Tuesday, August 05, 2014 - Go Firgure

Go Figure

by Sinclair Noe

DOW – 139 = 16,429
SPX – 18 = 1920
NAS – 31 = 4352
10 YR YLD - .01 = 2.48%
OIL - .86 = 97.43
GOLD + .40 = 1289.60
SILV - .39 = 19.84

We start with a couple of economic reports: The Institute for Supply Management’s services index rose to 58.7 last month, the highest level since December 2005, from 56.0 in June. A reading above 50 indicates expansion. Orders jumped to a 9 year high. A sub-index gauging services industry employment also rose as did order backlogs, but export order growth moderated.

In a separate report, the Commerce Department said orders for manufactured goods increased 1.1% in June, more than reversing May's 0.6% decline. Orders for non-defense capital goods excluding aircraft hit a record high; this might indicate a renewal in business confidence and equipment spending plans. Factory orders rose across all categories, with bookings for electrical equipment, appliances and components recording their largest gain since November 2010. In another sign of strength, unfilled orders saw their largest rise in seven months.

So, a couple of good reports on the economy, and the stock market tumbles. Go figure.

The situation in Ukraine appears headed to a tipping point. Ukrainian forces have been pushing back against Russian backed separatists in eastern Ukraine. Meanwhile, Russia is massing troops on the border. Some 20,000 troops are now stationed about 50 kilometers from the border, closer than they had been stationed previously. In April, Russian President Vladimir Putin had briefly deployed about 40,000 troops at the border. The latest troops include Russian Elite forces, armored brigades, artillery and anti-aircraft units. Poland’s foreign minister thinks Russia is preparing to invade Ukraine; he didn’t flat out say an invasion was imminent, just that the Russians are getting ready.

Putin has ordered his government to prepare retaliatory measures against US and European economic sanctions imposed on Russia. We don’t know what Putin means by retaliatory measures. Russia may limit or ban flights over Siberia by European carriers bound for Asia as a response to sanctions levied against the country. Russia has also called for the UN Security Council to hold an emergency meeting on the humanitarian situation in Ukraine. It isn’t a humanitarian situation when the pro-Russian rebels shoot a plane full of civilians out of the sky, but it is a humanitarian situation when the rebels start getting their butts kicked.

One thing that hasn’t happened yet is a disruption in oil and gas supplies from Russia to Europe. Russia derives half its tax revenue from the oil sector; Europe relies on Russian supplies. As the weather changes and winter sets in, Europe’s resolve, which has already been soft, will weaken further. For now, energy prices are moving lower, despite violence in Eastern Europe, Libya, and Iraq. Global oil demand has been running below supply over the last few months, building up a glut of high quality crude oil in the West African, European and Asian markets. The US Energy Information Administration reported last week that gasoline supplies rose by 400,000 barrels at a time when market bulls hoped to see a reduction. Oil prices are at their lowest levels since February.

Yesterday we told you about the collapse of Portugal’s Banco Espirito Santo; today we report on the fallout. The French bank Credit Agricole held a 14% stake in Banco Espirito Santo and two seats on its board. Crédit Agricole's ties to the Portuguese group go back to 1986 when it helped the Espírito Santo Group set up Banco Internacional de Crédito. Over the years, the French bank raised its stake in the Portuguese group, as part of a larger international expansion plan in southern Europe.The French bankers say they never detected any “slip or difficulties” at Banco Espirito Santo. The collapse of the Portuguese bank nearly wiped out all the second quarter profits at the French bank.

Standard & Poors today announced that it was dropping its 10-year estimate of annual GDP growth in the US from 2.8% to 2.5%, which over a decade amounts to a pretty significant reduction. Why are they cutting the growth forecast? Here’s what S&P says: "Our review of the data, as well as a wealth of research on this matter, leads us to conclude that the current level of income inequality in the U.S. is dampening GDP growth, at a time when the world's biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population... At extreme levels, income inequality can harm sustained economic growth over long periods. The U.S. is approaching that threshold...."

S&P analysts say it basically boils down to the idea that high levels of income inequality cause more affluent households to save more of their increasing income rather than spend it, and as that cash is withdrawn the economy slows. At the other end of the economic scale, as income declines, households go into debt to try to maintain their standard of living, a strategy that is simply unsustainable over time. And when the unsustainable ceases to be sustained, you get a breakdown, much like that of 2008. In fact, S&P notes, as income inequality increases, an economic system becomes more and more vulnerable to a boom-and-bust cycle. It cites research demonstrating that income distribution plays a much more important role in sustaining long-term economic growth than any other factor.

