Tuesday, August 26, 2014 - A Few Old Sayings

A Few Old Sayings
by Sinclair Noe

DOW + 29 = 17,106
SPX + 2 = 2000.02 (record)
NAS + 13 = 4570
10 YR YLD + .01 = 2.40%
OIL + .55 = 93.90
GOLD - .70 = 1280.90
SILV - .08 = 19.38

The S&P 500 notched its 30th record of the year and closed above 2000 for the first time ever. The Dow also rose but fell short of its record closing high after setting an all-time intraday high earlier in the session.

There are a few old sayings about the market that seem to fit. The first is, “the trend is you friend”; we have seen a few minor pullbacks since the bottom in 2009, but since the start of 2013 there has been a strong and steady uptrend. “A trend in place is more likely to continue than it is to reverse, until it reverses” and today marked a continuation of the trend, not a reversal.

Why is the market going up? Who knows? There are plenty of problems around the world. The US economy looks sluggish, but “stocks climb a wall of worry to march into bullish territory”; that’s a phrase that’s been thrown around for more than 60 years, but was made popular by Joe Granville in the 1980s.  Another financial proverb claims “Worry is interest paid on trouble before it falls due.” And the opposite of the “wall of worry” is “Bear markets slide down a slope of hope.”

And then there is the very, very old saying “buy low, sell high.” Any idiot off the street could repeat this phrase to you as if they had the secret recipe for investing success. Honestly, it’s good advice, because the overwhelming top indicator for investors and traders is price. You can’t spend volume or moving averages or stochastics or relative strength, and eventually, inevitably the trend will change.

If you want to look at a chart of an uptrend, just look at the S&P 500. If you want to see a chart of a downtrend look at the past four months’ worth of charts for wheat and corn and soybeans. As we near the end of summer, farmers are preparing for record crops in the Midwest. Wheat crops are forecast at a record 273 million bushels, up from 235 million last year; this year’s  soybean harvest is also expected to be a record, and corn will be a near record. But there is a problem. In many areas, such as the Dakotas, where agriculture has been a mainstay, the energy boom has taken over, and most of that oil travels by rail, and that means grain shipments have been held up, right as we head to harvest.

Reports the railroads filed with the federal government show that for the week that ended Aug. 22, the Burlington Northern Santa Fe Railway, North Dakota’s largest railroad, had a backlog of 1,336 rail cars waiting to ship grain and other products. Another railroad, Canadian Pacific, had a backlog of nearly 1,000 cars. Agriculture Department officials estimate that Canadian Pacific would not be able to fulfill nearly 30,000 requests from farmers and others for rail cars before October.

We have a couple of reports on home prices. The Federal Housing Finance Agency’s home price index shows house prices rose just 0.8% in the second quarter of 2014. This is the twelfth consecutive quarterly price increase for the FHFA index, but it also shows a slowdown. The FHFA index is based on home sales prices from conforming mortgages through Fannie Mae and Freddie Mac. Home prices are up 5.2% from the second quarter a year ago. Arizona ranked 5^th in annual appreciation.

In another indicator of a housing slowdown, the S&P/Case-Shiller National Home Price Index gained just 6.2% in the 12 months ending June 2014, while the 10-City and 20-City Composites gained 8.1%. That’s a dramatic shift from the double-digit, year-over-year price increases that had become the norm in the second half of 2013 and the first part of this year. All three indices saw their rates slow significantly from last month. To be clear, home prices are not dropping, simply rising at a slower rate.

The 20-city composite rose 1% in June. Phoenix posted a 0.6% gain for June, and a 6.9% gain from June of last year. Nationally, prices are still 17% below their peak. In Phoenix, the peak was measured to June 2006; from that point prices dropped 56%, and although prices have recovered, we are still 35% below peak prices.  

The takeaway from the housing reports is that price gains are slowing, and home supply has increased with higher prices and more people renting; consumers are slowly losing their ability to finance large purchases as home price appreciation continues to outpace wages. Absent a big increase in wages, you might expect home prices to remain flat or even decrease a bit in coming months.

Orders for durable goods jumped 22.6% in July; that is a record move, but much of the increase is because Boeing saw a jump in signed contracts for the 777X; it will take years before those planes are flying. Along with Boeing, automakers also turned in a strong performance. Demand for cars and small trucks climbed by 10.2%. Orders excluding the transportation sector, however, fell 0.8% with widespread weakness. Orders for primary metals, machinery, computers and defense goods all declined. Another key measurement of business investment, a category known core capital goods, dropped 0.5% in July. Orders for durable goods are volatile, and can jump around from month to month. While business investment has fallen in three of the past four months, it’s increased by an annual pace of 9% so far this year.

The Conference Board’s consumer confidence index jumped to 92.4 in August, the highest level since October 2007, from a revised 90.3 in July. Confidence has now increased for four straight months, and consumers remain quite positive about the short-term outlooks for the economy and labor market, even as the future expectations index declined from 91.9 to 90.9.

It’s official, minus the approval of regulators; Burger King will buy Tim Hortons for $11.4 billion and move the corporate headquarters to Canada, except they will keep corporate offices in Miami; and even though the deal would make sense without the tax dodging; it is a tax inversion deal. Warren Buffett’s Berkshire Hathaway is providing $3 billion in financing for the acquisition. Berkshire will earn 9% annual interest by taking a preferred equity stake.

The Department of Veterans Affairs says investigators have found no conclusive proof that delays in care caused any deaths at a VA hospital in Phoenix. That may be technically accurate, or not, but a troubled health care system in which veterans waited months for appointments while employees falsified records to cover up the delays, certainly did not serve those veterans with the care they deserved. The inspector general's final report has not yet been issued.

