be political opposition to the Pfizer-AstraZeneca deal from Washington.

Yesterday, the Obama administration announced a new round of sanctions to punish Russia, even as it acknowledged that sanctions are unlikely to bring an immediate change in Russian behavior. The new measures froze the assets of 7 Russian individuals and 17 companies associated with them, and prohibited any US dealings with them; all were identified as closely linked to Russian President Vladimir Putin. The administration also announced new restrictions on Russia’s import of US goods deemed to contribute to its military capabilities. The European Union said it would expand its sanctions list to include 15 more individuals.

The Russian stock market moved higher today; call it a relief rally. Putin responded by threatening to reconsider Western participation in energy deals in Russia where several western energy companies have big projects underway or planned. ExxonMobil has a deal with Rosneft to explore and develop shale oil fields in the Artic, with a potential of 9 billion barrels in reserves; that would put the value at as much as $900 billion. The sanctions leave Exxon in business with a group headed by a man who’s not allowed into the US. Drilling was scheduled to start in August; might not happen now.

Meanwhile, a New York based investment firm, Goldentree Asset Management is buying Russian bonds, saying the securities offer value after suffering a 5.4% selloff this year. Russian dollar-denominated corporate bonds are yielding 7.2%, up from 5.8% at the end of last year. Patriotism be damned in the chase for yield.

The Supreme Court has breathed new life into Environmental Protection Agency rules targeting air pollution that drifts across state borders, handing a victory to the Obama administration on one of its major environmental efforts. The agency for years, under two administrations, has struggled to carry out a directive under the federal Clean Air Act to protect downwind states from pollution generated in other states, mostly from coal-fired power plants. The EPA’s rules from 2011 were challenged by a coalition of upwind states and industry, which prevailed in lower courts.

In determining how much individual upwind states should be required to reduce their emission, the EPA’s interpretation of the law allows for several factors to be considered, including what it will cost and how much the state has already done to cut pollution. A lower court ruling disagreed with this approach and said the reductions must be proportional to the state’s share of responsibility for downwind problems. In a 6-2 ruling, the Supremes determined the EPA must have leeway to confront the complex challenge of interstate pollution.

Energy Future Holdings has filed for Chapter 11 bankruptcy protection. Energy Future Holdings owns TXU Energy, which has the largest share of the Texas retail electricity market, and Luminant, the state’s largest power generator; the company also has about $40 to $50 billion in debt; making this one of the biggest corporate bankruptcy cases in US history.

Energy Future’s troubles can be traced back to its bet that natural gas prices would rise, helping it repay the interest and loans it took to acquire TXU Energy in 2007, but a glut of US shale production has instead brought natural gas prices to record lows, hurting the company’s bottom line and its ability to pay its debt. And even while natural gas prices spiked sharply higher last winter as bands of arctic air froze broad swaths of the country, it was simply too little, too late. Recently, it skipped a deadline to pay $109 million in interest.

A crucial part of the restructuring is a $7 billion tax liability hanging over Energy Future’s head. When the company took over TXU in 2007, the new stakeholders were spared having to pay that federal tax bill on the acquisition. However, the terms of the deal stipulated that if the company split up, the massive tax bill would come due.  Stakeholders hope they have reached a restructuring framework that will allow them to shed some of their assets without having to pay that tax, and have asked the IRS to rule on their request.

Monday, April 28, 2014 - But Our Bankers Aren’t Oligarchs

But Our Bankers Aren’t Oligarchs
by Sinclair Noe

DOW + 87 = 16448
SPX + 6 = 1869
NAS – 1 = 4074
10 YR YLD + .01 = 2.67%
OIL - .03 = 100.57
GOLD – 7.50 = 1297.30
SILV - .16 = 19.67

This should be an interesting week. On Wednesday, the Federal Reserve’s Federal Open Market Committee, the FOMC, will meet to determine monetary policy; a statement will be issued Wednesday. On Friday, we’ll have the monthly jobs report.

The market is jittery. The Dow fell 140 points on Friday, rose 139 on Monday morning, and gave it all back Monday afternoon, then recovered at little at the close. Investors are worried about the Ukraine crisis, the Fed’s tapering, peak earnings, high PEs, low GDP, inflation, deflation, and of course, their own shadows.

So far, the stock market has merely been sluggish to start the year; no big crash, no big gains. Last week, the big 3 indices were down a little, while the indices are in negative territory year to date, that could change with one good week of trading. After doubling or tripling since 2009, stocks aren’t cheap any more. Companies, meanwhile, are finding it harder to keep raising earnings in a period of soft economic growth. This makes investors more cautious, but because speculative excess still hasn’t reached the extremes of past bubbles, and because the Federal Reserve is determined to sustain the recovery, there is less fear of a big decline. The Fed has started slowly rolling back its quantitative easing, gradually ending the unprecedented bond-buying program that dumped more than $1 trillion into financial markets. Investors are trying to figure out how well corporate earnings will grow with less Fed aid.

A big complication is that many companies are reaching the limit of their ability to boost profits by cutting costs. More companies now need to focus on building revenues, which means higher costs for investment, hiring and wages. The days may be ending when Wall Street will reward companies for holding down wages and doing little investing; the focus is shifting to sustainable earnings.

Margin debt, a measure of the use of borrowed money to invest, is at a record high in dollar terms. But as a percentage of market value, it is 2.6%, still between the 2008 low of 2.3% and the 2007 high of 2.8%. Still, the markets haven’t yet shown enough excess to warrant a crash, and so people are still buying the dips; probably because they haven’t yet figured out where else they can go.

Money managers are turning on stocks that have delivered the best returns during the bull market: small caps. Large speculators such as hedge funds are betting $2.8 billion this month that the Russell 2000 Index will fall. That’s the most since 2012 and the highest versus average levels since 2004.

Today, the National Association of Realtors reported its Pending Home sales index increased 3.4% to 97.4. The index is based on contracts signed last month to purchase previously owned homes. These contracts usually become sales after a month or two, and March's rise suggested home resales could rebound in the months ahead. Existing home sales had fallen to their lowest levels in more than 18 months, with March sales down 7.9%; but today’s report suggests the possible end to the soft patch in sales.

