Tuesday, July 22, 2014 - Curb Your Enthusiasm

Curb Your Enthusiasm

by Sinclair Noe

DOW + 61 = 17,113
SPX + 9 = 1983
NAS + 31 = 4456
10 YR YLD - .01 = 2.46%
OIL - .17 = 104.42
GOLD – 4.70 = 1308.50
SILV + .04 = 21.07

We start with a couple of economic reports. The National Association of Realtors reports existing home sales were up 2.6% in June to a seasonally adjusted rate of 5.04 million, compared to 4.91 million in May. Sales in June were 2.6% higher than last month, but were 2.3% below the June 2013 rate. Total inventory rose 2.2% in June to 2.3 million existing homes for sale; unsold inventory is up 6.5% from a year ago.

At June’s pace of sales, there was a 5.5 month supply of homes for sale. The Realtors’ group considers a 6-month supply to be a balanced market. Higher supplies favor buyers and lower supplies favor sellers. The Federal Housing Finance Agency says home prices in May rose 0.4% from the prior month and were 5.5% above their level of May 2013. Distressed sales accounted for just 11% of sales in June, down from 15% last year, 25% in 2012, and 30% in 2011. Fewer distressed sales probably explains why there were fewer sales than June of last year.

The Consumer Price Index, or CPI, measures inflation at the retail level; the CPI increased 0.3% in June. The core CPI looks at prices excluding food and energy, which is important for people who don’t eat food or drive cars or use electricity; core CPI was up 0.1% in June. On a year over year basis, CPI is up 2.1%, and the core CPI is up 1.9%. The big driver for the increase in June was higher prices for gasoline.

In earnings reports:

Quarterly profit at McDonald's fell more than expected. Second quarter net income fell almost 1% to $1.3 billion, or $1.40 per share. Sales at McDonald’s restaurants in the US dropped for a third straight quarter.

Coca Cola’s 2Q net income dropped to $2.6 billion from $2.68 billion a year earlier.

Verizon reported second quarter earnings nearly doubled, but it was a confusing report because Verizon paid for Vodaphone shareholders in the quarter, plus they sold some of their wireless spectrum to T-Mobile; cutting through the clutter, Verizon added 1.4 million devices; Verizon added three tablets for every new smartphone. Earnings were just a smidge above expectations.

Comcast reported net income of almost $2 billion for the second quarter, with total revenue of $16.8 billion, up 3.5% from the same period last year. The revenue increase came from high speed internet service. Comcast lost cable video customers, as more people bypass cable and satellite subscriptions in favor of cheaper streaming alternatives.

Credit Suisse reported a second quarter loss of $779 million, the largest loss since 2008; reflecting the charge of $2.6 billion related to the settlement with US law enforcement for a guilty plea to conspiring to aid tax evasion in helping American customers hide money in Swiss accounts. Or another way to look at it, they were one criminal conviction away from a $1 billion quarterly profit. Credit Suisse also announced it would exit the commodities trading business.

Meanwhile, it looks like bond traders are exiting the bond trading business. Trading in US government bonds has dropped 25% in the past few weeks compared to the same time period a year ago. Since the end of the second quarter, trading in investment grade bonds has dropped 17% and trading in junk bonds has dropped 8%.

Last week, Fed Chair Janet Yellen talked about overvaluation in the biotech and social media sectors. One of the most common measures of value is the P/E, or price to earnings ratio; there are certainly other measures of value, but PE is common. Generally, a low PE can point toward value, while a high PE might indicate overvaluation, or even an unprofitable company. Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share. So, you might think a PE of 165 would mean a stock was extremely overvalued, ready to crash; or not. In September 2003, Apple had a PE of 165; since then it has gained about 6,000%.

After the close of trade today, Apple posted fiscal third quarter results. Revenue came in at $37.4 billion versus $38 billion expected; EPS was $1.28 versus $1.23 expected; iPhone sales were on track; iPad sales were a little weak; Mac sales were a little better than expected. Apple posted profit of $7.75 billion, up from $6.9 billion in the year-ago period. Apple announced a new iPhone 6, not yet available, but ready to swamp stores before the end of the year; it will have a bigger screen. Curb your enthusiasm.

Also after the close, Microsoft posted profit of $4.6 billion, or 55 cents a share, on revenue of $23.4 billion. During the year-ago period, the world's largest software company earned $4.97 billion, or 59 cents a share, on $19.9 billion in sales. So, sales were up, profit was a slight miss, due to the Nokia acquisition. Bing search ad revenue is up 40%, and Bing now has about 20% of the market share for search engines. Microsoft is big in the cloud, where revenue is up almost 150%, topping 4 billion.

Hedge fund manager Bill Ackman went on CNBC yesterday and promised he would deliver the death blow against Herbalife. Ackman has been shorting the stock for about a year, a $1 billion bet the company will crash. Then he delivered a 3 hour diatribe with 250 slides in his PowerPoint presentation, alleging that Herbalife is not just a multi-level marketing nutritional club, it is a pyramid scheme preying on minorities, and the biggest fraud since Enron. Ackman didn’t present a great deal of evidence. Today the stock was up 15%, for no apparent reason, other than surviving an Ackman death blow.

There were two rulings from two federal appeals court panels on Obamacare today. The question was whether the government could subsidize health insurance premiums for people in states that use the federal insurance exchange; 36 states use the federal exchange, while the other states set up their own state exchanges. This goes back to wording in the original law that says subsidies can be applied to state exchanges.

 The United States Court of Appeals for the District of Columbia Circuit said that the government could not subsidize insurance for people in states that use the federal exchange. That decision could potentially cut off financial assistance for more than 4.5 million people who were found eligible for subsidized insurance in the federal exchange, or marketplace.

A couple of hours later, the United States Court of Appeals for the Fourth Circuit, in Richmond, upheld the subsidies, saying that a rule issued by the Internal Revenue Service was “a permissible exercise of the agency’s discretion.”

For now, nothing changes, with the exception that there will be many more billable hours for the attorneys.

Bloomberg reports that regulators are ready to label Metlife a potential threat to the financial system, subjecting the insurer to oversight by the Federal Reserve. MetLife, the biggest US life insurer, could be subjected to stricter capital, leverage and liquidity requirements as a result of Fed supervision. A decision by the Financial Stability Oversight Council may come as early as July 31, and MetLife would have 30 days to request a hearing before the FSOC to contest the decision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now 4 years old, even though it isn’t really in effect; just 52% of the rules mandated under Dodd-Frank have been finalized by regulators; Another 23% have been proposed but they’re still working out details, and regulators haven’t even gotten around to 24% of the rules. A recent report by consumer watchdog Public Citizen called out the Securities and Exchange Commission as a particularly egregious delayer, noting that it had pushed back the deadlines for 13 of the 23 rules it was supposed to finalize this year.