The VA is preparing a whole host of fixes for its healthcare system. Congress approved $17 billion to expand health care resources at the VA. Across the entire VA system, $400 million must be spent on staff overtime or private doctors to ensure veterans are treated quickly. As of Aug. 6, the VA had allocated $128 million in private care costs for 83,000 veterans; 8,248 VA schedulers across the country have been trained in appropriate ways of scheduling patients, including 764 Phoenix workers; an internal investigation board will be created to identify managers at the Phoenix hospital responsible for wrongdoing and what disciplinary actions should be taken; nearly $17 million has been spent in Phoenix to send veterans to private doctors for speedier care.

Also, mental health resources have been expanded in Phoenix by filling all but three of 13 psychiatric vacancies and six of seven psychologist positions and adding four social workers. The hospital's primary care staff has been expanded by 53 doctors, nurses and other caregivers. Twenty-seven temporary examination rooms have been opened, and two new outpatient clinics are planned with an additional 30,000 square feet of space.

President Obama went to Charlotte North Carolina today to address the national convention of the American Legion; and he announced steps to expand veterans’ access to mental health care and an initiative with financial companies to lower home loan costs for military families.

The US has begun surveillance flights over Syria to gather intelligence that might lead to airstrikes against ISIS militants in Syria. Military action inside Syria has not been approved yet. Pentagon officials have been drafting potential options for the president, including airstrikes.

Here’s a thought, before we send any more troops back into Iraq, or approve any airstrikes in Syria, we should make sure the VA has figured out a way to provide the best medical care to veterans. No excuses.

Ukraine has captured 10 Russian soldiers, though it did not state how they were caught. Weapons and fighters are able to cross the porous border freely, but until now there has never been confirmation that serving Russian soldiers were active inside Ukraine, despite repeated claims from Kiev. Russian President Vladimir Putin and Ukrainian President Petro Poroshenko held one-one-one talks today in Minsk, aimed at defusing the situation, which is positive, but the Russian POWs undoubtedly makes talks a bit awkward.

After 50 days of fighting, Egypt has brokered a ceasefire between Gaza and Israel. Palestinian and Egyptian officials said the deal called for an indefinite halt to hostilities, the immediate opening of Gaza's blockaded crossings with Israel and Egypt and a widening of the territory's fishing zone in the Mediterranean.

The United Nations has produced a new study on climate change; it includes a summarization of hundreds of scientific papers and is considered to present the best scientific and economic analysis on global warming, and is designed to provide policymakers with a scientific foundation for dealing with global warming. Bloomberg says it has received a leaked copy of the report which highlights the dangers from rising temperatures including damage to crop production, rising sea levels, melting glaciers and more pervasive heatwaves. The report mentions the word “risk” more than 350 times; “vulnerable” or “vulnerability” are written 61 times; and “irreversible” comes up 48 times.

The study, called the “Synthesis Report”, says global warming already is impacting “all continents and across the oceans,” and further pollution from heat-trapping gases will raise the likelihood of “severe, pervasive and irreversible impacts for people and ecosystems”. And the longer we wait to address the problems the more it will cost.

Monday, April 28, 2014 - But Our Bankers Aren’t Oligarchs

But Our Bankers Aren’t Oligarchs
by Sinclair Noe

DOW + 87 = 16448
SPX + 6 = 1869
NAS – 1 = 4074
10 YR YLD + .01 = 2.67%
OIL - .03 = 100.57
GOLD – 7.50 = 1297.30
SILV - .16 = 19.67

This should be an interesting week. On Wednesday, the Federal Reserve’s Federal Open Market Committee, the FOMC, will meet to determine monetary policy; a statement will be issued Wednesday. On Friday, we’ll have the monthly jobs report.

The market is jittery. The Dow fell 140 points on Friday, rose 139 on Monday morning, and gave it all back Monday afternoon, then recovered at little at the close. Investors are worried about the Ukraine crisis, the Fed’s tapering, peak earnings, high PEs, low GDP, inflation, deflation, and of course, their own shadows.

So far, the stock market has merely been sluggish to start the year; no big crash, no big gains. Last week, the big 3 indices were down a little, while the indices are in negative territory year to date, that could change with one good week of trading. After doubling or tripling since 2009, stocks aren’t cheap any more. Companies, meanwhile, are finding it harder to keep raising earnings in a period of soft economic growth. This makes investors more cautious, but because speculative excess still hasn’t reached the extremes of past bubbles, and because the Federal Reserve is determined to sustain the recovery, there is less fear of a big decline. The Fed has started slowly rolling back its quantitative easing, gradually ending the unprecedented bond-buying program that dumped more than $1 trillion into financial markets. Investors are trying to figure out how well corporate earnings will grow with less Fed aid.

A big complication is that many companies are reaching the limit of their ability to boost profits by cutting costs. More companies now need to focus on building revenues, which means higher costs for investment, hiring and wages. The days may be ending when Wall Street will reward companies for holding down wages and doing little investing; the focus is shifting to sustainable earnings.

Margin debt, a measure of the use of borrowed money to invest, is at a record high in dollar terms. But as a percentage of market value, it is 2.6%, still between the 2008 low of 2.3% and the 2007 high of 2.8%. Still, the markets haven’t yet shown enough excess to warrant a crash, and so people are still buying the dips; probably because they haven’t yet figured out where else they can go.

Money managers are turning on stocks that have delivered the best returns during the bull market: small caps. Large speculators such as hedge funds are betting $2.8 billion this month that the Russell 2000 Index will fall. That’s the most since 2012 and the highest versus average levels since 2004.

Today, the National Association of Realtors reported its Pending Home sales index increased 3.4% to 97.4. The index is based on contracts signed last month to purchase previously owned homes. These contracts usually become sales after a month or two, and March's rise suggested home resales could rebound in the months ahead. Existing home sales had fallen to their lowest levels in more than 18 months, with March sales down 7.9%; but today’s report suggests the possible end to the soft patch in sales.