Along with the economic news this week, we’re keeping an eye on geopolitical events, as Ukraine is crumbling under a constant barrage. Russian backed militants extended their hold on eastern Ukraine by seizing more public buildings in Donetsk region, breaking up rallies by supporters of the government in Kiev. The mayor of the second largest city in Ukraine was shot today. Russian gunmen are holding about 40 hostages, including 6 military observers from the Organization for Security and Cooperation in Europe, their interpreter and 4 Ukrainian army officers who were accompanying them.

Today, President Obama announce more sanctions against Russian oligarchs; imposing travel bans and asset freezes for 7 individuals and 17 companies. So far, most of the sanctions have been targeted toward energy companies or energy company executives and banks and bankers. Stop and think about that for a moment. Russian bankers are considered oligarchs fomenting geopolitical unrest and supporting the corrupt regime of Putin. And in the US we’re supposed to believe that our bankers are the beneficent titans of industry and pillars of commerce.

Last week we reported that the Department of Justice was in the early stages of negotiating a settlement with Bank of America. The government is reportedly seeking $13 billion in penalties, on top of $9.5 billion that BofA agreed last month to pay to the Federal Housing Finance Agency. The problem is that BofA sold mortgage backed bonds stuffed with shoddy mortgages that did not meet basic standards.

A big part of the settlement would go to the FHFA as compensation for selling the defective bonds to Fannie Mae and Freddie Mac. Another part of the settlement takes the form of consumer relief; requiring the bank to adjust mortgages to make them more affordable for borrowers; the problem is the bank probably doesn’t own the mortgages, so the bank wouldn’t really have that expense.

Also, digging deeper into the previously announced $9.5 billion settlement with FHFA, about $3.2 billion involved BofA buying back mortgage bonds, but they bought those securities for 20 cents on the dollar, and they still have value, probably a lot more than what BofA paid. When is a penalty a profit? When a big bank settles with the bank regulators.

The Supreme Court will hear a case that has some intriguing implications for mortgages; it involves the Truth in Lending Act. The case is Jesinoski v. Countrywide, the subsidiary of Bank of America. The Jesinoskis refinanced a mortgage in 2007; when their loan was closed, Countrywide did not provide all of the disclosures required by the Truth in Lending Act (TILA). Their suit states that they were not provided with two copies of a “Notice of Right to Cancel” and two copies of a “Truth in Lending Disclosure Statement.”

Under the Truth in Lending Act, a borrower has the right to rescind the loan by midnight of the third business day following the closing of the loan, or until the lender has provided the borrower with all the legally required loan documents. The Act also creates a three-year time limit to exercise the right to rescind the loan, even if the required disclosures have not been delivered to the borrower. Three years to the day, the Jesinoskis sent a letter to Bank of America rescinding the loan. BofA said the letter meant nothing. The Jesinoskis sued to enforce their rescission request, saying that their letter should have been sufficient.

The case has made its way through appellate courts, which denied their appeal, but other District Courts have been split on whether a letter is an allowable form of notification in instances such as the Jesinoskis’ case. The Supreme Court merely said they would hear the case; any actual decision is a long way off.

A more pressing matter for Bank of America is capital levels required by the Federal Reserve. You may remember the Fed recently conducted stress tests for big banks and it turns out that, following further review, Bank of America flunked the test; seems they miscounted  the treatment of structured notes assumed in its acquisition of Merrill Lynch in 2009. The bank notified the Fed of its mistake and the Fed is now “requiring the Bank of America Corporation to resubmit its capital plan and to suspend planned increases in capital distributions.” Or in plain English, no stock buybacks, and no dividend increases.

Particularly concerning for regulators and shareholders, the bank had been making the accounting error for more than four years, potentially inflating its true level of capital during that period. This basically goes to the practice of booking gains or losses based on changes in the value of a firm’s own debt, which led to BofA’s regulatory capital problem. Essentially, accounting rules mean that, in some cases, the worse off a firm is from a credit standpoint, the more it may gain in terms of earnings. That is because the value of its own debt would be falling during a stressed time. This would lead to a smaller liability. And a decline in a liability results in a gain to income.

This didn’t used to be much of an issue since the value of bank debt didn’t change all that much. Then came the financial crisis. And as bank debt remained volatile in its wake, firms were left with big counterintuitive gains or losses in their income based on fluctuations in the value of some of their liabilities. Banks started to exclude the impact of such changes from their results. Investors couldn’t make heads nor tails of the mess, and so they ignored it, at least until it affects buybacks and dividends. The important part to remember is that BofA flunked its stress test, and nearly 6 years after the financial meltdown they still have toxic junk on their books and they haven’t figured out how to count it.

Meanwhile, regulators in Britain announced they’ve begun criminal proceedings against 3 former Barclays employees suspected of manipulating the Libor. The new criminal proceedings are the latest development in a broad investigation into the manipulation of major interest rates by some of the largest global banks, including Barclays, UBS, Royal Bank of Scotland, and others. Twelve people in total are now facing criminal charges in Britain. All 12 are mid-level traders. Barclays, RBS, UBS, the Dutch lender Rabobank and ICAP have combined to pay more than $3 billion in fines to British and American authorities in the investigation of manipulation of various Libor-linked interest rates, but so far regulators have not been able to figure out whether higher level execs at these institutions knew anything about manipulation in a multi-trillion dollar market; which seems remarkably unlikely.

Friday, April 25, 2014 - Don't Hold Your Breath

Don’t Hold your Breath
by Sinclair Noe

DOW – 140 = 16,361
SPX – 15 = 1863
NAS – 72 = 4075
10 YR YLD - .02 = 2.66%
OIL – 1.25 = 100.69
GOLD + 9.90 = 1304.80
SILV + .07 = 19.83

Consumer sentiment rose in April to a nine-month high as views on current and near-term conditions surged. The Thomson Reuters/University of Michigan's final April reading on the overall index of consumer sentiment came in at 84.1, up from 80 the month before.

Meanwhile, a new Gallup poll shows more Americans are optimistic about the job market this month than at any time since the 2008 financial crisis, with 30% saying now is a good time to find a quality job.

That marks a significant improvement from the 8% who said they were optimistic about the job market in 2010, but it’s still a drop from the pre-2008 highs of almost 50%. And even though almost a third of Americans are optimistic, two-thirds still say the job market is lackluster; 66% of Americans say it’s not a good time to hunt for employment.

Next week’s economic calendar includes a two day Federal Reserve FOMC meeting. Next Friday, we’ll have a monthly jobs report; the current estimates call for 215,000 net new jobs in April and the unemployment rate dipping to 6.6% from 6.7%. Also, the Commerce Department will release its first guess of first quarter GDP; the consensus estimate on the initial estimate is that the economy grew about 1%.

