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.