Along with the economic news this week, we’re keeping an eye on geopolitical events, as Ukraine is crumbling under a constant barrage. Russian backed militants extended their hold on eastern Ukraine by seizing more public buildings in Donetsk region, breaking up rallies by supporters of the government in Kiev. The mayor of the second largest city in Ukraine was shot today. Russian gunmen are holding about 40 hostages, including 6 military observers from the Organization for Security and Cooperation in Europe, their interpreter and 4 Ukrainian army officers who were accompanying them.

Today, President Obama announce more sanctions against Russian oligarchs; imposing travel bans and asset freezes for 7 individuals and 17 companies. So far, most of the sanctions have been targeted toward energy companies or energy company executives and banks and bankers. Stop and think about that for a moment. Russian bankers are considered oligarchs fomenting geopolitical unrest and supporting the corrupt regime of Putin. And in the US we’re supposed to believe that our bankers are the beneficent titans of industry and pillars of commerce.

Last week we reported that the Department of Justice was in the early stages of negotiating a settlement with Bank of America. The government is reportedly seeking $13 billion in penalties, on top of $9.5 billion that BofA agreed last month to pay to the Federal Housing Finance Agency. The problem is that BofA sold mortgage backed bonds stuffed with shoddy mortgages that did not meet basic standards.

A big part of the settlement would go to the FHFA as compensation for selling the defective bonds to Fannie Mae and Freddie Mac. Another part of the settlement takes the form of consumer relief; requiring the bank to adjust mortgages to make them more affordable for borrowers; the problem is the bank probably doesn’t own the mortgages, so the bank wouldn’t really have that expense.

Also, digging deeper into the previously announced $9.5 billion settlement with FHFA, about $3.2 billion involved BofA buying back mortgage bonds, but they bought those securities for 20 cents on the dollar, and they still have value, probably a lot more than what BofA paid. When is a penalty a profit? When a big bank settles with the bank regulators.

The Supreme Court will hear a case that has some intriguing implications for mortgages; it involves the Truth in Lending Act. The case is Jesinoski v. Countrywide, the subsidiary of Bank of America. The Jesinoskis refinanced a mortgage in 2007; when their loan was closed, Countrywide did not provide all of the disclosures required by the Truth in Lending Act (TILA). Their suit states that they were not provided with two copies of a “Notice of Right to Cancel” and two copies of a “Truth in Lending Disclosure Statement.”

Under the Truth in Lending Act, a borrower has the right to rescind the loan by midnight of the third business day following the closing of the loan, or until the lender has provided the borrower with all the legally required loan documents. The Act also creates a three-year time limit to exercise the right to rescind the loan, even if the required disclosures have not been delivered to the borrower. Three years to the day, the Jesinoskis sent a letter to Bank of America rescinding the loan. BofA said the letter meant nothing. The Jesinoskis sued to enforce their rescission request, saying that their letter should have been sufficient.

The case has made its way through appellate courts, which denied their appeal, but other District Courts have been split on whether a letter is an allowable form of notification in instances such as the Jesinoskis’ case. The Supreme Court merely said they would hear the case; any actual decision is a long way off.

A more pressing matter for Bank of America is capital levels required by the Federal Reserve. You may remember the Fed recently conducted stress tests for big banks and it turns out that, following further review, Bank of America flunked the test; seems they miscounted  the treatment of structured notes assumed in its acquisition of Merrill Lynch in 2009. The bank notified the Fed of its mistake and the Fed is now “requiring the Bank of America Corporation to resubmit its capital plan and to suspend planned increases in capital distributions.” Or in plain English, no stock buybacks, and no dividend increases.

Particularly concerning for regulators and shareholders, the bank had been making the accounting error for more than four years, potentially inflating its true level of capital during that period. This basically goes to the practice of booking gains or losses based on changes in the value of a firm’s own debt, which led to BofA’s regulatory capital problem. Essentially, accounting rules mean that, in some cases, the worse off a firm is from a credit standpoint, the more it may gain in terms of earnings. That is because the value of its own debt would be falling during a stressed time. This would lead to a smaller liability. And a decline in a liability results in a gain to income.

This didn’t used to be much of an issue since the value of bank debt didn’t change all that much. Then came the financial crisis. And as bank debt remained volatile in its wake, firms were left with big counterintuitive gains or losses in their income based on fluctuations in the value of some of their liabilities. Banks started to exclude the impact of such changes from their results. Investors couldn’t make heads nor tails of the mess, and so they ignored it, at least until it affects buybacks and dividends. The important part to remember is that BofA flunked its stress test, and nearly 6 years after the financial meltdown they still have toxic junk on their books and they haven’t figured out how to count it.

Meanwhile, regulators in Britain announced they’ve begun criminal proceedings against 3 former Barclays employees suspected of manipulating the Libor. The new criminal proceedings are the latest development in a broad investigation into the manipulation of major interest rates by some of the largest global banks, including Barclays, UBS, Royal Bank of Scotland, and others. Twelve people in total are now facing criminal charges in Britain. All 12 are mid-level traders. Barclays, RBS, UBS, the Dutch lender Rabobank and ICAP have combined to pay more than $3 billion in fines to British and American authorities in the investigation of manipulation of various Libor-linked interest rates, but so far regulators have not been able to figure out whether higher level execs at these institutions knew anything about manipulation in a multi-trillion dollar market; which seems remarkably unlikely.

Thursday, January 23, 2014 - They Must Think We’re All Morons

They Must Think We’re All Morons

by Sinclair Noe

DOW – 175 = 16,197
SPX – 16 = 1828
NAS – 24 = 4218
10 YR YLD - .09 = 2.77%
OIL + .47 = 97.20
GOLD + 26.30 = 1264.10
SILV + .22 = 20.11

We have economic reports to cover, some interesting news out of China; lots to talk about today. But what is the top story on most major news outlets? Justin Beiber was arrested in Miami for DUI and drag racing his Lamborghini from strip club to strip club. Seriously. We could spend the whole hour talking about it…, if we were brain dead. That is the biggest story in the country, because they must think we’re all morons.

This has been a very quiet week for economic data but today we got a few economic reports.