The situation in Ukraine is going to hell in a hand basket. Russian militants have now become entrenched in towns across eastern Ukraine; Russian troops are massed on the border. Ukrainian leaders said operations to expel pro-Russian militants in eastern cities would continue, even though military action so far has done little more than prompt Russia to stage military exercises on Ukraine’s border and raise concerns about Moscow’s next move. The government in Kiev says that if the Russians cross the border they would view that as an invasion. Ukraine's Prime Minister said Russia wanted to start World War Three by occupying the country and creating a conflict that would spread to the rest of Europe.

A group of foreign military observers, possibly including some Germans, traveling under the auspices of the Organization of Security and Cooperation in Europe, along with their Ukrainian military hosts, were detained by pro-Russia separatists in Slovyansk. It was unclear precisely how many were in the group, about a dozen, but the detention appeared to be the first time that members of the Ukraine armed forces had been taken into custody by the separatists.

The US, Britain, and Germany are now calling for more sanctions against Russia, but none of the three countries gave any details of what the sanctions might be, or when they might be enacted. The standoff has already led to heavy capital flight from Russia, prompting credit rating agency Standard & Poor's to cut the country's ratings. That forced the Russian central bank to raise its key interest rate to reverse a drop in the ruble.

The Federal Communications Commission announced new rules governing Internet service. The rules effectively put an end to net neutrality, or the idea that all web traffic should be treated equally. A court decision in January struck down FCC rules meant to ensure that Internet providers do not discriminate by blocking or slowing certain content.

That new rule gives broadband providers what they’ve wanted for a long time, the right to speed up some traffic and degrade others. When broadband accelerates some traffic the result is that other traffic slows down. We take it for granted that bloggers, start-ups, or nonprofits on an open Internet reach their audiences roughly the same way as everyone else. Now they won’t. They’ll be moved over to a slow lane and forced to line up for their chance to reach an audience as they watch as companies that can pay tolls to the cable companies speed ahead. The motivation is not complicated. The broadband carriers want to make more money for doing what they already do. Never mind that American carriers already charge some of the world’s highest prices, around sixty dollars or more per month for broadband, a service that costs less than five dollars to provide.

After the ruling, internet providers like Comcast and Verizon cut deals with content providers, such as Netflix, which would pay to stream their content in an Internet “fast lane.” The new rules effectively create a fast lane and a slow lane on the internet. The fast lane includes big tech companies that can afford to pay; the slow lane includes startups, small businesses and everybody else. The internet providers are also becoming more and more involved in providing content, and it just makes sense to think their content will get preferential treatment. Companies like Verizon and Comcast will have staggering power to decide what bits of information reach your devices and mine, in what order and at what speed. That is, assuming we're permitted to get that information at all.

Bottom line is that the internet is going to get more expensive; if content providers have to pay extra for the fast lane, they’ll pass those costs on to the end user. The finer details will be hashed out in the coming months, starting on May 15, when the proposed rules become public.

Back in the Spring of 2010 the Office of the Comptroller of the Currency (OCC) and the Federal Reserve issued consent orders to 11 mortgage servicers, mandating that borrowers who had pending foreclosures, or had completed foreclosure sales in 2009 or 2010 could request an investigation by independent reviewers. The independent reviews would be paid for by the servicers, and in a shocking twist, the independent reviewers were anything but independent.

Eventually 16 servicers were included in the reviews, accused of using forged and shoddy paperwork to rapidly foreclose on homeowners, a practice known as “robo-signing.” The servicers, including Bank of America and Wells Fargo, agreed to have independent consultants review their foreclosure files for errors. In the 12 months that the review was up and running, not a single homeowner received any compensation. But the eight consultants managing the process were paid a total of $1.9 billion.

And so the independent review was cancelled and the regulators and the banksters worked out a quick and dirty settlement, with $3.3 billion going to wronged homeowners; a bunch of insultingly small checks distributed to a wide swath of people, and the regulators and banksters got to say: look how many people we helped. Meanwhile, nobody went to jail for the thousands of forged documents, the perjury, the obstruction of justice, etc., etc. in what was surely one of the largest fraud cases in American history.

Another problem is that nobody really knew who had been wronged and in what amounts, and so when the restitution was paid, nobody really knew if there was any rationale for the payments. The OCC said the consultant’s review had found an overall error rate of about 4.5% after assessing about 100,000 files, but that always seemed to be a lowball estimate.

Meanwhile, Representative Elijah Cummings continued to get data, and now that data is coming to light. In one example, a reviewer, Promontory Financial, found errors with 60% of the loan modifications conducted by Bank of America; a partially completed review found similar problems of the cases reviewed for PNC Bank. Based upon those numbers, the banksters got off with a puny little fine, and the wronged homeowners got shortchanged.

Now, you’re probably thinking to yourself, that this is old news about the robo-signing, but what is still relevant is  how the politicians have suppressed this information for so long; further proof of how deeply pretty much all of Washington DC is in bed with the banks. Only now when foreclosure abuses are considered old news does the public begin to get an inkling of how much the official story was close to a complete fabrication.

Of course, the people who went through the Independent Foreclosure Review process knew full well what a charade it was, but they were never taken seriously. The review process cost nearly $2 billion and it turned out to be a cost efficient whitewashing by the banksters. If you’ve lost your home, you are sure to be under financial duress, and people with no money don’t have any clout with our government. Foreclosure is considered a stigma, which discourages victims from telling their stories and sets those brave enough to do so up for abuse; the banks have done a great job of playing up the “deadbeat borrower” meme, whether it fits or not.

And we finish today with the story of how a top bank executive finally has to pay for his fraudulent actions. Bank of America's former finance chief, Joe Price, has agreed to pay $7.5 million to settle a New York lawsuit that accused the bank and its former executives of misleading investors during the lender's acquisition of Merrill Lynch. The top execs at BofA lied about the toxic assets on the books at Merrill Lynch and mounting losses leading to the merger; and misrepresenting the impact the merger would have on the bank's future earnings; this violated so many securities laws that it is crazy.

New York Attorney General Eric Schneiderman said: "This settlement is one more step in our effort to hold top financial executives accountable for their actions." What a crock.

