Tuesday, February 25, 2014 - Dumb Luck

Dumb Luck

By Sinclair Noe

DOW – 27 = 16,179
SPX – 2 = 1845
NAS – 5 = 4287
10 YR YLD  - .05 = 2.70%
OIL - .76 = 102.06
GOLD + 5.00 = 1342.60
SILV - .07 = 21.99

Just a couple of economic reports to start. The S&P/Case-Shilller home Price Indices for December were posted today. Nationally home prices closed the year of 2013 up 11.3%, while posting a fourth quarter decline of 0.3%. After 26 months of consecutive gains, Phoenix posted -0.3% for the month of December, its largest decline since March 2011. Phoenix once led the recovery from the bottom in 2012, but Las Vegas, Los Angeles and San Francisco were the top three performing cities of 2013 with gains of over 20%.

Another sign that the housing market slowed down during the fourth quarter: Fannie Mae, the nation’s largest mortgage guarantor, saw demand for foreclosed properties dip at the end of the year. Fannie reported last week an $84 billion annual profit for 2013 on the backs of large home-price gains and a series of one-time legal and accounting benefits. The report also showed that its inventory of foreclosed homes increased for the second straight quarter as it begins to take back more properties in Florida and other states where foreclosures have been tied up in courts. The report showed that the prices Fannie received on those properties, as a share of the underlying mortgage balances, declined slightly from the prior quarter for the first time in 2½ years.

The Conference Board’s Consumer Confidence Index decreased to 78.1 in February from a revised 79.4 in January.  Fewer Americans projected business conditions would improve over the next 6 months, dropping from 80.8 to 75.7 fueling anxiety over the outlook for jobs and income that risks restraining consumer spending. The most important thing that would get consumers feeling better about the outlook is if the labor market improves more substantially. Apparently people who work feel better about the economy and are more likely to spend money than people who don’t have jobs. Who knew?

Even if you have income from work, you might still be holding tight to your coin purse. The Labor Department reports that payrolls in December and January showed the smallest back to back gains in 3 years.

White House economist Jason Furman said today the economy could be in a period of slower potential growth, a development that puts greater urgency on longer-run investments. Gains in worker productivity have eased since the recession began compared with the technology-driven improvement of the prior two decades. Without new policies, the country could face slow productivity growth similar to that recorded in the 1970s and 80s.

Weaker productivity gains during that period was offset partially by a rapidly expanding workforce due to the baby boom and more women taking jobs. Over the next two decades, demographic shifts instead will present an impediment to growth. The workforce is projected to expand at less than a third of the pace it did between 1974 and 1992 because the average American is getting older.

Furman laid out six longer-run initiatives the White House will be pushing on the economic front in the forthcoming 2015 budget:

1. The so-called “Opportunity, Growth and Security” proposal would make investments in research, job training and education beyond what’s possible under the budget framework Congress agreed to late last year. Closing tax loopholes and trimming other spending would pay for the new investments.

2. Expand infrastructure investments, ranging from roads to wireless broadband networks. The spending would create jobs in the short run, with the longer-run effect of improving business productivity.

3. Overhaul the business tax system with the long-stated goal of lowering the top rate to 28% while removing loopholes. Furman says, “By developing a system that is more neutral, corporate decision makers can act for business reasons, not tax reasons, which would create an environment in which capital will flow to the most efficient purposes.”

4. Provide universal preschool education. The investment will improve students’ performance as they advance through the education system and ultimately provide employers with higher skill workers.

5. Change the immigration system to make it easier for workers to obtain green cards and clear the way for foreign students to stay in the U.S. once they earn degrees. Immigrants will not simply expand the labor force, but engage in innovative or entrepreneurial activity that further elevates the economy’s potential.

And idea number 6:  Complete free-trade agreements with countries in Asia and Europe. Those deals would make the U.S. more attractive for foreign investment and open markets for domestically produced goods abroad.

Mt. Gox has disappeared. I know, we’re all shocked, shocked I tell you. There is nothing but a blank page on the Mt. Gox website. There was a brief notation on the website saying there might be something happening, maybe an acquisition, or something, then that disappeared and the website was blank again.