Initial jobless claims held steady last week at a nearly 2-month low as 326,000 people filed for first time unemployment benefits.

The Markit Flash US Manufacturing Purchasing Managers' Index (PMI) fell to 53.7 for January, its slowest growth in three months. A reading of 53.7 still indicates growth in manufacturing, and the researchers say we shouldn’t read too much into the report because cold weather has to play into the results. According to the economist from Markit: "After allowing for companies that saw production and sales disrupted by the cold weather, the rate of growth of output and orders remained as strong, if not stronger, than seen late last year.”

In another consequence of the weather, natural gas prices jumped more than 5% during yesterday's session, pushing prices to levels not seen since late 2011. This morning, it's close to cracking $5. The government cut its gas inventory forecasts. Also, gas delivery to consumers in New York and Boston set records yesterday as the most recent snowstorm buried the Northeast. Nat gas is a common way to heat homes, especially in the Northeast, and we’ve had some serious storms this winter.

If you’re looking for ways to trade the move, there are funds and ETFs; among the best known is UNG, which is not to be confused with a trade on the oil sector in general. There is a tendency to chase anything that moves fast. I don’t know where the price of nat gas will go from here; I do know the storms will pass.

The Federal Housing Finance Agency reported home prices ticked up 0.1% in November, and were up 7.6% from the year-earlier period. The National Association of Realtors reports sales of previously owned homes rose in December for the first time in 5 months, and capping the best year since 2006. A total of 5.09 million U.S. previously owned houses were sold in 2013 compared with 4.66 million the prior year.

The index of US leading indicators rose in December. The Conference Board’s gauge of the outlook for the next three to six months climbed 0.1 percent after a revised 1 percent gain the prior month that was larger than previously estimated. The report noted progress in the labor market, rising equity prices, rising home values, continued strength in consumer spending, and rising orders to manufacturers. Five of the 10 indicators in the leading index contributed to the increase.

The biggest economic report today came from China. Activity in China's factory sector contracted in January for the first time in six months. Weighed down by weaker domestic and export demand, the flash Markit/HSBC Purchasing Managers' Index (PM) fell to 49.6 in January from December's final reading of 50.5, dropping below the 50 line which separates expansion of activity from contraction. The reading points to a further slowdown in manufacturing and the entire Chinese economy, which then has implications for the US economy. Chinese leaders have pledged to push reforms to unleash new growth drivers as the world's second-largest economy loses steam, burdened by industrial overcapacity, piles of debt and soaring house prices.

And this has been another area of concern about China. China’s growth model appears to be built on a mix of investments and exports and debt; the dependence on debt has been producing diminishing returns. Lending has in recent years been the driver of growth, but each yuan of new borrowing now produces 1/4 the amount of GDP increase that it did five years ago, and now there are concerns about an imminent default in its shadow banking system, or investments made off balance sheet.

The Chinese cabinet is seeking to increase government oversight of lending by companies that currently face little or no supervision. The shadow system has grown in recent years because the Chinese government has too tightly controlled traditional banking. It keeps the interest rates that conventional banks pay to depositors extremely low and gives out cheap loans to state-owned enterprises and favored companies that might not be able to repay the money.

And now it looks like one of those companies might not be able to repay. The China Credit Trust Company has told investors that it may not make a January 31 repayment on what would amount to the equivalent of about $500 million; that’s a big chunk of money but not a scary number, in itself. The problem is that nay significant defaults could shatter the widespread assumption that off-balance-sheet investments carry an implicit guarantee from state banks and their partner institutions. Regulators have warned that investors must assume the risks from high-yielding investments and not expect protection from losses unless such guarantees are explicit. Local governments have largely ignored these injunctions and have stepped in repeatedly in recent years with bailouts for local firms facing default on corporate bonds and trust loans.

The low rates, of course, have led savers to invest money in speculative real estate projects or dubious investments known as wealth management products offered by banks and finance companies that promise higher rates of return. Much of that money is then lent to private businesses and local governments, which cannot get conventional bank loans because regulated banks are required to give preferences to state-owned companies.

If there is a credit crunch, it would be very different from the Lehman contagion we experienced 5 years ago, and so we probably won’t see any Western style back crashes because the financial system is still an arm of the Chinese government. So, it will likely end in an entirely different way, and we’re not sure what that is.

Next week, the Federal Reserve FOMC meeting will take center stage. It will be Ben Bernanke’s final FOMC meeting. And although we see signs of an improving economy, (or as the Fed said: “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions.")  We have also seen a wobbly start to the trading year on Wall Street; and this came on the heels of the December FOMC meeting in which the Fed announced the first stage of tapering, curtailing asset purchases by $10 billion per month to just $75 billion per month. There is consensus that the Fed will take the next step in tapering next week; announcing an additional $10 billion a month in asset purchases.

The thinking has been that if things get bad, the Fed will simply ride to the rescue by postponing the taper and resuming or increasing asset purchases. We have to start by looking at what it means by “bad”. Economically speaking, it would be bad if unemployment were to spike; another credit collapse such as we saw in 2008 would be  bad; an economic  meltdown of any sort, domestic or international (think China, at least for today) – that would be bad. How about a 10% correction on Wall Street?

Stock market corrections are common, and we are overdue for some sort of correction, just based on past performance. The Fed’s taper announcement may very well serve as a catalyst or just an excuse for a correction. So, will the Fed jump in to clean up?

Not likely. The Fed has set a new course, and they will most likely have to stay the course, at least for the foreseeable future. There has been a concerted effort to emphasize forward guidance as the primary policy tool. Backtracking now would undermine the Fed's credibility. The Fed might like to talk about the importance of its independence and any reversal of taper would be seen as political. And any backtracking would be a serious blow to the Fed’s economic forecasting abilities and the Fed’s credibility.