The bank paid the fine for Joe Price, which means the shareholders are actually paying. Joe Price did not have to admit wrongdoing. Former BofA CEO Ken Lewis settled last month; the bank paid his fine too; Lewis did not admit wrongdoing.

Meanwhile, there is still a $2.3 billion class action lawsuit pending, and the Department of Justice is now offering a $13 billion settlement to Bank of America to resolve federal and state investigations of the lender’s sale of bonds backed by home loans in the run-up to the 2008 financial crisis. Don’t hold your breath for justice.

Thursday, April 24, 2014 - The Bridge From Bubbles to Prosperity

The Bridge From Bubbles to Prosperity

by Sinclair Noe

DOW unchanged 16,501
SPX + 3 = 1878
NAS + 21 = 4148
10 YR YLD unchanged 2.69%
OIL + .46 = 101.90
GOLD + 10.20 = 1294.90
SILV + .20 = 19.75

The Dow closed unchanged. That is just one of those freaky things that happens every few years. I remember it happened in 2008, and 1998 and 1996. I’m fairly sure there were other days where the Dow closed unchanged. I don’t know if there is any particular significance.

Orders to factories for durable goods rose 2.6%, adding to the 2.1% rise in February. The back-to-back gains followed two big declines in December and January, which had raised concerns about possible weakness in manufacturing. The earlier declines, however, were likely tied to bad winter weather.

On the jobs front, the number of people seeking unemployment benefits jumped 24,000 to a seasonally adjusted 329,000 last week. The four-week average of weekly unemployment claims decreased to 316,750, which puts us back to 2007 levels.

The big earnings report today was Microsoft, which posted income of $5.6 billion, or 68 cents per share, compared with $6 billion, or 72 cents, in the year-ago quarter. They beat estimates of 63 cents per share, but take it with a grain of salt; the estimates started the quarter around 80 cents per share.

Yesterday we talked about a tech bubble, and whether we were in one or not, and we looked at comments from Greenlight Capital manager David Einhorn; he says there is a bubble but it doesn’t necessarily mean the bubble will pop any time soon.

Today, Warren Buffet weighed in on whether stocks are too frothy. Buffett says, “we’re in a range, and it's a big zone always of reasonableness." He went on that "Stocks will become worth more decade after decade, not in any precise manner, not in an even manner or anything of the sort, but 10 years, 20 years, 30 years from now, stocks will be worth more than they are today."

A friend stopped by this morning and asked about bubbles; apparently this is a hot topic these days. How do you know you’re in a bubble? The most obvious answer is when it pops, but there are more helpful ways to address the issue.

The first indicator is that prices spike; a parabolic increase in prices. From March 1999 to March 2000, the Nasdaq rose 110%. Think of an airplane that climbs too fast; it stalls out, rolls over and plummets to the ground; same thing in most markets.

The next thing to watch is valuation. Prices can go up very fast, and if valuations also go up fast, we call that “growth”. When prices go up but valuations lag, we call that a divergence, and a bubble in the making. For stocks, this means that earnings need to keep pace with price.

Back in 2000, the P/E passed 44 based upon inflation adjusted 10 year average earnings, or what’s known as the Shiller P/E; now the Shiller P/E stands at 16. However, for some sectors, we are seeing a divergence; the P/E for internet stocks is up around 47. The P/E for utility stocks is 19, but that is significantly above the historical median of 16. One reason for that divergence might be the recent spike in natural gas prices combined with investors chasing dividend yield. A parabolic spike is relative to the underlying asset, which makes it a bit more difficult to identify, but some examples are not tough to spot.

Look at the spike in Bitcoin about 6 months ago; it went from around $150 to almost $1200 in about one month, and its underlying value was impossible to quantify; that was a bubble. It popped. Remember when gold prices jumped up in spring of 2011? Pop. How about bond prices right now in Spain and Italy? Up 1.1 percentage points in 12 months and just slightly above comparable US Treasuries. It might be a parabolic price increase in combination with a divergence from the underlying asset; or maybe it says something about US Treasuries. You decide.

Of course, the valuation of the underlying asset can change very quickly due to an exogenous event. For example, if Russia shuts off nat gas supplies to Europe, it would quickly change the underlying value of Italian or Polish bonds. When the tsunami hit Fukushima, it changed the value of nuclear sector stocks. When the Hindenburg exploded, it was a black swan event for manufacturers of dirigibles.

And then the other indicator to consider is the madness of the masses. As investors identify a price move, they jump in; when everybody has jumped in, there is no one left. Or as Joe Kennedy said in the winter of 1928: “You know it's time to sell when shoeshine boys give you stock tips. This bull market is over.” By the way, the shoeshine boy reportedly told Kennedy to buy stock in the Hindenburg.

So, markets can get frothy and remain frothy, prices fluctuate, and the market can remain irrational longer than you can remain solvent. Spotting bubbles is possible, but tricky; so it’s important to remember you won’t go broke taking a profit.

Some things seem pretty straightforward. You accept that some things will work in very specific ways. You drive over a bridge and you expect that bridge to not fall into the river below. Yea, good luck with that. A report, released today by the American Road and Transportation Builders Association, warned that there are more than 63,000 bridges in this country in need of urgent repair; the dangerous bridges are used some 250 million times a day by trucks, school buses, passenger cars and other vehicles.

 Pennsylvania led the list of structurally deficient bridges, with 5,218, followed by Iowa, Oklahoma, Missouri and California. Nevada, Delaware, Utah, Alaska and Hawaii had the least. Overall, there are more than 607,000 bridges in the United States, according to the DOT's Federal Highway Administration, and most are more than 40 years old, and more than 10% are considered structurally deficient.

States rely heavily on federal funds to pay for road and bridge projects. The Fed collects 18.4 cents-a-gallon tax on gasoline and 24.4 cents-a-gallon tax on diesel to fund the Highway Trust Fund, which then pays out to the states. The Highway Trust Fund may be insolvent by this time next year unless Congress extends a temporary funding measure which is scheduled to expire in September.

The American Society of Civil Engineers estimates it will take $20.5 billion annually to clear the bridge repair backlog, up from the current $12.8 billion spent annually. That’s just the backlog; to really make a difference, it will take an investment of $3.6 trillion by 2020 to keep the transportation infrastructure in a good state of repair.