City workers and retired city workers in Detroit have agreed to pension cuts to help bailout the city from bankruptcy. General retirees would get a 4.5% pension cut and lose annual inflation adjustments. They accepted the changes with 73% of ballots in favor. Support for the pension changes triggers an extraordinary $816 million bailout from the state of Michigan, foundations and the Detroit Institute of Arts. The money would prevent the sale of city-owned art and avoid deeper pension cuts.

Most people travel to or from Israel by air, and the major airport, really the only airport is Ben Gurion in Tel Aviv; last year, 14 million people went through Ben Gurion Airport, in a country with a population of 8 million.  Yesterday a rocket from Gaza landed about one mile from the airport; we don’t have further details on that rocket; it didn’t hit the airport; it was a mile away. When news spread, Delta diverted a flight to Paris. United airlines cancelled flights. The Federal Aviation Administration banned all US passenger and cargo flights to and from Tel Aviv for at least the next 24 hours. European airlines cancelled flight to Israel. The possibility of a passenger jet being shot down over a war zone is a very realistic and fresh memory.

US and United Nations diplomats are in Israel, trying to broker a ceasefire of some sort. Israel continues to pound targets across the Gaza Strip. It does not appear a ceasefire is near. If there is any light at the end of the tunnel, the tunnel will be destroyed.

The European Union today threatened Russia with harsher sanctions if Russia doesn’t cooperate in the investigation of the downing of the Malaysian flight 17 and if Russia doesn’t stop sending weapons to Russian backed separatists in Ukraine. But it was just a threat, and they’ll get together later in the week to draft proposals for sanctions.

Tuesday, June 17, 2014 - What Could Go Wrong?

What Could Go Wrong?
by Sinclair Noe

DOW + 27 = 16,808
SPX + 4 = 1941
NAS + 16 = 4337
10 YR YLD + .06 = 2.65%
OIL - .30 = 106.60
GOLD un = 1272.70
SILV + .09 = 19.86

The FOMC, the Federal Open Market Committee started two days of meetings today; tomorrow they are expected to announce more of the same. The FOMC is largely expected to taper its asset purchase program by $10 billion to $35 billion. Effective July 1, the Fed is expected to lower its asset purchases to $15 billion in agency mortgage backed securities (MBS) and $20 billion in Treasuries. The Fed is also expected to maintain its current forward guidance language on federal funds rate support; in other words, they will keep telling us that rates might increase sometime next year.

The committee is likely to make some upgrades to its description of the economic outlook in its economic projections. The committee will probably need to reduce its 2014 real GDP growth forecast to take into account the Q1 disappointment, and we can probably expect the committee to reduce its unemployment rate forecast and lift its inflation forecast slightly.

The consumer-price index climbed a seasonally adjusted 0.4% in May from a month earlier. It marked the fastest increase since February 2013 and doubled the pace of economists' forecasts. Excluding food and energy components, so-called core prices increased 0.3%, the fastest pace since August 2011. From a year earlier, core prices were up 2%, the most since February 2013, and now match the Fed's target.

Another inflation measure closely watched by the Fed, the core personal-consumption expenditure, has stayed far below 2%. Inflation at wholesale level unexpectedly dropped by 0.1% in May, but remember the PPI rose 0.6% in April, so this is just a leveling out process. Wage pressure remains stubbornly low and consequently, the pace of the economic growth remains uneven. In May, the real average hourly wage fell 0.2%. Real wages have fallen three straight months even as inflation has picked up slightly.

The average hourly wage for a typical American worker registered just $10.28 in May, adjusted for inflation and measured in constant dollars. The real hourly wage totaled $10.31 in June 2009, the last month of the 2007-2009 recession. This is part of a trend that stretches back about 30 years.

Still, with core prices up 2% on an annual basis, the Fed will need to address the topic of inflation tomorrow. Let’s hope they also mention the lack of wage gains.

Another report today shows housing starts posted a bigger-than-forecast 6.5% decline. Housing starts declined to an annual rate of 1 million units last month from 1.07 million in April. What’s more, permits for new construction fell by 6.4% in May to a 991,000 annual pace, the slowest in fourth months.

The situation in Iraq is still bad. The ISIS rebels are about 40 miles north of Baghdad and seem intent on the idea of attacking the capitol city. Or they might attack the major source of revenue for the ruling government, and that means oil. One of three major oil refineries has now fallen under control of ISIS; the other two are in Baghdad and the south and not considered to be threatened at this time. About 2.5 million barrels of oil a day are exported from Basra, Iraq’s main port, located in the south.

The world consumes about 92 million barrels a day, so that would be a major disruption, and it would not be surprising to see prices jump; with price levels increasing along with the severity of the given scenario, running anywhere from a few dollars per barrel to a worst case of $200 a barrel.

Not too long ago, Iraq was claiming that it would be producing 12 million barrels a day by 2017. That now seems a little too optimistic.  At best, the ISIS rebellion guarantees that any potential additional Iraqi oil output gains are not going to materialize in the near future. No oil companies are going to invest in Iraq until and unless the situation stabilizes.

Although the consequences for Iraqi oil production of what has happened so far appear to be minimal, all this comes at a time when the earlier and still ongoing conflicts in Libya and Syria have already disrupted nearly 2 million barrels a day in world oil production. If Iraq’s recent 3 million barrels a day was also taken out, we would be talking about a significant disruption in world oil supplies, and likely an oil price in excess of $150 a barrel.

The worst case scenario sees a regional conflict break out that pits the Middle East’s Shiites (Iran) against the Sunnis (Saudi Arabia), leading to a compromise of the Strait of Hormuz. Forty percent of the world’s exported oil is transported through this waterway.

And if that isn’t enough, focus you attention on Ukraine. Yesterday, Russia announced it was cutting off natural gas shipments to Ukraine; today an explosion destroyed one of Ukraine’s main pipelines for gas headed to Western Europe.

EU-brokered talks failed to reach a compromise between the countries, which remain far apart on a “fair” price for gas. Ukraine’s state-run gas operator filed a suit in an international arbitration court, claiming $6 billion in overpayment for gas since 2010. Its Russian counterpart filed a suit of its own, alleging unpaid debts worth $4.5 billion on gas delivered since 2009. Until these cases are resolved, Ukraine will receive only gas it pays for upfront, and must not impede the flow of gas destined for the EU, which gets around 15% of its gas via pipelines that pass through Ukraine. There is another pipeline running from Russia directly to Germany, but still, the global energy picture looks less and less stable.

On Friday we reported that Tesla, the electric car company started by Elon Musk, was freeing up its patents, making its technology available to competitors. Now Nissan and BMW are considering negotiations for cooperation on charging networks; basically using and enlarging Tesla’s existing network of 97 charging stations in the US. Nissan already produces the electric Leaf and BMW last week unveiled the electric i8 in Germany.

So, why design new chargers and invest in building a whole new infrastructure for BMW and Nissan drivers? The Tesla network already stretches from coast to coast and is expected to expand rapidly over the next year. And Tesla leads in battery technology, with a gigafactory planned to start production in 5 years, which will be the biggest battery making facility in the world, producing 500,000 lithium-ion battery packs per year; more than enough for Tesla and its competition.