And then there is the idea that the Fed’s balance sheet has grown too large, too fast. Increasing asset purchases would be seen as increasing the risks of future imbalances given the surge in stock prices that coincided with prior QE programs. In other words, there is the concern that QE could lead to bubbles, especially QE without an exit date would surely end badly. And a final reason, backtracking on taper and jumping back into the markets might not work this time. Each round of QE has resulted in slightly diminished returns. What if the Fed announced new stimulus and it failed to stimulate?

If the Fed is compelled to go back to the QE well, though, the cyclical sectors would be at heightened risk of underperforming as optimistic expectations get wrung out of stock prices. But this would only happen if things get bad (a subjective term) and we would likely see that coming.

The economic data have remained supportive of the Fed's tapering announcement in December. The December jobs report was weak, but it will be revised. Investor expectations are that the economy is stronger; not really strong but certainly not as weak as it was. So the Fed will likely continue with the taper, slowly and surely. And if the economy falters or something melts down, well they still have some other tools in the tool belt.

  

It’s still earnings reporting season and the big report today came after the close of trade as Microsoft posted net income of $6.5 billion, or 78 cents a share, compared with $6.3 billion, or 76 cents a share, in the year-ago quarter.  Revenue rose 14% to $24.5 billion, partly reflecting the release in November of a new Xbox videogame console and a fresh version of Microsoft’s Surface tablet computer ahead of the holidays. The results topped analysts’ guesses. No word on a replacement for CEO Steve Ballmer, who has announced his retirement.

Treasury prices rallied today. In part it was a safe haven move, with the weak data out of China; maybe some rebalancing or even an old fashioned short squeeze. Mortgage rates fell, decreasing borrowing costs for homebuyers. The average rate for a 30-year fixed mortgage was 4.39 percent this week, down from 4.41 percent and the lowest since November. The average 15-year rate slipped to 3.44 percent from 3.45 percent.

I mentioned earlier that we had a couple of reports on housing today. The Federal Housing Finance Agency reported home prices ticked up 0.1% in November, and were up 7.6% from the year-earlier period. The National Association of Realtors reports sales of previously owned homes rose in December for the first time in 5 months, and capping the best year since 2006.

Another report shows that the housing recovery has reached a level where it is increasingly unaffordable. You guessed it, California topped the list. The salary you have to earn to  be able to buy the median home in San Francisco is just over $125,000 as of November, and the median cost of a home in San Francisco is somewhere between $705,000 and $813,000, depending on what data source you look at; best guess is that home prices in San Francisco are up 24% over the past year. San Francisco tops the list of the most unaffordable cities. Next are San Diego and Los Angeles – the California trifecta – then New York City, where a mere $71,245 in income suffices to buy the median home. Households earning the median income of $51,000, well, forget it.

The reason San Francisco tops  the list is fairly simple, the tech bubble has attracted billions in fresh money, and one reason it has gravitated to San Francisco is past history and also tax incentives handed out to tech companies.

San Francisco may be extreme, but housing bubbles are now re-cropping up across the nation – and so are the very factors that helped inflate the prior housing bubble and then magnified the ferociousness of its implosion.

Helocs, or home equity loans, were up 30.8% in the first nine months of 2013 from prior year and are expected to reach $60 billion for the year, the highest level since 2009 when the market was in collapse mode. But it’s still a far cry from 2006, when such loans hit an all-time crazy record of $430 billion. Using the home as an ATM cranks up consumer spending. If the money is plowed back into the house, such as remodeling a bathroom, it adds some value to the house and lowers the risk of the loan. If it is used to buy gadgets, cars, or vacations, it still cranks up the economy in the US and other countries. But when home prices decline, homeowners and banks get slaughtered.

Also, the housing boom has seen the return of creative financing. Interest only home loans are back and they’re especially popular for jumbo loans. In a number of high-cost counties, including San Francisco, these are loans over $625,500 that banks can’t sell to Fannie Mae and Freddie Mac but have to keep on their balance sheets. Bank of America said that 36% of its fourth-quarter mortgages were jumbo loans, up from 23% in the first quarter. And adjustable rate mortgages, or ARMs made up 22% of all purchase loans in December, up from 11% in December 2012, the highest ratio since July 2008.

The result of higher prices has been slowing sales. In December sales volume was down 17.7% in San Francisco and 12.7% in the Bay Area from a year earlier. In California, volume dropped 12.1% to 34,949 sales, the worst December since 2007 – and 19.7% below the average for all Decembers since 1988.

In Palo Alto, at the center of the techie induced price hikes, home prices are now 40% above the prior bubble peak. But don’t call it a bubble, it’s a housing recovery, at least until it pops.

Friday, October 25, 2013 - New Records on Bad News

New Records on Bad News

by Sinclair Noe

DOW + 61 = 15,570
SPX + 7 = 1759
NAS + 14 = 3943
10 YR YLD - .02 = 2.51%
OIL + .79 = 97.90
GOLD + 5.60 = 1353.90
SILV - .13 = 22.70

The S&P 500 closed at a record high. The Nasdaq Composite closed at a 13 year high. The Russell 2000 hit a record high intraday, but closed slightly down on the day. The Dow Industrial Average did not hit a high; maybe next week, but not today, and so no milk and cookies.

For the week, the Dow was up 1.1%, the S&P up 0.9%, the Nasdaq up 0.7%. Based on results so far and estimates for companies still to report, S&P 500 earnings are expected to have risen just 3.4 percent in the third quarter, with 69 percent of companies reporting earnings above analysts' expectations. Revenue growth is seen at 2.2 percent for the quarter, with just 54.2 percent beating sales estimates, below the long-term average of 61 percent.

Consumer sentiment dropped in October to its lowest level since the end of last year. The Thomson Reuters/University of Michigan's final reading on the overall index on consumer sentiment fell to 73.2 in October from 77.5 in September and was the lowest final reading since December 2012. This report covered the time when the government shutdown. Consumer confidence is often linked to consumer spending expectations, and so there is some concern this report might foretell a weak holiday spending season.

