Monday, July 28, 2014 - You Might Not Like the Solution

You Might Not Like the Solution
by Sinclair Noe

DOW + 22 = 16,982
SPX + 0.57 = 1978
NAS – 4 = 4444
10 YR YLD + .02 = 2.47%
OIL - .52 = 101.57
GOLD – 4.80 = 1304.50
SILV - .18 = 20.67

This will be a busy week for economic reports. Today’s reports included the National Association of Realtors’ index of pending home sales for June; it dropped 1.1%. This index looks at contracts signed, and usually about 80% of signed contracts result in a sale within 2 months. The pending home sales index is up 9% from February, but it is down 7.3% compared to June a year ago. The blame can be placed at the usual suspects: tough credit requirements, rising home prices, and weak wage growth.

In a separate report the Markit preliminary services Purchasing Managers Index for July was 61, unchanged for June; a reading above 50 indicates expansion. The services sector continued to add employees, though at a slower pace. The employment index fell from 56.1, the fastest rate on record, to 52.8 in July.

Wednesday morning brings the first estimate of second quarter gross domestic product. It is widely anticipated the economy grew at about a 3% pace in the second quarter, following a 2.9% contraction in the first quarter, largely blamed on bad winter weather combined with the expiration of long term unemployment benefits and working through excess inventory accumulation. So, the first quarter and second quarter will kind of cancel each other out and result in a flat first half. If the economy can maintain 3% growth for the next couple of quarters, it will result in annualized growth a little below 2%. Wednesday’s GDP report will include revisions to output for the past 3 years.

A few hours after the GDP report, the Federal Reserve FOMC will wrap up a 2 day meeting on monetary policy, and issue a statement. However, the Fed will not update its economic forecast, nor will they hold a press conference until the September 17^th FOMC meeting; so don’t expect any major changes to Fed policy this week. Still, Fed watchers will look for nuances to the Fed statement for any hint of policy changes, specifically when the Fed will start to raise interest rates.

Friday brings the non-farm payroll report for July. It is expected the economy added about 235,000 net new jobs in July; anything close is in the ballpark; anything under 200,000 or over 300,000 would shock the markets. The unemployment rate is expected to drop to 6%, but the unemployment rate has quite a few variables to consider, including the participation rate – the percentage of the population still looking for work or working. The participation rate has dropped from 65.8% in 2007 to 62.8% last month. This means that a lot of people have dropped out of the labor market. If some of those people re-enter the labor market and start looking for jobs, the unemployment rate could move higher, even if the economy adds a bunch of new jobs.

We kick off the week with a Merger Monday. Zillow will buy Trulia for $3.5 billion. Zillow and Trulia are No. 1 and 2 in the online real estate market, followed by No. 3 Move Inc. Zillow reported nearly 83 million monthly unique visitors in June. Trulia reported 54 million. The combination would create something like a monopoly in the online home hunting market.

Dollar Tree has agreed to buy Family Dollar Stores for $8.5 billion. The deal was pushed forward by investor Carl Icahn, who had built up a 9.5% stake in Family Dollar, and with the bump up in price from the merger, Icahn pockets a cool $150 million increase this weekend. The new Dollar Tree, or maybe Dollar Family Tree, would keep operating separate chains, but would have about 13,000 locations across the US and Canada, with 145,000 employees and about  $18 billion in revenue.

Tesla and Panasonic have reached a deal for Panasonic to invest in Tesla’s gigafactory. The initial Panasonic investment will be about $200 to $300 million, but could grow to $5 billion. The gigafactory would make battery packs for cars. Panasonic is the main supplier of battery cells for Tesla. Tesla has said it is evaluating sites in Arizona, California, Nevada, New Mexico, and Texas to place its massive battery factory. The electric car maker would break ground on the gigafactory later this year. Tesla is scheduled to report earnings on Thursday.

Lloyds Banking Group has agreed to pay $370 million to US and British regulators to resolve investigations into manipulating interest rates or Libor rate rigging. There were 2 main issues with Lloyds: rigging Libor, for which seven other institutions have already been punished; and for the first time, manipulating another rate, known as the repo rate. This repo rate was used to calculate the scale of the fees paid to the Bank of England for its special liquidity scheme (SLS), which was created in April 2008 to cheapen the prices at which money could be obtained by banks as the credit crisis unfolded; in other words, Lloyds manipulated their own bailout. The British lender is the latest big bank to admit criminal wrongdoing, and they entered into a deferred prosecution agreement. Under that agreement, Lloyds will avoid criminal charges if it stays out of trouble for the next two years.