SolarCity, the largest US installer of residential solar panels whose largest shareholder is entrepreneur Elon Musk, announced that it plans to acquire solar panel maker Silevo and expand into manufacturing with new panel factories, likely including the world’s largest high efficiency solar panel plants in New York. At a conference call announcing the move, Musk said: "We expect to have to install 10 gigawatts [of high-efficiency panels] a year. If you look at the current capacity in the world, we're not able to do that right now."

It's not just a supply question. Solar panel prices have been falling in recent years thanks to a production boom in China; and the panels getting produced, though cheap, aren't terribly efficient and prices have begun bottoming out anyway. Prices might start climbing soon. Government subsidies for renewables start getting phased out in 2016, and the political environment for rebooting subsidies remains unstable at best. Plus, recent moves by the US to slap tariffs on Chinese panels likely served as a catalyst for looking into building the Silevo plant.

According to a study by two professors at the Stern School of Business at New York University and one professor from McGill University, a quarter of all public company deals may involve some kind of insider trading. The professors examined stock option movements, when an investor buys an option to acquire a stock in the future at a set price, as a way of determining whether unusual activity took place in the 30 days before a deal’s announcement. They determined statistically that the odds of the trading “arising out of chance” were “about three in a trillion.” [...] But, the professors conclude, the Securities and Exchange Commission litigated only “about 4.7 percent of the 1,859 M&A deals included in the sample.”

The study also says: “While the SEC has taken action in several cases where the evidence was overwhelming, one can assume that there are many more cases that go undetected, or where the evidence is not as clear-cut, in a legal/regulatory sense.” Plus another finding from the abstract: “Historically, the SEC has been more likely to investigate cases where the acquirer is headquartered outside the US.”

A new survey by Greenberg Quinlan Rosner, on behalf of Better Markets, finds voters regard Wall Street and big banks as “bad actors. A 64% majority believes the “stock market is rigged for insiders and people who know how to manipulate the system. Another 55% believes “Wall Street and big banks hurt everyday Americans by pouring money into ’get rich quick schemes’ rather than real businesses and investments. A 60% majority favors “stricter regulation on the way banks and other financial institutions conduct their business” and just 28% oppose. Support for stricter regulations inspires bipartisan support; most notably voters who own stocks are more likely to support stricter regulation than voters overall. And there is urgency in the issue because 83% of voters believe another crash is likely in the next 10 years.

Tuesday, April 15, 2014 - Yellen in the Lions' Den

Yellen in the Lions' Den
by Sinclair Noe

DOW + 89 = 16,262
SPX + 12 = 1842
NAS + 11 = 4034
10 YR YLD - .01 = 2.62%
OIL - .22 = 103.83
GOLD – 24.20 = 1303.40
SILV - .41 = 19.66

Stocks were all over the place today. We started with triple digit gains for the Dow Industrials, dipped to triple digit losses, then back into positive territory for the close with the major indices closing just below their morning highs. This kind of volatility does not engender confidence; it does warrant caution.

The utilities sector gained 1.3% and finished ahead of the other groups, extending its YTD gain to 11.8%; the biotech ETF added 1%, while the broader healthcare sector advanced 1.1%.Tech stocks have been beaten up quite a bit over the past couple of weeks. The Nasdaq 100 Tech Index (NDXT) is down 7% since April 1st. The Nasdaq Composite has exhibited weakness, but not to the point of meeting the definition of a correction; it would take a slide to 3,922 to mark a 10% fall from the March 5 closing high at 4,357; a 10% pullback from the March 6 intraday high of 4,371 would be achieved at 3,934.

The Labor Department’s Consumer Price Index, or CPI, increased 0.2% in March after posting a 0.1% increase in February. Excluding volatile food and energy prices, core prices ticked up 0.2%.Prices rose 1.5% for the 12 months ending in March. That is up from February’s year-over-year reading of 1.1%. Core prices moved up 1.7% over the 12 months, up from 1.6% in February.

A major factor in both headline and core CPI in March was a 0.3% increase in shelter costs. On an annual basis, housing costs were up 2.7%, the fastest pace in six years. The indexes for medical care, used cars and airline fares also increased in March. Apparel prices rose for the first time this year. Household furnishings and recreation prices dipped in the month. Real or inflation-adjusted hourly wages, meanwhile, fell 0.3% in March to $10.31. Real wages have risen 0.5% over the past 12 months. So, we’re not seeing wage-push inflation.

The big difference has been housing; shelter costs account for a full third of the basket of goods and services tracked in the consumer price index. In the past year, consumer prices excluding shelter have risen just 1%, an indication that inflation pressures are subdued outside of housing.

The old rule of thumb was that rents and utilities combined should not take up more than 30% of household income. A new study by Zillow finds 90 cities where the median rent, not including utilities, was more than 30 percent of the median gross income. A study by Harvard finds that nationally, half of all renters are now spending more than 30% of their income on housing, up from 38% of renters in 2000. Part of the reason for the squeeze on renters is simple demand; between 2007 and 2013 the United States added, on net, about 6.2 million tenants, compared with 208,000 homeowners.

For many middle and lower income people, high rents choke spending on other goods and services, impeding the economic recovery. Low-income families that spend more than half their income on housing spend about a third less on food, 50% less on clothing, and 80% less on medical care compared with low-income families with affordable rents.

Federal Reserve Chairwoman Janet Yellen is scheduled to go to the lion’s den tomorrow, making a speech before the Economic Club in New York. Today, Yellen took the show on the road, speaking to a banking conference in Atlanta, she said current rules on how much capital banks must hold to protect against losses don't address all threats. She said the Fed's staff is considering what further measures might be needed, and such measures would likely apply to only the largest and most complex banks. Yellen said the Fed would review the likely effects of imposing stricter rules on banks. That probably plays better in Atlanta than Manhattan.

At some point Yellen must press the case of the Fed as regulator and in control of the banks rather than vice versa. Now, any threat or hint of threat at tighter control is only likely to result in the big banks moving risky behavior into less regulated areas of the financial system. These areas are often called the shadow banking system.

One area of concern for Yellen and her Fed colleagues is the short-term debt markets. So, Yellen would like to see the banks hold more capital; the idea being that it would make them less susceptible to a run. Now, when you hear that the Fed Chair is concerned about a bank run, this is not the old fashioned bank run, with customers lined up at the door of Bedford Savings and Loan and Jimmy Stewart trying to persuade his neighbors that their long-term loans will provide sufficient liquidity to short-term needs.

The problem goes to an area of regulation overlooked, or perhaps neglected by Congress and the various regulators; specifically derivatives; and after the collapse in 2008 what the regulators did was to concentrate the risk of the derivatives among four major Wall Street banks; the big banks just got bigger.