Meanwhile, we’ve been watching the Fed’s quantitative easing plan for some time and wondering why it hasn’t really helped the broader economy; it has helped banks, but not much beyond Wall Street. This is not to say the large scale asset purchase program hasn’t had an impact; it has. There is fairly concrete evidence that it has led to lower long-term interest rates; which in turn helped lift some real estate markets that were battered after the housing bubble burst. Some real estate markets are downright hot. Home values in San Francisco and Honolulu are at least 20 times as high as estimated rents. In other words, prices have jumped up and there is a divergence with the underlying asset, which has the makings for a bubble, but that just a couple of markets.

The broader real estate market has experienced a slowdown in the recovery and one cannot help but wonder about the extent to which Fed actions to pull back on their large scale asset purchases is implicated in the said slowdown. When former Fed chair Bernanke set off the "taper tantrum" in a press conference in June of last year by pointing out that at some point, the Fed would start scaling back the LSAP, bond and mortgage rates spiked. The 30-year fixed-rate mortgage went up about a point around then from the mid-threes to the mid-fours and has stayed there.

The Fed has tried to explain away the housing slowdown on the bad winter weather, but that’s just part of the problem. The other part of the problem is that the housing recovery only helped recover lost equity, it didn’t help create equity. In other words, it was a recovery effort not a wealth creation effort.

Kind of like the situation right now with bridges. From the day President Eisenhower signed the Federal-Aid Highway Act of 1956, the Interstate System has been a part of our culture; as construction projects, as transportation in our daily lives, and as an integral part of the American way of life.  Every citizen has been touched by it, if not directly as motorists, then indirectly because every item we buy has been on the Interstate System at some point.  President Eisenhower considered it one of the most important achievements of his two terms in office, and historians agree.  Economists recognize that this enormous public works project helped propel the economy, and still does.

Right now, interest rates are low; they won’t stay low forever. Right now, people need jobs; a massive infrastructure project would provide jobs, especially for long-term unemployed workers. Putting more people to work would mean more money moving through the economy, increasing demand, improving productivity. It seems like a no-brainer, until you remember that the problem rests squarely with our elected officials. Maybe the Federal Reserve could stop its insane and ineffective large scale asset purchases; stop the helicopter drops over Wall Street and instead make helicopter drops of cash strategically, directly over about 63,000 bridges. 

Wednesday, April 23, 2014 - A Brilliant Future From Cool Ideas

A Brilliant Future From Cool Ideas

by Sinclair Noe

DOW – 12 = 16,501
SPX – 4 = 1875
NAS – 34 = 4126
10 YR YLD - .05 = 2.68%
OIL - .2- = 101.55
GOLD un 1284.70
SILV + .06 = 19.55

It’s earnings season, and this is a chance to compare and contrast. This morning, Facebook posted earnings of $642 million in net income, or 25 cents a share, in the first quarter, versus $219 million, or 9 cents a share in the year ago period. Overall revenue grew 72% year-on-year to $2.5 billion in the first quarter, topping estimates. Facebook now has 1.28 billion active users, and more than 1 billion do their Facebook stuff on a mobile device. Then Facebook announced their Financial Director was resigning. Shares were up about 3%.

Nobody puts on a better presentation than Apple, that’s how they grew to be the most valuable company in the world. Steve Jobs would walk out and announce Apple had created a new mp3 player, and also a new way to connect to the internet, and also a new camera. Wow, three new products, nope…, he would hold up the iPhone – just one very cool thing from Apple; tech geeks heads would explode.

Today, Apple posted earnings of $10.2 billion or $11.62 a share, on revenue of $45.6 billion. Analysts expected the company to report earnings excluding items of $10.18 a share; Apple reported a 4.6% rise in March-quarter revenue to $45.6 billion; Apple sold 43.7 million iPhones in the quarter. Then they announced they were adding to their stock buyback with an additional $30 billion over the next year. Then they announced a 7 for one stock split, to make their $500-plus shares a little more affordable. Wow, the share price exploded in after-hours trade by about 8%.

You see the difference.

The really cool thing that Apple is now working on is something you’ve probably never heard of and wasn’t part of the earnings report today. Apple is making sapphires. Natural sapphire is a gemstone variety of the mineral corundum, a crystalline form of aluminum oxide. Corundum is colorless, but in natural sapphires, various impurities create a range of colors: chromium makes the gem red, becoming a ruby; iron and titanium create the prized cornflower blue of a true sapphire. Synthetic sapphire is colorless, unless deliberately colored.

Sapphire has been used in a variety of specialized applications for years, where its purity, clarity, high stable dielectric conductive properties, and high optical quality, along with its hardness, have made it worthwhile despite its relatively high price. Think lasers and high end, luxury watch faces.  Apple is making a billion dollar bet on sapphire as a strategic material for mobile devices such as the iPhone, iPad and perhaps an iWatch. Though exactly what the company plans to do with the scratch-resistant crystal, and when, is still the subject of debate.

Apple is creating its own supply chain devoted to producing and finishing synthetic sapphire crystal in unprecedented quantities. The new Mesa, Ariz., plant, in a partnership with sapphire furnace maker GT Advanced Technologies, will make Apple one of the world’s largest sapphire producers when it reaches full capacity, probably in late 2014. By doing so, Apple is assured of a very large amount of sapphire and insulates itself from the ups and downs of sapphire material pricing in the global market.

The Arizona project was revealed in November, with Apple paying $578 million for GTAT to install and run its advanced sapphire growth furnaces in a plant built and owned by Apple. The news triggered a frenzy of speculation that Apple planned to use sapphire crystal sheets to replace the glass currently used in touch displays for its 2014 iPhones, iPads or a new line of “wearables” such as the long-rumored iWatch, or all of the above.

That’s only the tip of Apple’s investment. Once the synthetic sapphires emerge from the furnaces, they’ll be shipped to Apple’s supply chain partners in Asia for slicing, polishing, laser cutting, coating and eventual assembly. No one has used sapphire in large-scale consumer electronics or consumer goods products. Apple created a sapphire cover for the iPhone 5 camera lens, and for the iPhone 5s Touch ID fingerprint sensor. It’s mainly the sheer foundry capacity that Apple is creating in sapphire that fuels the speculation that it has big plans for sapphire in bigger uses, such  as a replacement for the cover glass, presumed to be Corning Gorilla Glass, in at least the high-end iPhone model.

A sapphire cover would presumably be less likely to break or scratch, but the big payoff could be the ability to change the underlying LCD technology of the screen, rendering more colors and using less power than today’s LCDs, while improving the speed and accuracy of the touch interface. 

