Tuesday, June 24, 2014 - A Funny Thing Happened

A Funny Thing Happened
by Sinclair Noe

DOW – 119 – 16,818
SPX – 12 = 1949
NAS – 18 = 4350
10 YR YLD - .04 = 2.58%
OIL + .81 = 106. 84
GOLD + .70 = 1320.00
SILV + .03 = 21.03

Let’s start with a couple of reports on housing; the Commerce Department says new home sales increased 18.6% to a seasonally adjusted annual rate of 504,000 units, the highest level since May 2008. The increase in sales was the biggest since January 1992. Compared to May of last year, sales were up 16.9%.

Meanwhile, the S&P/Case-Shiller index of existing home prices rose 0.2% in April; the smallest gain since March of last year, with the year-on-year increase slowing to 10.8%.

Today’s reports seem to indicate a strong new home market and a weak existing home market, but that’s probably not quite accurate. Homebuilders are working through inventory, while existing home inventories are low and starting to rise; for existing homes that means we’ve mainly worked through most of the distressed sales that were out there. The housing market is moving forward modestly, but also in fits and starts.

The Conference Board said its index of consumer confidence rose to 85.2 from 82.2 in May, with optimism about the labor market. June's reading was the highest since January 2008. Consumers think jobs are more widely available. The survey found 14.7% of consumers think jobs are “plentiful,” the best reading since May 2008, while the share characterizing jobs as “hard to get” fell to a three-month low of 31.8%.

While government data showed confidence at January 08 highs, Gallup's latest survey shows, only one in five Americans (22%) say the economy is excellent or good, while 34% say it is poor; and worse still, Americans continue to be less optimistic about the economy's future:  38% say the economy is getting better, while 58% say it is getting worse; the worst differential since 2013. Gallup's US Economic Confidence Index lost another point last week, the third week in a row, dropping to its lowest in over 2 months.

Not much confidence in the equity markets today. I haven’t seen anything earth shattering that would explain why stocks moved from positive to negative territory, and even with the rollover, the major indices still didn’t drop a full percentage point; 119 points ain’t what it used to be. The S&P 500 closed down more than half a percent for its sharpest loss since June 12, after setting a fourth record high in five sessions. Maybe its concern about Iraq, maybe the high frequency traders ran out of shorts to squeeze.

A funny thing happened in Russia today; President Putin appeared to back away from the fight with Ukraine; Putin asked Russia’s upper house to revoke the right it had granted him to order military intervention in Ukraine. At the same time, pro-Russian insurgents in eastern Ukraine shot down a Ukrainian helicopter killing 9 servicemen.

There is no backing off the fighting in Iraq, where a dire situation has gone from bad dream to nightmare in two weeks of fighting that have seen Sunni Muslim gunmen assert control over a growing area, including at least two towns that lie on a crucial supply route linking Baghdad, the capital, with the mostly Shiite Muslim south.

Secretary of State John Kerry urged Kurdish leaders to remain part of Iraq, as fighters from local Sunni tribes wrested control of at least part of Iraq’s largest oil refinery after battling for days with government troops over the key facility. Armed tribal factions from the Baiji area breached the refinery complex 140 miles northwest of Baghdad.  Kerry flew to the Kurdish region on a trip through the Middle East to rescue Iraq following a lightning advance by the Sunni fighters led by jihadis of the Islamic State in Iraq and the Levant. U.S. officials believe that persuading the Kurds to stick with the political process in Baghdad is vital to keep Iraq from splitting apart. Washington has placed its hopes in forming a new, more inclusive government in Baghdad that would undermine the insurgency. Kerry aims to convince Kurdish leaders to join it. Something will likely tip one way or the other in the next week or two.

The spike in instability in several oil producing regions around the world is threatening to knock some production offline, but it is also boosting profits for drillers operating in trouble-free zones. Oil prices have hit their highest levels in almost 9 months as places like Iraq, Syria, Ukraine and Libya continue to experience violence and political upheaval. For companies with heavy investments in these regions, the situation is perilous, but for oil companies elsewhere, the higher price is good news.