If you’ve ever stood in a teller’s line at the bank, you may have noticed the FDIC sticker, which reads, “Backed by the full faith and credit of the United States Government.” Effectively, that means, if the assessments the FDIC charges the banks to meet the needs of the Deposit Insurance Fund run short, the taxpayer must prop up the fund to make insured depositors whole. On top of that promise, the National Depositor Preference statute came into being in the US in 1993, making all deposit liabilities at insured depository banks preferred over the claims of other creditors.

The serious wrinkle in the plan is that if one of the four largest banks in terms of derivative exposure was put into receivership by the FDIC, its derivative counterparties have the legal right to assert a super-priority claim on the liquid assets of the bank, jumping in front of depositors. Typically, the counterparties start grabbing their collateral before the public is even aware of the problem.

The Deposit Insurance Fund probably has about $40 billion in assets. With the Dodd-Frank prohibition against further taxpayer bailouts of banks, where would the FDIC turn to stem a run on one of the largest banks?

Under the Federal Deposit Insurance Act, the FDIC, acting as a conservator or receiver for an insured depository institution, has the right to “disaffirm or repudiate any contract or lease.” But here again, Wall Street has the FDIC between a rock and a hard place. Let’s say there was a reenactment of 2008 and Citigroup was sliding toward insolvency. If the FDIC repudiated Citigroup’s derivative contracts, it would set off a panic and contagion at the other three largest banks holding trillions in derivatives, creating an even larger financial tab for the Deposit Insurance Fund to meet. Banks taking deposits of public funds are required to pledge collateral against any funds exceeding the deposit insurance limit of $250,000. But derivative claims are also secured with collateral, and they have super-priority over all other claimants, including other secured creditors. The money is gone before you get to the teller’s window.

But before you lose any sleep over the prospects of another, potentially far worse global financial meltdown, take solace that the economy is recovering. There are a few more jobs, and consumers are spending, and the housing market is improving, and the Fed has been pumping money into the economy to foster this growth of credit. Right?

Well, one of the lessons we’ve learned in the recovery is that there is a difference between credit growth and economic growth. And absent real and sustainable economic growth a gap eventually forms as credit growth expands. The more one spends on a place of shelter the less one has to spend on other things, and overall demand is reduced. Bank lending finances the purchase of existing assets, particularly with reference to real estate. Such existing asset finance does not directly stimulate investment or consumption, but it drives up asset prices, and that leads lenders and borrowers to believe that even more credit is both safe and desirable. The expansion is like a rubber band that can only stretch so far.

So, it seems the greatest danger to the current economy are the very mechanisms that are still used to “fix” the last financial crisis: money-printing and asset-purchases by major central banks around the world that unleashed a global flood of liquidity for over five years. Most of this massively huge pile of cash has landed in the laps of banks, institutional investors, hedge funds, private equity firms, and other speculators has not been used to boost lending to the private, and thus has not contributed to the recovery of the real economy. Instead, it has been poured into financial assets and has artificially goosed their valuations.

This money sloshing through the system and the persistence of zero-interest-rate policies have driven desperate investors ever further out into “all risky asset classes,” including emerging assets, junk-rated corporate credit, Eurozone peripheral debt, and equities. That buying pressure has inflated their valuations even further. And in the emerging markets, it led to an appreciation of exchange rates.

And when the rubber band breaks, there will be a derivatives bet on it. When the derivatives default, the counterparties, operating in an unregulated shadow banking world of their own design, do not have sufficient capital to pay off the derivatives bet, and so the first thing they’ll do is raid the bank vaults, and when that dries up, the short-term credit markets freeze, because none of the counterparties have faith that the other party has any more in capital reserves than they have.

Tuesday, March 18, 2014 - Food and Oil

Food and Oil

by Sinclair Noe

DOW + 88 = 16,336
SPX + 13 = 1872
NAS + 53 = 4333
10 YR YLD - .02 = 2.68%
OIL + 1.62 = 99.70
GOLD – 12.00 = 1356.50
SILV - .38 = 20.92

Let’s start with some economic news. The National Association of Home Builders housing market index increased to 47 in March, up from 46 in February. A reading below 50 means more builders view conditions as poor rather than good. Fewer homes are being started in early 2014 than at the end of 2013. Housing starts came in just slightly below economists’ expectations of 910,000 at 907,000.

Separately, a quarterly survey by the Business Roundtable found US chief executive officers somewhat more positive about the economy, including plans for hiring and capital spending over the next six months; they expect gross domestic product to advance 2.4% this year. The forecast is a slight upgrade from an expectation of 2.2% in the previous survey but still less than robust.

The Consumer Price Index, or CPI, increased a seasonally adjusted 0.1% in February, matching the increase in January. According to the Labor Department report, the increase was mainly due to higher prices for food. Energy prices decreased 0.5%. Over the last 12 months, the CPI is up 1.1%. Costs for meats, poultry, fish, dairy and eggs drove the gains. Most notably, beef and veal prices surged.

Prices for beef saw their biggest monthly change in February since November 2003; that was when fears of mad-cow disease abroad led to a spike of export demand for US beef. When the disease was later confirmed in domestic cattle, prices shot down.

So, with food, and specifically meat prices moving higher, the next logical step is that dairy prices are moving higher; up 0.7% from January to February. The price that consumers paid for a gallon of milk was more than $3.56 in February, up more than 10 cents since September. The good news is that the full impact of higher prices hasn’t hit your wallet, yet. For example, the price of a block of cheese on the wholesale market is up 35%, but this price hike hasn’t been passed on to shoppers. The bad news is that those higher wholesale food prices will slowly but surely result in higher retail prices.

Federal forecasters estimate retail food prices will rise as much as 3.5% this year, the biggest annual increase in three years. The reason is simple - drought. We’ve tried to warn you this was coming and it is. California and Texas have seen tight cattle supplies after years of drought. Prices also are higher for fruits, vegetables, sugar and beverages.

In futures markets, hogs are up 42% on disease concerns and cocoa has climbed 12% on rising demand, particularly from emerging markets; coffee prices have soared so far this year more than 70% because of a drought in Brazil.

The price increases pose a challenge for food makers, restaurants, and retailers, which must decide how much of the costs they can pass along. During previous inflationary periods, food makers switched to less-expensive ingredients or reduced package sizes to maintain their profit margins. Retailers and restaurants usually raise prices as a last resort.

In 2008, a spike in food prices caused riots from Haiti to sub-Saharan Africa and South Asia. In 2011, rising food prices were a factor behind the Arab Spring protests in North Africa and the Middle East that ultimately toppled governments in Tunisia and Egypt. We probably are not looking at severe shortages this year, but a lot depends on the weather. If conditions get worse; if the drought gets worse; if the corn and soybean crops in the Midwest get hit by inclement weather; if they do, then we could see significant food price increases.

California farmers say a number of products could be affected later this year, including broccoli, sweet corn and melons from growing regions in Fresno to Huron, where farmers will likely cut acreage due to water shortages. Spring and fall lettuce production in the San Joaquin Valley also could drop by 25% to 30% this year, although growers could try to make up some of that by extending the planting season in the desert and in the Salinas Valley.