It will cost more, by some estimates about $20 more per screen, but what it shows is that when Apple believes in a new technology or material, they’re willing to take a hit on the bill of materials costs. Of course, to commit for the long term, there needs to be a convincing cost reduction roadmap somewhere.

Some think technology stocks are poised for a 2000-style crash. And if they aren't ready to fall now, they may be soon. What is it about financial bubbles that make them so hard to detect? One reason is that memories are short. Some 20 years ago Wall Street merrily poured into technology stocks, and was horribly burned. Not many years later, the rest of America piled into residential real estate with similar abandon, and similar results. Meanwhile, big tech companies are using their stock to fund eye-popping mergers and acquisitions, most famously Facebook's $19 billion takeover of WhatsApp in February (of which $12 billion is in Facebook shares). Apple seems to be able to continue to do cool stuff, and maybe a billion dollars is a good price for a better iPhone screen. Maybe it’s a sign of over valuation in tech. David Einhorn of Greenlight Capital thinks tech may be ready to resume its slide, but it is a cautionary tale:

We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year.

Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it.

In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm. Some indications that we are pretty far along include:

The rejection of conventional valuation methods;

Short-sellers forced to cover due to intolerable mark-to-market losses; and

Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.

And once again, certain “cool kid” companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is “non-cash.” Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?

Given the enormous stock price volatility, we decided to short a basket of bubble stocks. A basket approach makes sense because it allows each position to be very small, thereby reducing the risk of any particular high-flier becoming too costly. The corollary to “twice a silly price is not twice as silly” is that when the prices reconnect to traditional valuation methods, the derating can be substantial. There is a huge gap between the bubble price and the point where disciplined growth investors (let alone value investors) become interested buyers. When the last internet bubble popped, Cisco (the best of the best bubble stocks) fell 89%, Amazon fell 93%, and the lower quality stocks fell even more.

In the post-bubble period, people stopped talking about valuing companies based on eyeballs (average monthly users), total addressable market (TAM), or price-to-sales. When the re-rating occurred, the profitable former high-fliers again traded based on P/E ratios, and the unprofitable ones traded as a multiple of cash on the balance sheet.

Our criteria for selecting stocks for the bubble basket is that we estimate there to be at least 90% downside for each stock if and when the market reapplies traditional valuations to these stocks. While we aren’t predicting a complete repeat of the collapse, history illustrates that there is enough potential downside in these names to justify the risk of shorting them.

So is there a tech bubble, or isn't there? Maybe tech stocks aren’t overvalued; the market is more balanced now than it was in 2000. Back then, tech stocks accounted for 14% of all earnings in the S&P 500, but a third of the index's capitalization. Nowadays the two figures are about the same at 19%.  Nor is the IPO market overly frothy like it was 15 years ago. In the first quarter of 2000, 115 companies went public, raising $18 billion; in the first quarter of this year, 63 IPOs raised $11 billion. Moreover, the IPO market isn't as crazed as it was 15 years ago: The first day run-up in share prices after their IPO is a third of what is was in 2000, evidence that investors haven't lost all sense of proportion.

The problem is that bubbles, tech and otherwise, can easily be analyzed away. No one expects the tech bubble to explode using exactly the same formula it did 14 years ago. Tech is more bubble-prone than other industries. Investing by nature is betting on the future, but in the case of tech, the future is a growth story based on extracting a brilliant future from a cool idea. 

Tuesday, April 22, 2014 - Helicopter Drops Were Successful, and Other Revisions

Helicopter Drops Were Successful, and Other Revisions

by Sinclair Noe

DOW + 65 = 16,514
SPX + 7 = 1879
NAS + 39 = 4161
10 YR YLD + .01 = 2.73%
OIL – 1.77 = 101.88
GOLD – 6.60 = 1284.70
SILV - .05 = 19.49

Sales of previously owned homes fell in March for a third consecutive month as rising prices and a lack of inventory discouraged would-be buyers. The National Association of Realtors reports closings, which usually take place a month or two after a contract is signed, fell 0.2% to a 4.59 million annual rate, the lowest level since July 2012. It was the seventh drop in the last 8 months pushing sales down 8.5% compared with the same month last year before adjusting for seasonal patterns.

The drop in demand might not lead to a flat-line in home prices. That’s because one obstacle to lower sales is the low number of homes on the market. The number of houses for sale at the end of last month rose to 1.99 million compared with 1.93 million a year earlier. At the current pace, it would take 5.2 months to sell houses compared with 5 months at the end of February.

There are some positives in the housing market: distressed sales are down; delinquencies are down; negative equity has declined; and even though inventory is up slightly, that is a positive because inventory had been too tight.

The median price of an existing home climbed 7.9% from March 2013 to $198,500. The appreciation was led by a 12.6% year-to-year advance in the West, while the Northeast posted a more moderate 3.2% increase. As prices increased, sales dropped, with the biggest 12-month drop coming in the West at 13.5%, and the smallest in the Northeast, with a 4.4% decrease.

Million-dollar home sales are on the rise, while deals for cheaper homes are dropping. In March, sales of single-family existing homes priced at $1 million and above were up 7.8% from the year-earlier period. Meanwhile, sales of homes that cost between $100,000 and $250,000 fell 9.9% over the past year. This might say something about the weak labor market and eroding income levels; it also speaks to mortgage lending practices, which remain strict for all but the jumbo market, where standards have eased; and it screams about the growing divide in America.  

Meanwhile, each month Bloomberg conducts a survey of 67 economists and one of the questions is where yields on the 10-year Treasury note are headed for the next six months; and the answers have overwhelmingly been that yields are headed higher. This month’s survey was more than overwhelming, it was unanimous; 100% say yields will be up by the end of the year. The last time the survey had that result was in May 2012, when benchmark yields were well below 2%.

Of course the Federal Reserve has said they intend to keep their target for Fed Funds rate right at zero; that has been the policy since the aftermath of the 2008 meltdown and Janet Yellen has let the markets know that there is no reason to expect a change in the policy “for a considerable time” after it ends its QE bond buying program, which means no change until around the Spring of 2015; and even then, it will be dependent on data showing the economy has improved. So, what has unanimously convinced economists that yields are going higher, faster than the Fed has plotted? What is wrong with the current, low interest rate environment?