Plenty of banks have entered into deferred prosecution agreements but I have never heard of one that violated a deferred prosecution agreement; and it isn’t because the banksters keep their nose clean; it’s because the regulators never apply the DPA.

Taking a look at geopolitical hotspots. Israel had agreed to a 12 hour ceasefire, but Hamas continued to fire rockets into Israel, so the ceasefire is off. Palestinian fighters launched a cross-border raid. Israeli Prime Minister Netanyahu is now warning of a protracted war in Gaza.

The Ukrainian government said today its troops had taken more territory from the rebels and were moving towards the site of the Malaysian airlines crash which international investigators said they could not reach because of the fighting. Meanwhile, US and European leaders agreed to impose wider sanctions on Russia's financial, defense and energy sectors.

Separately, an international arbitration court at The Hague ruled that Russia must pay $50 billion for expropriating the assets of Yukos, the former oil giant. Finding that Russian authorities had subjected Yukos to politically-motivated attacks, the panel made an award to a group of former Yukos shareholders that equates to more than half the entire fund Moscow has set aside to cover budget holes. The ruling hit back at decisions made under President Vladimir Putin's rule during his first term as president to nationalize Yukos and jail Mikhail Khodorkovsky, who had criticized him. The hardline approach was seen by Kremlin critics at the time as a stark message to oligarchs to stay out of politics. Khodorkovsky, who used to be Russia's richest man, was arrested at gunpoint in 2003 and convicted of theft and tax evasion in 2005. Yukos, once worth $40 billion, was broken up and nationalized, with most assets handed to Rosneft, an energy company run by an ally of Putin.

And don’t forget Libya. Two rival brigades of former rebels fighting for control of Tripoli International Airport have been throwing bombs at each other’s positions; then somebody bombed a huge nearby fuel depot, and that is now burning out of control. The conflict has forced Tripoli International Airport to shut down. Airliners were reduced to smoldering hulks on the tarmac and the aviation control center was knocked out. Libya's government has asked for international help to try to contain the disaster at the fuel depot on the airport road, close to other tanks holding gas and diesel. With Libyan security deteriorating, the United States evacuated its embassy in Tripoli on Saturday; British, Italian, Philippine, and Australian embassies have followed suit.

The typical American household has been losing ground. According to a new study by the Russell Sage Foundation the inflation-adjusted net worth for the typical household was $87,992 in 2003. Ten years later, it was only $56,335, or a 36% decline. Even as the average American household’s wealth declined, the net worth of wealthy households increased substantially. The average wealth of the American household in the 95th percentile was $1,192,639 in 2003, and $1,364,834 ten years later, an increase of 14%.

The authors of the study said the reason for the disparity was that affluent households were able to ride the success of the surging stock market after the 2008 crash, while middle class families were severely impacted by the decreasing value of their homes. Wealth declined for everyone in the aftermath of the Great Recession, but better-off families were able to rebound. Households at the bottom of the wealth distribution, on the other hand, lost the largest share of their wealth.

So, as we look at the economic news this week, the GDP estimate and the jobs report, it’s a little hard to imagine sustainable economic growth without a strong middle class. The lesson of the past 10 years, and we might even say the past 30 years, is that pumping up the upper echelons of the economy and hoping it trickles down to the rest, doesn’t work. The middle class gets clobbered, small businesses are being knocked out of the competition; in the early 1980s small business startups accounted for 50% of all business growth, but that dropped to 35% by 2010, and more small businesses are closing than are being created; and yes, that equates to fewer jobs being created by small businesses.

Back in 1929, the top 10% earned nearly 50% of the income. Today, income inequality is even wider. In 2012, the top 10% surpassed 50% of the total US income for the first time, and the problem has only grown in the past 2 years. Wealth disparity alarms often coincide with major financial peaks, such as 1929, 1999, 2007, and today; that’s because wealth disparity and income inequality are not sustainable, and there are only 2 solutions: the first is to grow the middle class, encourage small business, lift people out of long term unemployment; the second solution, is that the wealth distribution problem tends to be solved by falling markets.