Meanwhile capital goods orders were weak in September. Excluding orders for aircraft, orders dropped 1.1%. This report covers data prior to the shutdown. It's estimated the shutdown will shave as much as 0.6 percentage point off annualized fourth-quarter gross domestic product through reduced government output and damage to both consumer and business confidence. And even before the impasse, the pace of hiring by US employers had slowed sharply in September, as we learned earlier this week in the delayed jobs report.

This shutdown and threat of another coming in January are clearly going to change how people act and feel. Government employees and contractors (and other creditors) have been presented with a realistic scenario of not being paid either for a period of time, or even never being paid. Behavior will change in response to this newly found recognition of a vulnerability. The partial bounce back may even be muted by social security recipients realizing that they may one day find their checks delayed (and need to have a cash reserve to deal with that).

The single biggest impediment to a stronger economic recovery has been the years of dysfunction in Washington and the policies that have emerged. S&P estimates the shutdown will cost the economy $24 billion, but that's just the shutdown. Most substantively, the sharp decline in the budget deficit, from $1.4 trillion in 2009 to $642 billion in the 2013 fiscal year that ended Sept. 30, has braked the economy at a time when it was already improving only slowly.

Federal spending has been declining for 2 straight years and the Congressional Budget Office calculates that the pullback in spending, together with higher taxes will cause the economy to grow by 1.5 percentage points less this year than it would have if the deficit had remained constant, that’s the equivalent of 1.5 million fewer jobs.

So, we have bad economic news and expectations for a weak 4^th quarter and the stock market at record highs, because on Wall Street, bad news is good news. The weak economy means the Federal Reserve is not going to taper, or cut back on it's quantitative easing program of buying $85 billion a month in securities.

Right now the potential costs of withdrawing even a little bit of monetary support from the economy appear much greater than they were. For proponents of asset purchases, the cost-versus-efficacy calculation that figures into their votes each meeting is now chiefly about assessing the impact of slowing purchases, rather than of continuing them. The Fed holds its next FOMC meeting next week, and it looks like there will be about zero chance of a change in QE. The window to make changes in the bond buying program is now closed, and likely closed for quite some time.

Yesterday I addressed at length (click here) the Federal Reserve's proposals to have banks increase capital reserves, which is a positive though incomplete effort to avoid future bailouts. That process of increasing reserves would be phased in beginning in January 2015, and that taper could produce a shortage of high-quality assets. So, the pigs on Wall Street gorge at the Fed's Free Money trough, and push equities to new highs; and if it all sounds irrational and a tad exuberant, well it is; but the market can be irrational at times and brutal at others.

White House officials say the have submitted the paperwork necessary to confirm Janet Yellen as the next head of the Federal Reserve. Yellen will meet Senators next week as part of the process to install her as the next head of the central bank.

Yellen is expected to secure the 51 Senate votes needed to confirm her position. However, the hearings are expected to be contentious. Several Republican Senators have already indicated that they will oppose Yellen's nomination. Kentucky Senator Rand Paul is threatening to block the nomination to get a vote on his Fed transparency bill, which would require the Fed to undergo a complete audit by a specific deadline. 

Today, JPMorgan Chase announced it has reached a $5.1 billion settlement with the US Federal Housing Finance Agency (FHFA) over charges it misled mortgage giants Fannie Mae and Freddie Mac during the housing boom. A separate settlement with the US Justice Department is expected to be announced soon, that's the proposed $13 billion deal. It is the biggest settlement ever by a US bank. In a statement JP Morgan said the settlement resolves the biggest case against the firm relating to mortgage-backed securities.

The bank added that the agreement relates to "approximately $33.8 billion of securities purchased by Fannie Mae and Freddie Mac from JP Morgan, Bear Stearns and Washington Mutual" from 2005 – 2007. As part of the agreement with the FHFA, the bank will pay $4 billion to Fannie Mae and Freddie Mac to settle claims that it violated US securities law.

It will pay the agencies an additional $1.1 billion for misrepresenting the quality of single-family mortgages.JP Morgan has set aside a total of $23 billion to help the bank work through its many investigations by regulators in the US and abroad.

Last month, the bank agreed to pay more than $1bn to help it end various investigations into its 2012 "London whale" trading debacle, which cost the bank more than $6 billion in trading losses.

It's estimated that JPMorgan has now paid out more than $31 billion in fines and legal costs since 2009. The settlement announced today is the biggest settlement ever by a US bank. Now, what seems really crazy is that you have these massive fines and legal costs, and you still have apologists for Jamie Dimon to stay on as the chief at JPM. Either JPMorgan is incapable of turning a profit without violating the law, or they have squandered an enormous amount of profits by violating the law.

Meanwhile, kudos to Bill Black for recognizing a bit of media legerdemain, specifically, this one sentence which describes this week's jury verdict against Bank of America for the Hustle scam: “Bank of America, one of the nation’s largest banks, was found liable on Wednesday of having sold defective mortgages, a jury decision that will be seen as a victory for the government in its aggressive effort to hold banks accountable for their role in the housing crisis.”

I'm still waiting for aggressive efforts to hold banks accountable.

An earthquake of magnitude 7.3 struck early Saturday morning off Japan's east coast, the U.S. Geological Survey said. Japan's emergency agencies declared a tsunami warning for the region that includes the crippled Fukushima nuclear site. Japan's Meteorological Agency issued a 3-foot tsunami warning for a long stretch of Japan's northeastern coast, which isn't really much more than a swell.

There were no immediate reports of damage on land. Tokyo Electric order workers near the Fukushima nuclear plant to move to higher ground but there were no reports of trouble at the plant. All but two of Japan's 50 reactors have been offline since the March 2011 magnitude-9.0 earthquake and ensuing tsunami triggered multiple meltdowns and massive radiation leaks at the Fukushima Dai-ichi nuclear power plant, about 160 miles northeast of Tokyo. About 19,000 people were killed.