Fed Governor Jeremy Stein delivered a speech last month arguing that the Fed should withdraw stimulus or raise interest rates, even if that means allowing a higher-than-normal unemployment rate, all to prevent the growth of a bubble in the bond market. Stein points to three things: first, the rising level of private-sector debt as a percentage of the US economy; second, narrowing spreads between risk-free Treasuries and corporate bonds; and third, the growing proportion of corporate debt going to riskier companies, or junk bonds going to companies that have a greater likelihood of defaulting on their loans.

Private sector, non-financial debt has now grown to 55% of gross domestic product. Meanwhile, low rates may have distorted the proper evaluation of risk; the spread between Baa rated corporate debt and risk-free Treasuries has dropped. Those spreads were high during the financial crisis but have since dropped down below pre-crisis levels. Total corporate bond issuance hit $1.3 trillion last year, not just recovering but surpassing pre-crisis levels and a big chunk of that issuance, $336 billion, is going to junk bonds.

The housing market has seen some recovery, depending on location, but the latest data on new and existing sales shows a market that is slowing for now. The market for debt has been expanding much faster than seems reasonable, and might indicate an area of concern for the Fed. Or maybe the Fed is realizing that their policy just hasn’t worked and they are now sitting on a huge balance sheet that can’t be artificially propped up indefinitely.

Meanwhile, the former Fed Chairman Ben Bernanke was speaking today at the Economic Club of Toronto and he said the Fed could have done a better job communicating during the financial crisis. He said the public incorrectly believed the Fed’s emergency-lending programs benefited Wall Street over Main Street. Bernanke also said, “There will be a time coming soon when inflation will improve and when central banks will move to a more normal monetary-policy road.”

Of course, that might be part of the problem; the markets always expected the Fed to have their helicopter drops directly over Wall Street and then get back to more normal monetary policy. In other words, the Fed never truly committed to all out monetary stimulus, and the result was a prolonged economic slump as the velocity of money slowed to a crawl. Bernanke would like to say everything worked out for the better, but that wasn’t really the case.

Bernanke likes to think Fed policies helped Main Street as much as Wall Street, but we all know better and now we have facts to refute Bernanke. The New York Times reports the American middle class is no longer the most affluent in the world; we have lost that distinction even as the wealthiest Americans outpace their global peers and most American families are paying a steep price for high and rising income inequality.

After-tax middle-class incomes in Canada are now higher than in the United States. The poor in much of Europe earn more than poor Americans. The data on Europe is a bit tricky as some countries such as Portugal and Greece have seen income fall sharply in recent years, while other countries, such as Sweden and the Netherlands have narrowed the gap. One large European country where income has stagnated over the past 15 years is Germany, but even poor Germans have fared better than poor Americans.

The struggles of the poor in the United States are even starker than those of the middle class. A family at the 20th percentile of the income distribution in this country makes significantly less money than a similar family in Canada, Sweden, Norway, Finland or the Netherlands. Thirty-five years ago, the reverse was true. The top 5% of American income earners still top their global counterparts, and for those well-off families, the US still represents the world’s most prosperous economy. The US still holds the title of the world’s richest large country based upon per capita gross domestic income, but those numbers are averages which don’t capture the distribution of income.

The results of the 35 year study compiled by LIS recognize 3 major factors behind the weak income performance in the US. First, educational attainment in the US has risen far more slowly than in much of the industrialized world, and especially among younger workers. Literacy, numeracy, and technology skills of younger Americans have fallen well behind counterparts in Canada, Australia, Japan, and Scandinavia, and close to those in Italy and Spain.

Another factor is the distribution of income in the US; it has been growing faster for the top earners, but shrinking for the middle class and poor. Yet the American rich pay lower taxes than the rich in many other places, and the United States does not redistribute as much income to the poor as other countries do. As a result, inequality in disposable income is sharply higher in the United States than elsewhere.

So despite Bernanke’s assertions that the Fed helicopter drops benefitted all American, we know better. And we also know that there are some policy tools that haven’t been used that could change the situation. The best place to start would seem to be the financial industry, since this is the sector that benefitted most from Fed policy and has continued to act as a drain on the productive economy.

A new IMF analysis found the value of the implicit government insurance to backstop too big to fail banks, just the idea that the government would not allow the mega-banks that have been labeled systemically important would not be allowed to fail, that subsidy is pegged at $50 billion a year in the US, and about $300 billion a year in the Eurozone.

Maybe the Fed could even act like a regulator and break up the biggest banks, cut them into small pieces; and in that way, if there was a failure, it wouldn’t represent a threat to the broader economy; as long as that threat hangs over our heads, it is hard to accept Bernanke’s assurances that Fed policy benefits all equally.

Monday, April 21, 2014 - Why Stocks Continue Going Higher

Why Stocks Continue Going Higher
by Sinclair Noe

DOW + 40 = 16,449
SPX + 7 = 1871
NAS + 26 = 4121
10 YR YLD un 2.72%
OIL - .01 = 103.64
GOLD – 4.30 = 1291.30
SILV - .21 = 19.54

The S&P 500 has gained for five straight sessions, marking the longest winning streak since October. This has not been a pretty rally. Volume was light today; that has been part of the trend; light volume on up days and heavy volume on down days.

We are smack dab in earnings reporting season, and 87 companies have posted results through this morning with 62% beating earnings expectations; that’s down from 66% beating earnings over the past 4 quarters, and those earnings expectations have been ratcheted lower and lower, so it should be an easy bar to cross. And still the markets have been moving higher.

Dozens of S&P 500 components will report earnings this week, including Apple, Biogen, Facebook, McDonald’s, AT&T and Caterpillar. More than 30 companies in the Nasdaq 100 (NDX) are slated to report earnings. After the close of trade Netflix posted a first-quarter profit of $53 million, or 86 cents a share, up from $3 million, or five cents a share, a year ago. The company in January had projected a profit of 78 cents a share. The stock shot up about 7% to $372 in extended-hours trading. After a jump of 300% in 2013, Netflix had slumped recently.

As part of the earnings announcement, Netflix announced a price hike, but it will only be for new customers, and the hike won’t happen for about 2 or 3 months, and existing customers will be grandfathered in with a non-specific grace period.