Mt. Gox, once the world's biggest bitcoin exchange, abruptly stopped trading today. Several other digital currency exchanges, including Bitstamp and BTC-E, issued statements attempting to reassure investors of both bitcoin's viability and their own security protocols.

Bitcoin investors deposit their holdings in digital wallets at specific exchanges, so the Mt. Gox shutdown is similar to a bank closing its doors - people cannot retrieve their funds. Released in 2009 by an anonymous creator known as Satoshi Nakamoto, the Bitcoin program runs on the computers of anyone who joins in, and it is set to release only 21 million coins in regular increments. The coins can be moved between digital wallets using secret passwords.

While Bitcoin fans have said the technology could provide a revolutionary new way of moving money around the world, skeptics have viewed it either a Ponzi Scheme or an investment subject to potential fraud or just a bad idea. Bitcoin was supposed to be a new, subversive alternative to a financial system that had been exposed as fragile, dangerous and too big to fail in the financial crisis of 2008. If you’re confused by what that is supposed to be, don’t worry, you are still sane; the bitcoin world is the crazy one in this story.

Tokyo-based Mt. Gox began as a venue for trading cards; the name stands for Magic the Gathering Online Exchange. No, I did  not make that up. Mt. Gox had surged to the top of the bitcoin world, but critics, from rival exchanges to burned investors, said the digital marketplace operator had long been lax over its security. Mt. Gox halted withdrawals earlier this month after it said it detected "unusual activity on its bitcoin wallets and performed investigations during the past weeks." The move pushed bitcoin prices down to their lowest level in nearly two months.

This morning, Mt. Gox CEO Mark Karpeles told Reuters in an email: "We should have an official announcement ready soon-ish. We are currently at a turning point for the business. I can't tell much more for now as this also involves other parties." He did not give any other details.

A document circulating on the Internet purporting to be a crisis plan for Mt. Gox, said more than 744,000 bitcoins were "missing due to malleability-related theft", and noted Mt. Gox had $174 million in liabilities against $32.75 million in assets. It was not possible to verify the document or the exchange's financial situation. If accurate, that would mean approximately 6 percent of the 12.4 million bitcoins minted would be considered missing.

But at the same time that the news about Mt. Gox was emerging, a New York firm announced plans to create an exchange that could draw the world’s largest banks into the virtual currency market for the first time. It could still happen, or not. This might be the death knell for bitcoin, or not. Imagine the lunacy of a private entity, printing money out of thin air, thinking that people would accept it as real currency, despite having no inherent value, based on nothing more than the beneficence of the issuer; subject to meltdown and freeze up, where massive amounts of value just disappear in the blink of an eye. The whole idea is the height of lunacy; unless, you’re the Federal Reserve of course.

There is more to it of course. A sovereign government that issues its own “nonconvertible” currency cannot become insolvent in terms of its own currency. It cannot be forced into involuntary default on its obligations denominated in its own currency. It can “afford” to buy anything for sale that is priced in its own currency. It might be able to buy things for sale in foreign currency by offering up its own currency in exchange, but that is not certain. If, instead, it promises to convert its currency at a fixed price to something else (gold, foreign currency) then it might not be able to keep that promise. Insolvency and involuntary default become possible. This seems to be where bitcoin failed; the convertibility part, or at least the part where you could actually buy something with bitcoin.

Speaking of the Fed and failure. Last week we finally saw the transcripts from the Fed from back in the crisis year of 2008. Now, Tim Geithner has a book coming out, titled “Stress Test”.  Geithner has a number of attention-grabbing takeaways. Among them: “We saved the economy from a failing financial system, though we lost the country doing it,” he writes in the book, due out May 13. Geithner led the Federal Reserve Bank of New York at the onset of the meltdown. He served as the Obama administration’s top economic official from January 2009 until January 2013.

On the book’s website, Geithner says: “We made mistakes, it was messy, and the damage was devastating and long-lasting. And yet, at the moments of most extreme peril, the United States was able to design and execute a remarkably effective strategy.” Actually, what we’ve been learning from the transcripts of the Fed in 2008, is that the remarkably effective strategy was more like a drunkard managing to survive a stroll through a landmine; i.e., persistence and dumb luck.