Although the issue of income inequality is often addressed in moral terms, S&P concludes, at its foundation it is really an economic issue, saying: "A rising tide lifts all boats … but a lifeboat carrying a few, surrounded by many treading water, risks capsizing."

Earnings reporting season:

Retailer Target cut its second quarter earnings estimates due to higher promotions and more discounting; they also lost about $148 million related to that data breach, where hackers gained access to customer credit card info; that’s a small number compared to total sales at Target, but it apparently proved a costly distraction. Morgan Stanley reduced its second quarter earnings by 2 cents per share due to increased legal settlements. Disney posted better than expected earnings; shares moved just a smidge higher in after-hours trading. Cablevision cut back on its promotions and subscriber losses doubled in the second quarter. First Solar posted profits that missed estimates by a wide margin; they blamed project delays. Groupon fell in after-hours trading after posting a second quarter loss nearly triple the loss from a year ago. Zillow announced a second quarter loss, even as revenue increased; and they raised their full year revenue outlook. This was Zillow’s first quarterly report since they announced a $3.5 billion deal to acquire rival Trulia.

Time Warner and Fox both report earnings tomorrow, but the big news came today. Fox withdrew its offer for Time Warner. Game over. When Fox made the hostile bid, its stock dropped and Time’s stock soared; meanwhile Time’s board and management opposed the takeover and refused to discuss the offer. Now that Murdoch has dangled a huge windfall in front of Time Warner shareholders, only to take it away, one imagines that some of those shareholders may soon be venting their frustration to Time Warner's board and management.

Several America corporations have found a loophole in the tax code, which allows for a company to acquire a partial interest in a foreign company, and then change the address of its headquarters in order to evade US taxes; it’s called an inversion. There have been 22 such deals since 2011, most have been in the pharmaceutical industry, where overseas sales generate significant income that cannot be brought back to the US without suffering a major tax hit; but there have also been inversion deals in the media, consumer and manufacturing sectors. Some of those deals have collapsed, amid disputes over price and political scrutiny.

Walgreens was next on the list; closing in on a deal to buy the 55% of British pharmacy retailer, Alliance Boots; Walgreens already owns 45% of Alliance Boots. Walgreens will buy out Alliance Boots, but it won’t move its corporate headquarters abroad and it will not change its corporate citizenship to a lower tax country. They say they won’t do the inversion move because they would have had to renegotiate an existing agreement, and Alliance Boots wasn’t willing. There may also have been some political pressure.  President Obama has denounced tax inversions as unpatriotic and has urged Congress to stop them; which is like asking a Kleenex to stop a freight train. So, now the Treasury Department says there may be an executive order to provide a partial administrative fix, you know, until Congress gets back from its 5 week vacation.

As Ebola spreads, pharmaceutical giants are sitting this one out. That's mainly because treating a disease that affects a relatively small number of people who typically don’t have a lot of money doesn’t offer a great return on investment. It's unclear how much profit it would take to get Big Pharma interested in finding an Ebola cure, but right now such a project could well be a money-loser. Instead, small biotech firms, academics and government agencies are leading the search for an Ebola cure. And in a twist of fate, they may have found a way to treat the virus: tobacco.

A tiny San Diego-based company provided an experimental Ebola treatment for two Americans infected with the deadly virus in Liberia. The biotechnology drug, produced with tobacco plants, appears to be working. Mapp Biopharmaceutical produced an experimental drug called ZMapp, an antibody that had been tested only on infected animals; now it’s been given to human patients, and it seems to make a big difference. The antibody work came out of research projects funded more than a decade ago by the U.S. Army to develop treatments and vaccines against potential bio-warfare agents, such as the Ebola virus.

The tobacco plant production system was developed because it was a method that could produce antibodies rapidly in the event of an emergency. To produce therapeutic proteins inside a tobacco plant, genes for the desired antibodies are fused to genes for a natural tobacco virus. The tobacco plants are then infected with this new artificial virus. The infection results in the production of antibodies inside the plant. The plant is eventually ground up and the antibody is extracted. The whole process takes a matter of weeks.