Supplies of other items may be supplemented from other growing regions, but at a higher cost. For example, buyers may have to rely more heavily on Florida and Mexico for corn, and there may be more melons coming from Mexico and even offshore. California supplies nearly 90% of the nation's strawberries; growers typically plant a second crop in the summer for fall production; if we don’t see more rain, we won’t see a second planting. It’s not like somebody can step in and fill that void.

For the moment, fair weather accompanying the drought has caused vegetable crops to come to market ahead of schedule, creating an overlap from the deserts and the San Joaquin Valley, creating a temporary oversupply of some veggies. Enjoy it while you can, better yet, can it while you enjoy it.

Stocks are rallying in the wake of the latest developments in the Ukraine region. Gains were broad, with all 10 primary sectors of the Standard & Poor’s 500-stock index higher. Groups tied to the pace of economic growth, including materials, were among the day’s biggest advancers.  After five days of nervous anticipation that held stocks lower last week, stocks so far this week have gone straight up, even with Russian troops massed along the eastern border of Ukraine. In an address to the Russian Parliament, Putin said Russia did not want Ukraine to be divided further, and that he did not want to seize more of the country.

According to Reuters, Crimea may nationalize oil and gas assets within its borders belonging to Ukraine, and sell them off to Russia. The ongoing political standoff in Crimea has already halted Ukraine’s oil and gas ambitions. Ukraine came close to inking a deal with a consortium of international oil companies that would have led to an initial $735 million investment to drill two offshore wells. The consortium led by ExxonMobil, with stakes held by Shell, Romania’s OMV Petrom, and Ukraine’s Nadra Ukrainy, had been particularly interested in a nat gas field in the Black Sea, which holds an estimated 200 to 250 billion cubic meters of natural gas.

If it can get the field up and running, Exxon hopes to eventually produce 5 billion cubic meters per year. Exxon’s consortium outbid Russian oil company Lukoil for the rights to the block. Exxon’s plans for Black Sea nat gas may not have a future if Russia simply takes Ukraine’s assets. The speaker of Crimea’s parliament said that its oilfields should be under the care of Moscow. After Sunday’s referendum, those reserves appear to have shifted to Russian control.

Exxon likely doesn’t see much upside in getting into a tiff with Russia over the Black Sea, especially since it hadn’t even agreed on a production sharing agreement with Kiev yet. But Exxon has billions of dollars of investments in the Russia Arctic in a co-venture with Rosneft, its largest non-US project. If the situation escalates, Rosneft might possibly be targeted with sanctions.

It’s not easy diagnosing the insanity being spouted by the media regarding Russia’s invasion of Crimea, and I don’t claim to have the answers, but it appears to be closely tied to oil interests. It certainly looks like Russia will take Crimea, won’t pay a big price for it, and there’s not a thing anyone can do about it. And the best explanation is oil. Russia is now the world’s #1 oil exporting nation, topping Saudi Arabia by more than a million barrels a day. Russia has an estimated 80 billion barrels in reserves and everybody wants some.

Wall Street has figured out that they can’t allow jingoism to affect their bets. Analysts from Goldman Sachs Group, Bank of America, and Morgan Stanley have said Europe probably won’t back sanctions that limit flows of Russia’s oil and gas. European members of the Paris-based International Energy Agency imported 32% of their raw crude oil, fuels and gas-based chemical feedstocks from Russia in 2012.

Even if Angela Merkel isn’t bluffing when she says Germany is willing to suffer in the cold and dark to punish Russia, she’d have a hard time getting the less disciplined countries of the EU to participate in her stoic resistance. And even if Merkel and the EU can herd cats and present a unified front, Russia will simply sell oil out the back door. Yes, Russia now has a back door. Last year, Russia completed East Siberian-Pacific Ocean pipeline, and that connects Russian oil to China and East Asia.

This weekend on the CNN, Senator John McCain said, “Russia is a gas station masquerading as a country. It’s kleptocracy, it’s corruption, it’s a nation that is really only dependent upon oil and gas for their economy.” Yea, O.K., so what?  You could say the same thing about Saudi Arabia, that beacon of democracy and a fine American ally.

Let’s keep it simple; you probably drove a car today; the food you eat today was transported by truck; everything in this country runs on oil. It certainly isn’t the best source of energy but it is the dominant source of energy. And for a long time now, we have run our foreign policy on the idea of securing oil to keep the economic engine running. We have sent troops into harm’s way to keep the oil flowing. We have sacrificed untold bounty and blood at the altar.

You might think we would be smart enough to step back and reconsider this strategy. It might make sense to concentrate our energy and our brainpower and our capital toward developing alternatives to the insanity.

I can tell you that very soon you will be hearing about groundbreaking alternatives in energy that have the potential to break this old cycle. Energy stories that sound impossible, but just remember, something is only impossible until it is done.

Thursday, February 20, 2014 - Searching for Inflation

Searching for Inflation
by Sinclair Noe

DOW + 92 = 16,133
SPX + 11 = 1839
NAS + 29 = 4267
10 YR YLD + .02 = 2.75%
OIL + .02 = 102.86
GOLD + 12.10 = 1324.00
SILV + .29 = 21.92

The Conference Board’s Leading Economic Indicators rose 0.3% in January following no change in December. Over the six months through January, the LEI rose 3.1%. The LEI tracks 10 indicators designed to signal business cycle peaks and troughs. In the most recent report, 5 of the 10 indicators were positive, including a drop in jobless claims and a pickup in factory orders; on the negative side, declines in building permits and hours worked. Meanwhile, the Conference Board’s index of coincident indicators, a gauge of current economic activity, rose 0.1 percent for a second month. Overall, the leading indicators point to moderate expansion once the nation gets past inclement weather, with the caveat that consumer demand needs to pick up. No surprises in that report.

The Consumer Price Index rose 0.1% in January after a 0.2% gain in December. The CPI measures prices at the retail level. The core rate, excluding food and energy prices, also rose 0.1%. Over the past 12 months, consumer prices were up 1.5%, and the core CPI was up 1.6%. Energy costs increased 0.6% from a month earlier and were up 2.1% over the past 12 months. Food costs rose 0.1%. Gains in the cost of hotel rooms, medical care and rents were mostly offset by declining costs for new and used cars, clothing and airline fares.

Yesterday, Fed policymakers released the minutes of the January FOMC meeting and we learned they had expressed concern about inflation being too low. Some participants wanted an “explicit indication” in their annual statement on policy goals that prices persistently above or below their 2 percent inflation target would be “equally undesirable.”

Prices are about to move higher, at least for food. It’s pretty simple; the state that produces the most vegetables is going through the worst drought it has ever experienced. Just consider the statistics regarding what percentage of the produce you eat is grown in California: 99% of artichokes, 44% of asparagus, 66% of carrots, 50% of bell peppers, 89% of cauliflower, 94% of broccoli, 95% of celery, 90% of lettuce, 83% of spinach, 33% of tomatoes, 86% of lemons, 90% of avocados, 84% of peaches, 88% of strawberries, and 97% of plums.