Thursday, November 07, 2013 - The Road Not Taken

The Road Not Taken

by Sinclair Noe

DOW – 152 = 15,593
SPX – 23 = 1747
NAS – 74 = 3857
10 YR YLD - .03 = 2.61%
OIL - .51 = 94.29
GOLD - 10.00 = 1308.60
SILV - .14 = 21.77

Big story on Wall Street today was the Twitter IPO. I will now tell you everything you need to know about it in 140 characters or less.

TWTR IPO 2day. Priced @ $26. Pop 2 $50. Close @ 44.90 up 72%. Market cap = $24 bil, earnings = < zero. Smooth not Facebook. #bubblicious

Economic growth accelerated in the third quarter. Gross domestic product grew at a 2.8 percent annual rate, the quickest pace in a year, after expanding at a 2.5 percent clip in the second quarter. Inventories, however, accounted for a 0.8 percentage point of the advance made in the third quarter, as businesses restocked shelves, but the slowest expansion in consumer spending in two years suggested an underlying loss of momentum. Consumer spending expanded at a 1.5 percent rate, the slowest pace since the second quarter of 2011. It grew at a 1.8 percent rate in the April-June period. So, unless there is a surge in 4^th quarter demand, we might see future production reduced to clear out inventories.

The economy grew at a 1.8 percent rate in the first half of 2013, expect growth of around 1.5% for the fourth quarter. The private sector decelerated over the summer, providing less of a cushion for the government shutdown in October. Steady growth in spending by state and local authorities pushed government spending up for the first time in a year, but federal spending continued to drop.

If we are to see a surge in demand, it would likely come from improvement in the labor markets. In a separate report today, initial claims for state unemployment benefits fell 9,000 to a seasonally adjusted 336,000 last week. Tomorrow we'll get the monthly jobs report for October, which will be more than a bit bizarre due to the government shutdown.

Although the unemployment rate has declined significantly from a peak of 10 percent in October 2009, it remains at an uncomfortably high 7.2 percent. About 21.5 million people are either unemployed, working only part-time despite wanting full-time work, or want a job but have given up the search.

Meanwhile, the Commerce Department reports home ownership is holding near 18 year lows. For the 3^rd quarter, the seasonally adjusted homeownership rate, the share of households owning a home, held at 65.1 percent, the lowest since the fourth quarter of 1995.

Separately, Fannie Mae and Freddie Mac, the government sponsored entities that provide financial backstops to the housing industry will send the Treasury $39 billion in December, meaning they have almost paid back the government bailout of 2008. The companies, which own or guarantee about two-thirds of all US home loans, were seized by the government at the height of the financial crisis as mortgage losses threatened their solvency. They are now seeing profits surge as housing rebounds.

Freddie Mac will pay about $30 billion and Fannie Mae will make an almost $9 billion payment. By early next year, taxpayers likely will have turned a profit. The two firms' bailout agreements, however, do not provide a way for them to buy back the $189 billion worth of senior preferred shares the government received in return for its aid. Under the bailout terms, they will continue to make dividend payments as long as they are profitable.

The European Central Bank cut interest rates today. The ECB cut its main refinancing rate by 25 basis points to 0.25 percent. It held the rate it pays on bank deposits at zero and cut its emergency borrowing rate to 0.75 percent from 1.00 percent. That is the lowest rates on record for the EU. ECB President Mario Draghi says they still have room to act if needed. The ECB said it would prime banks with as much liquidity as required until mid-2015, indicating a new round of cheap money stimulus within the next few months. Shares in major European markets, from the German DAX to France’s CAC40 all jumped on the news, gradually giving up their gains into the close. The euro took a tumble, falling as low as 1.33 against the dollar before recovering.