The Fukushima plant has been leaking radioactive water into the ground and into the ocean, and there are concerns about the stability of the damaged buildings holding radioactive fuel rods. So, something like an earthquake could easily damage the buildings, resulting in a meltdown 85 times larger than Chernobyl. But the good news is that did not happen; not today.

Tuesday, August 27, 2013 - The Drums of War

The Drums of War

by Sinclair Noe

DOW – 170 = 14,776
SPX – 26 = 1630
NAS – 79 = 3578
10 YR YLD - .07 = 2.71%
OIL + 3.34 = 109.55
GOLD + 11.00 = 1417.00
SILV + .19 = 24.62

Yesterday Secretary of State Kerry laid out the case against Syria. Today we learned the US could be ready to take military action as soon as Thursday. Defense Secretary Hagel today said: "We have moved assets in place to be able to fulfil and comply with whatever option the president wishes to take."

This follows last Wednesday's suspected chemical attack near the Syrian capital, Damascus, which reportedly killed more than 300 people; more than 3,600 people were treated for nerve agents, and by some estimates the death toll is now approaching 500. You've surely seen the grisly videos. They are compelling, but in light of the faulty intelligence that preceded the war in Iraq, there is a call for stronger proof. White House spokesman Jay Carney says a report on chemical weapons use being compiled by the US intelligence community and will be published this week.

There is not a requirement for Congressional approval for the president to initiate military action including strikes; rather the War Powers Act requires congressional notification, and that has been happening; of course questions of legality will be debated. The UK Parliament is to be recalled on Thursday to discuss possible responses. Prime Minister David Cameron said the world could not stand idly by after seeing appalling scenes of death and suffering caused by suspected chemical weapons attacks. French President Francois Hollande said France was "ready to punish" whoever was behind the attack. The Arab League said it held Syrian President Bashar al-Assad responsible for the attacks and called for UN action.

Russia, China, and Iran - allies of the Syrian government - have stepped up their warnings against military intervention, with Moscow saying any such action would have "catastrophic consequences" for the region.

After almost 12 years of war, the public is not keen on new battles; the latest polls show only 9% support for military intervention. And an almost irresistible feeling that something needs to be done is running head-on with the reality that there is no course of action that is attractive and that does not carry significant risks. A diplomatic response seems unlikely at this point. A minimalist response of stepping up support for Syrian opposition forces has so far proven ineffective. A more likely response is strategic missile and air strikes, perhaps similar to the Bosnian campaign of 1999 or the more recent campaign against Libyan dictator Kaddafi. Regime change is explicitly not the goal of military action, and administration officials have suggested any airstrikes will be limited.

Or the whole damn thing could explode into World War III. At the very least, Syria will be a mess for quite some time; we don't know who or what will replace the Assad regime, and even a fairly smooth transition of power can prove challenging as we've learned in Egypt; the situation in Syria will be an even bigger challenge. The outlook for military action is stark.

Warships are on the move. The impending conflict is rippling across financial markets. Europe and Asia moved lower. Equity markets in the Middle East were down significantly. Syria is not considered a major player in oil, but the region is vital, and so oil prices spiked this morning, up 2.95 at 108.87 a barrel. We've seen oil prices top out at 108.00 a couple of times this summer, so a breakout above 108 is important. We're at six month highs. Post-financial crisis highs for crude sit just below $114. We're not that far off.

Gold loves fear. Yesterday, gold closed above $1400, and today it kept running, hitting an intraday high of 1425; there is a major level of resistance at 1420, and it is being challenged. We're not that far off. After that the big levels of resistance are around 1520; that is still pretty far off.

Emerging markets could absorb the brunt of the selling as this crisis continues to unfold. Money has been flowing out. Although this is more likely a result of other factors not associated with military moves in the Middle East. Many are now dubbing the BRIC countries (the grouping of Brazil, Russia, India and China) down and out, but the lower prices also make valuations more enticing. Maybe periods of pessimism are good times to buy, but only if you have a constitution suited to catching falling knives. For investors bracing for an end of cheap dollars from the Federal Reserve, emerging market currencies are getting hit hard.

Meanwhile, I went to the New York Times website today, and it was down; hacked by the Syrian Electronic Army, a group which supports Syrian president Bashar al-Assad. So I guess the war has already started.

With all the talk about war, it would be easy to overlook the banks behaving badly, but don't worry, I've got it covered. Let's start with JPMorgan; the Federal Housing Finance Agency wants JPMorgan to pay more than $6 billion to settle claims that it knowingly sold bad mortgages to Fannie Mae and Freddie Mac ahead of the financial crisis. Such a settlement would be the biggest single penalty paid by any bank for actions ahead of the crisis. It would also roughly match the $6.2 billion JPMorgan lost in the "London Whale" trading debacle in early 2012.

The FHFA regulates Fannie Mae and Freddie Mac, and they claim JPMorgan misled the mortgage agencies about the value of $33 billion in mortgage backed securities. JPMorgan expects to settle the case, but they're balking at the price.

Meanwhile, a former JPMorgan trader wanted by the United States for allegedly falsifying bank records to cover up $6 billion in trading losses was arrested in Madrid. Javier Martin-Artajo was arrested after he presented himself to police in Madrid and was later released on bail. Now there will be extradition hearings.

For years I've been saying the biggest banks should be broken up, chopped into smaller pieces, more easily digestible. It would be the best thing for the economy, and according to a new research report from the investment bank Keefe, Bruyette and Woods, it would be good for the banks' shareholders. The report says  JPMorgan's value might be 30 percent higher if it were broken into pieces. If JPMorgan were broken into four units -- traditional banking, investment banking, asset management and private equity -- the market value of those segments could total $255.7 billion -- a 29.9 percent premium over Thursday’s market valuation of $196.9 billion. The move also would unlock some $19.5 billion that the bank is setting aside to satisfy capital reserve requirements for so-called too big to fail banks. That's money the bank might make available for lending.