If fruits and veggies don’t fill your plate, you’ll want to take note that the US cattle herd is now the smallest it has been in 63 years. The drought in California and also Texas means that there are fewer cows, as ranchers in the West sell off their livestock because grazing land has dried out and buying feed is prohibitively expensive. And you can’t just snap your fingers and have a cow ready for market; it takes a couple of years. The lower supply means higher prices; offsetting the supply is lower demand; nearly 40% of Americans say they eat less beef today than 3 years ago.  Ground beef prices were up 5% for the past year. Chicken prices up more than 18% in the past 3 years, and bacon up 23% in the past 3 years.

If there is any good news on the food front, the US Department of Agriculture today reported that corn, soybeans, and wheat prices should be lower over the next 12 months.

Anyway, no inflation on the horizon in today’s CPI report. And the reason is not just what is happening in the USA. Goods inflation is exposed to global trade. When China was flooding the world with low cost goods in the 1990s and 2000s, it put immense downward pressure on consumer goods prices and held down the overall U.S. inflation rate. Unlike the 1990s and early 2000s, the latest downdraft in goods inflation is likely being driven not so much by an influx of cheap goods produced by low-cost emerging market labor, but by a slowdown overseas driven by over investment in emerging markets during their boom. An acceleration of global growth is probably a necessary condition for headline inflation to accelerate.

That’s just a small part of the inflation picture. The service sector makes up a larger part of the US economy these days. Services inflation is highly exposed to domestic housing and the cost of domestic labor. In other words, rent and wages. The owners’ equivalent rent index had been rising at a steady pace through most of 2012 and 2013, with 12-month percent changes hovering around 2%, but toward the end of 2013, the pace picked up. By January OER was up 2.5% compared to year-ago levels. That’s not a hot pace for housing costs but it bears attention. Meanwhile, wages have been flat for what seems like forever, and that means there is no demand to push prices higher, at least for services. For that matter, we may be setting up a divergence between wages and rents. You can’t push rents higher unless people earn enough wages to pay the rent.

The Federal Reserve Bank of New York has issued a paper on why people are having a hard time finding a job. The old excuse was “structural unemployment.” The new excuse is a decline in “job matching efficiency.”

The White House budget to be released early next month will propose $56 billion in new spending on domestic and defense priorities and drop a proposal that was included in last year's budget as a way to attract Republican support; a plan that would have cut Social Security benefits based on a “chained CPI”. The budget would aim to reduce the emphasis on austerity that has been the preoccupation of American politics for the past four years.

A White House official said President Obama decided to release a budget that fully represents his "vision," rather than to continue to pursue a fiscal agreement, because Republicans have refused to engage in good-faith negotiations over the nation's top priorities.

The new budget is due March 4.

The protests in the Ukraine have escalated into gun battles between police and anti-government forces. The death toll has climbed to 75. Three hours of fierce fighting in Kiev's Independence Square, which was recaptured by the protesters, left the bodies of over 20 civilians strewn on the ground. Nearby, President Viktor Yanukovich was meeting with a EU delegation trying to broker a political settlement. For now, there is no agreement.

Increasingly, we’ve seen big banks involved in commodity markets, and an interesting idea was recently tossed out by Theodore Butler regarding the origins of the 2008 crash. I don’t know if it is true but it’s an interesting story.

You’ll remember that Bear Stearns imploded six years ago; JPMorgan took it over as the doors were closed. It was an unprecedented fall. As Butler said: “The cause was said to be a run on the bank as nervous investors pulled assets from the firm. Bear Stearns was said to be levered by 35 times, meaning it had equity of $11 billion and total assets of $395 billion. This is a very small cushion if something negative suddenly appears… Since Bear had a significant presence in sub-prime mortgages and that market was in distress, it is assumed the fall of the firm was mortgage related. That may be true, but there was no general stress in the stock market through mid-March 2008 reflecting a credit crisis. Was there instead some specific trigger behind the company’s sudden collapse?”

One idea is that Bear Stearns was short the silver market. The exact holdings haven’t been established but the 4 largest short traders in silver was at an extreme level of more than 300 million ounces; triple the long positions, and Bear Stearns was the largest short in COMEX gold and silver contracts.

The day of Bear Stearns demise coincides with historic high points in gold and silver. “Gold prices rose from under $800 in mid-December 2007 to $1,000 in mid-March 2008, a gain of more than $200. Silver prices rose from under $14 in mid-December to $21 when Bear Stearns failed on March 17, 2008. That was a gain of $7. This was the highest price for silver and close to the highest price of gold since 1980. Obviously, a $200 rise in the price of gold and a $7 rise in the price of silver is not good if you are the biggest gold and silver short…. Bear Stearns had to come up with $2.7 billion because gold and silver prices rose sharply in the first quarter of 2008 and the company bet the wrong way. That it couldn’t come up with all the margin money for the losses in gold and silver, is the most visible reason it went under.”

We can’t say with certainty that this is what happened to Bear Stearns, but it is probably more than mere coincidence that JPMorgan ended up acquiring Bear, and really, it makes  sense, and at the very least it’s a great story.

Friday, February 14, 2014 - Cold, Cold, Cold

Cold, Cold, Cold

by Sinclair Noe

DOW + 126 = 16,154
SPX + 8 = 1838
NAS + 3 = 4244
10 YR YLD + .01 = 2.74%
OIL - .05 = 100.30
GOLD + 16.30 = 1320.10
SILV + 1.02 = 21.61

The cold weather back East has left its frozen footprints all over a variety of economic reports from payrolls to new home sales to retail sales. Estimating the extent of the weather effect is a guess at best, and it is possible that consumer spending might have slowed even with more pleasant weather.

The best guesses from economists are that the snow, ice and bitter cold this winter will shave about 0.3 percentage point from economic growth; that works out to about $47 billion in lost productivity and about 76,000 jobs. Other estimates suggest fourth quarter GDP could be revised from 3.2% to as low as 2.2%(so maybe - $15 bln). Fortunately, a revision in GDP does not mean you have to write a refund check; whatever you made or lost in the fourth quarter is unchanged.

Schools closed, traffic non-existent, or massive traffic pile-ups, businesses closed, thousands of flights cancelled, electricity outages, the Great Lakes are 75% frozen over; it’s all a big frozen, expensive mess. The most recent storms, the ones going on right now in the East, could cost $20 to 40 billion.

The Federal Reserve reported this morning that manufacturing output fell 0.8% in January; they blamed the severe weather. At the same time, utility use jumped 4.1% last month, the biggest increase since March 2013. The Fed said the gain reflected “strong heating demand because of the extremely cold weather.” High heating bills mean less money in the purse for other possible purchases.  