Oil markets could be looking at an extended period of elevated prices, which is bad news for companies with billions invested in Iraq. ExxonMobil and BP already started evacuating some of their workers from southern Iraq, despite the fact that militants remain north of Baghdad. But for companies drilling far from the violence – in Texas for example – a $5 per barrel increase in prices can be the difference between whether or not an oil project is economically viable. Oil companies are using the opportunity to step up drilling. The Eagle Ford shale in southern Texas, for example, saw four more oil rigs and one gas rig come into operation over the past week. Across the U.S., the number of oil rigs in use reached 1,545 -- the highest level since record keeping began in 1987.

The Supreme Court has ruled on the case of Halliburton v. Erica P. John Fund. Halliburton is trying to block a class-action lawsuit claiming the company inflated its stock price. A group of investors claims they lost money when Halliburton's stock price dropped after revelations the company misrepresented revenues, understated its liability in asbestos litigation and overstated the benefits of a merger.

Writing for the court, Chief Justice John Roberts said companies should have a chance in the early stages of a lawsuit to show that any alleged fraud was not responsible for a drop in the company's stock price. The Supremes did not overturn a precedent setting case that might have ended class action suits completely. The old case is Basic v.  Levinson, and it established the theory of “fraud on the market”, or the idea that shareholders who claim fraud don’t need to show they relied on specific false statements. The theory presumes a company’s false statements inflated its stock price. This seems to make sense; if a company lies about its revenue, lies about its liabilities, lies about the benefits of a merger that will inflate the stock price; but I suppose you could also argue the stock price might be inflated because the economy improves or because algorithmic traders inflated the price or maybe the moon and stars were aligned in a particular way.

The truth is that it is nearly impossible to pinpoint exactly why stock prices go up; but it is possible to identify when a corporation lies about revenues, liabilities, and benefits. The Supreme Court seems to be saying that it’s O.K. for corporations to lie, so long as nobody can prove a direct link between the lies and the share price.

The case now goes back to the lower courts, where Halliburton will have another chance to block the investors from joining together as a class.

Just a reminder, the Sabanes Oxley Act of 2002, also known as the Public Company Accounting Reform and Investor Protection Act, was supposed set a new standard for all public companies, and top management to certify the accuracy of financial information or face possible punishment of up to 20 years in prison. When President Bush signed it into law he said: “The era of low standards and false profits is over; no boardroom in America above or beyond the law.”

A funny thing happened over the past 14 years: nobody has been convicted of criminal wrongdoing under Sarbanes Oxley, at least as best we can tell. There may have been some civil charges, but the “Justice Department doesn’t directly track Sarbanes-Oxley prosecutions, so there may be another case here or there. Even four or five SOX criminal cases in 10 years, though, makes them as rare as a blue moon.” (see Reuters)

There’s a new report on climate change predicting serious consequences, especially for American businesses. The funny thing about this report is that it comes from a panel chaired by former New York City Mayor Michael Bloomberg, former Treasury Secretary Hank Paulson and hedge fund manager turned climate activist Tom Steyer. It includes devastating forecasts for American companies, including dramatic declines in agricultural yields, loss of productivity due to intense heat and up to $35 billion spent dealing with coastal storms.

Bloomberg said “Climate change is costing governments and businesses billions of dollars,” and he hopes it "will mobilize the business community and forge a consensus for leadership across the aisle." Paulson says he now believes that “climate change is the existential issue of our age." Paulson also penned an op-ed in the New York Times last weekend warning of a "climate bubble" that poses risks to the economy just like the credit bubble did in 2008.

Steyer, a billionaire who has pledged to spend millions electing pro-climate-action politicians, said he hopes that the report will help "change the spreadsheet for American business" as companies calculate risks and opportunities. The business community, he said, should "get to a point where calculation of the value of a company includes how they are responding to this problem."