The report also looked at JPMorgan's legal problems, which include 13 investigations by federal regulators, not to mention some overseas legal problems on charges ranging from manipulation of energy markets to hiding large losses during the “London Whale” debacle in early 2012. The bank also faces a barrage of lawsuits from individuals and its trading counterparties. The legal uncertainties have taken their toll on JPMorgan's stock, with shares trading at 8.65 times the bank's earnings over the past 12 months. Similar institutions trade at multiples that are 25 percent to 40 percent higher. The report says the legal problems aren't enough to bring the bank down.

Ah, we can't let this one pass without notice. The New York Attorney General has sued Donald Trump for his Trump University. Attorney General Eric Schneiderman says many of the 5,000 students who paid up to $35,000 thought they would at least meet Trump but instead all they got was their picture taken in front of a life-size picture of “The Apprentice” TV star.

“Trump University engaged in deception at every stage of consumers’ advancement through costly programs and caused real financial harm,” Schneiderman said. “Trump University, with Donald Trump’s knowledge and participation, relied on Trump’s name recognition and celebrity status to take advantage of consumers who believed in the Trump brand.”

Schneiderman is suing the program, Trump as the university chairman, and the former president of the university in a case to be handled in state Supreme Court in Manhattan. He accuses them of engaging in persistent fraud, illegal and deceptive conduct and violating federal consumer protection law. The $40 million he seeks is mostly to pay restitution to consumers.

And honestly,… I’m not saying there shouldn’t be consumer protections, and fraudulent activity should certainly be punished, but if you’re paying $35,000 to go to something called Trump University the words caveat and emptor do leap to mind.

In economic data today, the Case-Shiller Home price index showed price gains of about 1% for the month and 12% year over year, roughly inline with previous gains as well as expectations. However, this is a June report for home sale closings from late spring and early summer (meaning the sales contract was signed even earlier). It contains virtually no information about how home prices are reacting to the sharp jump in interest rates this summer. That said, some details: All 20 cities posted monthly and annual gains, but prices rose faster this month than last in just 6 cities as opposed to 10 in May. Dallas and Denver hit new all-time highs. San Francisco is up 47% from its March 2009 low. Phoenix is up 37% from its September 2011 low. Las Vegas prices are up 24.9% Y/Y, San Francisco +24.5%, Phoenix up 19.8%, Los Angeles +19.9%. On the lower end, Cleveland +3.5%, D.C. +5.7%, Chicago +7.3%, New York +3.3%.

The story of the West is a story of water; droughts, floods, the development of water infrastructure. But the story of water in the West is also being told, every day, in the growing crisis facing communities, watersheds, ecosystems, and economies. This isn’t a crisis of for tomorrow. It is a crisis today. What is, perhaps, a surprise, is that it has taken this long for the entire crazy quilt of western water management and use to finally unravel. But it is now unraveling.

The old adage of the blind men describing an elephant based on their experience touching different parts of it applies to western water. In the past few years, we’ve seen bits and pieces of the puzzle: a well, and then two wells, and then a town goes dry. A farmer has to shift from water-intensive crops to something else, or let land go fallow. Vast man-made reservoirs start to go dry. Groundwater levels plummet, yet the response is to try to drill new and deeper wells and pump harder, or build another dam, or move water from an ever-more-distant river basin. Competition between industry and farming increases. And politicians run back to old, tired, half-solutions rather than face up to the fact that we live in a changed and changing world.

Here are a few pieces of the puzzle that we had better start to put together into a coherent picture if we hope to change our direction.

In January 2012, the Texas town of Spicewood Beach ran out of water. Then Magdalena, New Mexico ran out. More recently, Barnhart, Texas. Now Texas publishes a list of towns either out or running out of freshwater. In some parts of Texas, demands for water for fracking are now competing directly with municipal demands.


Because of a severe, multi-year drought (described as “the worst 14-year drought period in the last hundred years”) and excessive water demands, the US Bureau of Reclamation, this week,announced it will cut water released from Lake Powell on the Colorado River to the lowest level since the massive reservoir was filled in the 1960s. Water levels in Lake Mead have already dropped more than 100 feet since the current drought began in 2000, but even in an average year, there is simply more demand than supply.


Las Vegas is so desperate for new supplies they have proposed a series of massive and controversial ideas, including: a $15+ billion pipeline to tap into groundwater aquifers in other parts of the state, diverting the Missouri River to the west, and building desalination plants in Southern California or Mexico so they can take a bigger share of the Colorado.


Governor Jerry Brown is pushing a $25+ billion water tunnel project to try to improve water quality and reliability for southern California farmers and cities and improve the deteriorating ecosystems of the Sacramento-San Joaquin Delta, with no guarantees that it will do any of those things at a price users are willing and able to pay.


San Luis Reservoir in California, which serves the Silicon Valley and other urban users, has fallen to 17 percent because of severe drought, making business, communities, and water managers nervous. Other major California reservoirs are also far below average, though massive deliveries of water continue on the assumption that next year will be wet.


Praying for rain has become an official water strategy for some politicians in Texas, Georgia,Florida, Oklahoma, and elsewhere.


Another popular water strategy seems to be to sue your neighboring state. Here are some examples: Texas v. Oklahoma and Kansas v. Nebraska and Colorado, and outside of the west,Florida v. Georgia (and Alabama too)


Groundwater is disappearing in California, the Great Plains, Texas and elsewhere in the West, because our laws and policies ignore the fact that surface and groundwater are connected. Contributing the problem, water managers and legislators typically put no restrictions on groundwater pumping, leading to inevitable, and inexorable, groundwater declines.

There is more and more and more evidence of declining snowpack in the western US as the climate warms.

These are just a few recent examples of the growing water-related dislocations in the western US. Writ large, the entire region is at risk. Oh, one more, the Colroado River, at Lake Mead, backed up by the Hoover Dam, the lake is receding; it's estimated that in four years there won't be enough water to cover the turbines to produce the elctricity for Las Vegas. You can replace a power plant. I'm not sure how you replace a river