The bad weather was blamed for a 0.4% drop in retail sales in January compared with December. The good news is that most people will still buy things, they’re just waiting for the weather to clear, and so sales could pick up in the second quarter. Pent-up demand should lead to a boost in second quarter growth of about 0.23 percentage point, reducing the total economic impact to about 0.3 percentage point.

Industrial production usually bounces back after a period of bad weather, as postponed orders are completed. With the weather having been lousy in December, January, and now February, we might not see a bounce back until March, or even April. But it will happen, eventually. The more lasting weather impact will be from the California drought. Snow and ice melt. Dust doesn’t melt.

Next week’s economic calendar will be slightly compressed; the markets are closed Monday for President’s Day. We’ll get a report on housing starts next Wednesday; expect a drop in the January numbers; some of that is weather related, some is related to higher mortgage rates. Two other economic series will offer guidance on the outlook for housing. Building permits are taken out before actual construction can begin. Economists think permits fell slightly last month after falling 2.6% in December. Builder confidence will be captured in the housing market index, out Tuesday. A reading about 50 means more builders think conditions are good than the number who see conditions as bad. The index has been above 50 for 8 consecutive months.

We’ll also see reports on inflation; the PPI, or Producer Price Index will report on wholesale level prices on Wednesday; the Consumer Price Index, or CPI, will report on retail level prices on Thursday. The Labor Department is changing how they calculate the PPI. The new index will include measures of services and construction. Instead of the old top-line label of “Finished Goods,” the headline PPI will now capture “Final Demand.” I’m not sure what that really means just yet. I’ll have to look into it, but economic indicators are always changing. You wouldn’t use a 1950s road map to plan a cross country drive.

Also next week, the Fed will release minutes of the January 28-29 FOMC meeting. Maybe we’ll learn more about the possible changes in the unemployment threshold of 6.5%.

Also, next week, I predict we will see; and this is not something that’s on any official calendar, but I predict we will see more wealthy people putting their feet in their mouths. It seems to be all the rage lately. This past week we had a couple of fine examples. John Mack, the former CEO of Morgan Stanley gave an interview to Bloomberg TV. In a discussion about executive pay, Mack said we're all being too rough on his fellow too-big-to-fail bank CEOs.

He would love, he said, "to see people stop beating up on Lloyd and Jamie," endearingly referring to Goldman chief Lloyd Blankfein and Chase chief Jamie Dimon by their first names (Mack must be in a bowling league with both men). He added: "I think that would make a lot of sense, and I'm in favor of that."

Mack went on to say that the debate over compensation was healthy, just not always warranted. "As long as shareholders reward performance," he said, "we can argue." But, he added, "The last time I checked, this business is still a business that pays people extremely well."

It's already funny that of all the injustices in the world, this was the one Mack decided to worry about on TV: the criticism of poor Jamie Dimon's 74 percent raise. But more to the point: If we really did live in a world where shareholders rewarded performance, would a CEO who just oversaw a record $20 billion in regulatory penalties even have a job, much less be getting a raise?

Mack had stones enough to be whining about people "beating up" on Jamie Dimon, given the year Chase just had. But to do so and simultaneously scold us that high compensation on Wall Street is just "shareholders rewarding performance," that’s just a bit more than bravado. It’s more like lunacy.

John Mack was the CEO of Morgan Stanley from 2005 to 2009. He was paid well. Morgan Stanley received bailouts. So, it just seems strange when he talks about “shareholders rewarding performance”.

Meanwhile, Tom Perkins is desperately trying to extend his 15 minutes of infamy. Perkins told an audience in San Francisco Thursday that people who pay more money in taxes should get more votes. Perkins said: "The Tom Perkins system is: You don't get to vote unless you pay a dollar of taxes, but what I really think is, it should be like a corporation. You pay a million dollars in taxes, you get a million votes. How's that?"

The audience laughed. But it isn’t so funny. After all, that’s not really how democracy works. Unfortunately, Perkins wasn’t joking around. Perkins is no stranger to outrage, and it seems like he’s starting to kind of like it that way. The Internet freaked out last month after he argued in a letter to the Wall Street Journal that there are parallels between progressive activists’ “war on the American one percent” and Nazi Germany’s persecution of Jews. Even the venture capital firm he co-founded, Kleiner Perkins Caufield & Byers, was quick to distance itself from his controversial comments.

“This is a very dangerous drift in our American thinking,” Perkins wrote in the letter. “Kristallnacht was unthinkable in 1930; is its descendant ‘progressive’ radicalism unthinkable now?” Perkins later apologized for that remark, or at least the specific reference to Kristallnacht. Even with the controversy, Perkins picked up some followers. Rich guys from real estate mogul Sam Zell to billionaire Wilbur Ross piled on, claiming the one percent is getting picked on unfairly.

Not all rich guys have jumped on the Perkins bandwagon; former AT&T Broadband CEO Leo Hindrey says executive pay has gotten so out of hand that it has caused a "structural breakdown of the meritocracy of our nation." You can blame the stagnant economy on a "handful of women and men" who run the country's largest companies. And that's according to a man who used to be one of those people. Hindery pointed out that, even as CEO pay has skyrocketed in recent decades, it has not "trickled down" to workers, who must increasingly borrow money to finance their spending. That dynamic helped set the stage for the most recent recession and helps explain today's sluggish recovery.

Fortune 500 CEOs now make more than 200 times what their average workers make, according to Bloomberg data. That ratio has increased by 1,000 percent since 1950. Hindery says that as CEO pay has exploded, worker pay has stagnated: Workers have not had a real cost-of-living increase since the 1960s. And these CEOs are not exactly earning their exorbitant pay.

Hindery describes says: "It's a fraud. It's born out of cronyism."  That cronyism is demonstrated in a new analysis of executive-pay data showing the compliance of corporate boards in approving CEO pay, regardless of corporate performance. Those directors are themselves well-paid for their vigorous rubber-stamping.

The problem, Hindery said, isn't just that the rich are getting richer. The tragedy, he said, is the rise of the low-wage workforce. Half of the jobs created in the past three years have been low-paying while the wealthiest Americans continue to capture record earnings.  The federal minimum wage, which stands at $7.25, is worth much less today than was in 1968. And all recent efforts to raise it have been stalled by Congress.

It's no wonder most of us are feeling entirely fed up. Two-third of Americans think CEO pay is out of hand.  Hindery would agree. After all, rising income inequality is putting a damper on the economy as a whole. "The only time the U.S. economy and any of the developed economies prosper is when there's a vibrant middle class that grows from the bottom up," he said. "We've trashed that whole principle."

Wednesday, November 20, 2013 - Fed Minutes, Fed Conundrum

Fed Minutes, Fed Conundrum

by Sinclair Noe

DOW – 66 = 15,900
SPX – 6 = 1781
NAS – 10 = 3921
10 YR YLD + .09 = 2.79%
OIL - .01 = 93.33
GOLD – 32.40 = 1243.80
SILV - .49 = 19.95

The Federal Open Market Committee, Federal Reserve policy makers, met October 29-30, and to no one's surprise they did not change monetary policy. Today, minutes of that meeting were released. The policy makers “generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months.”