Also, Netflix sent a letter to shareholders in opposition to the proposed Comcast-Time Warner Cable merger. The letter says that if the merger is approved, “the combined company’s footprint will pass over 60 percent of U.S. broadband households...with most of those homes having Comcast as the only option for truly high-speed broadband. The combined company would possess even more anti-competitive leverage to charge arbitrary interconnection tolls for access to their customers. For this reason, Netflix opposes this merger."

Two months ago, Netflix agreed to pay Comcast for access to its high-speed network to improve the video quality and loading speed for Netflix streaming customers.

On a related note, major television broadcasters and Aereo will argue before the US Supreme Court tomorrow in a case that is about much more than the future of a controversial startup. The outcome could have far-reaching effects on the future of television and cloud computing, the quality of wireless service, and entrepreneurs trying to create the next big thing in technology.

You’ve never heard of Aereo? Don’t feel bad, I’m not even sure I’m pronouncing it correctly. It is a 2 year old startup that captures broadcast airwaves and then streams those signals to users, for about $8 a month. The broadcast channels such as NBC, CBS, ABC, and Fox are transmitted free of charge to anyone who has a television and an antenna. But cable companies like Comcast and Time Warner pay the broadcasters billions of dollars in fees for the right to re-broadcast the network TV channels as part of paid cable packages. Aereo argues it doesn't need to pay those fees because the broadcast signals which it's capturing and then retransmitting to its subscribers over the Internet, are free.

Broadcasters sued, claiming Aereo is violating copyright law by retransmitting the shows and threatening their industry's business model. If Aereo is legal, they fear there’s nothing stopping cable companies from copying Aereo to avoid paying the broadcasters billions of dollars in fees. If Aereo wins, broadcasters have threatened to yank their broadcast signals off the free airwaves and instead offer them only to paid subscribers.

Aereo streams network TV to subscribers via servers in “the cloud.” A Supreme Court decision against Aereo threatens to outlaw the entire cloud-computing industry. If Aereo is violating copyright law, that means other cloud providers could also be held responsible for helping users access illegal content. For example, Google or Dropbox could be responsible for policing the content stored in a Google Drive or Dropbox account to avoid copyright violations.

If Aereo wins and broadcasters follow through on their threat to stop beaming over-the-air programming, it could have an unintended benefit for smartphone users. As people consume more data on their mobile devices, it has created a shortage of wireless spectrum that could lead to dropped calls and slower wireless speeds if more airwaves aren't freed up.

The government is preparing to auction off some of those unused broadcast airwaves to wireless companies so they can improve service and avoid network congestion. An Aereo victory could prompt broadcasters to sell more of those airwaves to wireless companies, which could ultimately lead to improved smartphone service.

Now, think back a few years, no a few more years, maybe you are old enough to remember when the entertainment industry sued Sony, claiming that allowing customers to use its Betamax VCRs to record TV programming for later viewing amounted to copyright theft. The Supreme Court dismissed their arguments.

Sometimes it is difficult to make sense of the cyber world. For example, do you like Cheerios? The little circular breakfast cereal? Well, if you like Cheerios on Facebook, General Mills thinks that is reason enough to prevent you from suing them, or at least that’s what they thought. Last week, General Mills revealed a new rule to prevent people from joining class action lawsuits if they had joined the General Mills online communities, or entered a contest, or subscribed to newsletters or liked Cheerios on Facebook.

Under the new terms, those who violated the rule would be limited to arbitration or informal negotiations as a means of conflict resolution. And when you think about it for a moment it seems a bit heavy handed that a cereal company could take away your right to sue, even if you found a rat in your Progresso soup, or something yucky in your Yoplait, or actual leprechaun parts in your Lucky Charms. General Mills has now reversed the policy, and they even claim there was no policy in the first place, it was just a misunderstanding of how far they could throw around their corporate weight.

Financial markets have been fairly calm lately — no big banking crises, no imminent threats of euro breakup. But it would be wrong and dangerous to assume that recovery is assured; our still-sluggish economic progress could still be undermined by bad policies, or the argument of the past few months is that the economy could be derailed by inclement weather.

The Conference Board’s leading index is designed to forecast economic activity, not the weather. So, the split between the leading and coincident indexes so far this year offers further evidence of how the weather slowed growth in the first quarter. It also supports expectations that economic activity is picking up this quarter.

The board compiles 10 forward-looking data series, including jobless claims and new orders, to calculate its leading index, and the coincident index contains four series, including nonfarm payrolls and business sales. While growth in the coincident index usually follows the rate of the leading index with a lag, the gap between the two has widened in recent months.

Today, the board said its leading index increased a larger-than-expected 0.8% in March, and the coincident index increased 0.2%. In the past four months, which included the harsh winter period, the leading index has increased 1.5% while the coincident is up just 0.4%. The gains in the leading index mean economic fundamentals should allow the recovery to pick up steam in coming months. If so, the coincident index should post better gains. Today’s Leading Economic Index says, “The economy is rebounding from widespread inclement weather and the strengthening in the labor market is beginning to have a positive impact on growth.”

The Fed is trying to exit QE, but it won’t be easy, and they say one of the determinants is the employment picture and inflationary pressures. A new research paper by Fed economists says those two categories should not be considered separately.

Fed Chairwoman Janet Yellen has argued that a significant portion of the long-term unemployment problem is due to a depressed economy rather than structural issues such as aging or the gap between workers’ skills and employers’ needs. According to her line of thinking, Fed policies could help spur hiring by boosting demand. If the problem is primarily structural, as some other economists have argued, Fed policies are less likely to make any difference in employment. In a speech earlier this month, Yellen said, “I believe that long-term unemployment might fall appreciably if economic conditions were stronger.”

The new research paper corroborates Yellen’s findings. The new research says that by using regional data sets rather than simply national figures, and economists were able to “discriminate the independent influences of short- and long-term unemployment” on inflation.

“The results suggest that long-term unemployment has exerted similar downward pressure on inflation to that exerted by short-term unemployment in recent decades.”

Or economic recovery could be undermined by green men.

For the past two weeks, pro-Russian gunmen in green uniforms with no insignias, have been taking over government buildings in eastern Ukraine. Russia did not claim them; they were unidentified “green men”. To no one’s surprise, US intelligence is now saying the “green men” are indeed Russian military, and this is a pretty clear breach of the non-escalation agreement reached last week in Geneva. So, now the US State Department is saying that Russia and their “green men” need to vacate occupied buildings and checkpoints, accept an amnesty and address their grievances politically, or the financial sanctions against Russia will be escalated.