They think the economy is improving, despite the government shutdown and ongoing political dysfunction, the economy is getting better and the FOMC is considering how and when they can exit Quantitative Easing; they would like to scale back $85 billion per month in purchases of Treasuries and mortgage backed securities without triggering a rise in interest rates that could slow economic growth and wipe out gains in the labor market. That is not to say they are ready to raise their Fed Funds target for interest rates. That target has been right at zero and will likely remain at zero for at least a year or more.

They want to get out of the bond buying business without the market noticing, and independently pushing interest rates higher. It'll be a fine trick if they can pull it off.

In a speech to the National Economists Club, Ben Bernanke said: "I agree with the sentiment, expressed by my colleague Janet Yellen at her testimony last week, that the surest path to a more normal approach to monetary policy is to do all we can today to promote a more robust recovery," and he says, "The FOMC remains committed to maintaining highly accommodative policies for as long as they are needed."

Exactly how long the accommodative policies will remain in place is the $85 billion dollar question; the market is now guesstimating the Fed won't taper till March or maybe January. The idea is that they will wait for signs that the economy is strong enough to finally reach escape velocity. We're not there yet.

The National Association of Realtors reported that home re-sales fell 3.2 percent last month from September to a seasonally adjusted annual pace of 5.12 million. That's down from a 5.29 million pace in September and the slowest since June. A healthy pace is around 5.5 million. Sales of single family homes declined 4.1 percent, while condominium sales rose 3.3 percent. The median sales price of an existing home was $199,500 in October, up 12.8 percent from a year earlier and the 11th straight month of double-digit annual increases.

The 16-day partial government shutdown pinched home sales last month by creating uncertainty about the economy and slowing loan approvals: 13 percent of real-estate agents reported that transactions had been delayed. Now, that might just mean that sales were postponed, and they'll pick up in the next report, or it might signal a plain old slowdown.

The Fed's bond purchases have kept long-term interest rates low. Mortgage rates are still low by historical standards, but interest rates began to rise in late May on speculation the Fed would slow its bond purchase program. Add to that the idea that many younger potential home buyers, or first time buyers saw the carnage of 2006 and 2007 and they just aren't interested. In this past month's report, first time buyers accounted for 28% of sales, down from around 40% in healthier housing markets.

Cash purchases made up 31 percent of October's sales. This might indicate that the Fed's easy monetary policy has only been easy between the Fed and the banks. So, this gets right to the Fed policy makers' conundrum; how can they withdraw easy money from the markets without creating a slowdown; if the Fed stops buying mortgage backed securities, that would almost certainly make it even tougher to get a mortgage and the housing market would surely suffer.

One idea is to counter any taper of asset purchases by reducing the interest rate on funds that banks keep on deposit with the Fed. That's right, the Fed not only buys mortgage backed securities from the banks, but then they pay the banks to keep funds on deposit with the Fed, essentially discouraging the banks from taking the money and lending it out in the community and into the economy. This is something that might be a small step, worth considering, but the reality is that any Fed taper from QE will be met with a taper tantrum, and for now the Fed doesn't want to rile the markets.

This is not to suggest the economy is horrible; the Fed's assessment of a growing economy was reinforced with a report this morning that consumer spending rose in October, despite the shutdown, and suggesting upside momentum heading into the fourth quarter. Retail sales excluding automobiles, gasoline and building materials increased 0.5 % last month after advancing 0.3% in September. Overall retail sales rose 0.4% after being flat in September. Core retail sales last month were bolstered by gains in receipts at clothing, furniture, electronics and sporting goods shops, among others. Sales at electronics and appliance stores rose by the most since April.

Meanwhile, the Labor Department reported that inflation is a bit less than optimal; the Consumer Price index dipped 0.1% last month as gas prices dropped, after rising 0.2% in September; this was the first decline in 6 months. In the 12 months through October, the CPI increased 1.0%, the smallest gain since October 2009.

Stripping out the volatile energy and food components, the core CPI edged up 0.1%, rising by the same margin for a third consecutive month. Over the past 12 months, the core CPI increased 1.7%, matching the previous month's rise. A reminder that the Fed targets inflation at 2%; that's the level they want; less than 2% indicates a greater concern that disinflation could lead to deflationary pressures. All the more reason for the Fed to continue with its easy money policies.

The other target, or guidance, offered by the Fed is that they will stick with easy money until the unemployment rate hits a target of 6.5%; in last night's speech, Fed Chair Ben Bernanke, indicated that it is still a target but it doesn't mean that if the target is hit, it will automatically change anything. Bernake said:

“In the judgment of the Committee, the unemployment rate--which, despite some drawbacks in this regard, is probably the best single summary indicator of the state of the labor market--is sufficient for defining the threshold given by the guidance. However, after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation. In particular, even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.”

Bernanke went on to say:

“When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently for the Committee to rely more heavily on its rate policies, the associated forward guidance, and its substantial continued holdings of securities to maintain progress toward maximum employment and to achieve price stability. In particular, the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.”

The Dow just skirted 16K and virtually the entire run-up of the stock market is based on one thing, and one thing only, the Fed pumping money into the markets.  That is it, that is all.  Since the market bottom the market has more than doubled, but jobs aren’t even close to recovering as a percentage of the population, Europe is still in crisis, and oil prices are still ludicrously high. You cannot have profits higher than actual productivity increases plus inflation plus population increase.  Anything more than that is not profit, it is fraud, underinvestment in real capital or it is diverting future profits to the present.

 The problems the economy has cannot be fixed by giving more money to banks and rich people and attempting to turn the housing market into a cash cow again. The economy requires targeted spending, to get off oil, to break up the big banks and other oligopolies, to open up the economy to actual competition, and to increase the pricing power of labor and reduce the pricing power of employers while making sure they don't run up against supply bottlenecks.  It does not require giving money to people who will simply use that money for more leveraged financial plays or to bury bad assets on balance sheets at mark to make believe.

To the extent a market works it must be regulated to be competitive, and assets must not be allowed to pile up in a few hands.  Financial profits cannot be allowed to be higher than non-financial profits, and the labor market must be tight, so that people are free to move away from jobs they hate (if your employees hate their jobs they should either be very well paid because the job is absolutely necessary, or it shouldn’t exist at all.) And the employees who are actually working need enough to actually live on. Did you hear about the Wal-Mart in Ohio that held a Thanksgiving food drive – for their own employees?

Whatever the Fed is doing or thinking about doing, the first step should be acknowledgment that the trickle down wealth effect from the housing market and the stock market is limited, very limited. As for the stock market, it is in fantasy land, entirely a creature of the Federal Reserve, almost completely divorced from the actual economy. Of course, the stock market can remain irrational longer than you can remain solvent.