By contrast, many economists expect the Federal Reserve to begin withdrawing stimulus next year; and the stronger than expected GDP report today reinforced that expectation. Of course, right now it's just expectations and the last time the Fed floated the trial balloon on cutting back Quantitative Easing, the markets threw a taper tantrum. So, we'll wait and see. There is much buzz over the possibility the Federal Reserve will lower the unemployment rate threshold at an upcoming FOMC meeting. To a certain extent, the issue of thresholds has taken on a new urgency as a result of the tapering debate.  The Fed's excellent adventure with tapering this summer indicated that they do not fully understand the transmission mechanisms of large scale asset purchases. Despite some improvement in the economy, and in spite of fiscal headwinds, and forgetting about today's GDP report momentarily; the economy has been giving little room for the FOMC to maneuver. They do not want to withdraw accommodation at this point, only to limit additional accommodation. 

The Senate Banking Committee says it will hold a hearing on November 14 on the nomination of Federal Reserve Vice Chair Janet Yellen to take the helm of the central bank when Ben Bernanke steps down at the end of January.

Back to Europe for a moment. There has been talk of improvement in the Eurozone economies, but clearly the ECB action today indicates that there hasn't been enough growth; and gross domestic product growth alone is not enough to provide sustainable prosperity, especially if it doesn't result in significant job growth.

Technically the Spanish recession is over; third quarter GDP grew at a rate of 0.1%. But a glance at their job figures shows the country has a long way to go before it can genuinely say it has escaped the diminishing effects of austerity — in the form of tight fiscal policies, public spending cuts and labor and entitlement reforms — imposed indirectly by Germany through the European Union.

In Europe, only in Germany and Austria is youth unemployment under 10 percent. In Spain, where economic growth is occurring only in the export sector, there is little suggestion the economy has been genuinely fixed by this protracted austerity regime. Spain and Greece each have more than 25% unemployment, and 13 other Eurozone countries have unemployment higher than 10%. Spanish unemployment is at 26%, and half of those age 25 and under are unemployed. More than half those age 25 and under in Greece and Croatia are also unemployed. Those kind of numbers can lead to a lost generation, or worse.

In Britain, where the Conservative government imposed austerity measures ostensibly to ward off a sovereign debt crisis and a run on the pound, the quarterly growth rate is up to 0.8%. Britain may have averted a triple dip recession, but only because they loosened up the austerity policy and the Bank of England has kept rates artificially low while the government has subsidized the housing industry with mortgage subsidies. According to the International Monetary Fund, Britain’s economy will grow 1.4 percent this year and 1.9 the next; though it is still 2.5 percent smaller than it was in early 2008.

So, after five years of austerity, there are still 11 Eurozone countries with negative growth. Only four Eurozone countries have growth above 2%: Latvia, Lithuania, Malta, and Luxembourg. Apparently there is some advantage to being small. And the Euro powerhouse, Germany is only growing at 0.5%, which is hardly cause for celebration. The European Commission says the euro zone as a whole will decline by 0.4 percent this year, year on year, though they predict 1.1 percent next year. Output in the euro zone, however, is still about 3% lower than in 2008.

But even if the modest European recovery is sustained, it remains fickle, capable of being blown off course by temporary setbacks such as an American federal government shutdown. And the US Treasury points out that even the slender European recovery has taken place on the back of America’s by comparison expansive economic policies (so to speak).

Germany’s postwar economic model has always been export-led. In the last five years Berlin has defended the very existence of the euro because it allows German exports to be priced comparatively cheaply, far cheaper than if they had continued to use the deutsche mark — which reflected the true strength of the German economy.

Added to this, in the last five years Germany has browbeaten its European partners into adopting austerity rather than allowing them to borrow and grow their way out of the Great Recession. Only Britain, outside the euro, has largely evaded Germany’s beggar-thy-neighbor policies.

It is impossible to predict the outcome of a road not taken. So it is unknown whether, if the Europeans had not reneged on the deal struck after the 2008 crash at the Washington G20 summit to ensure “the action of one country does not come at the expense of others or the stability of the system as a whole,” we would now be in a more prosperous world with millions more in work.

It does, however, seem likely.

Wednesday, August 07, 2013 - A Crack in QE

A Crack in QE

by Sinclair Noe

DOW – 48 = 15,470
SPX – 6 = 1690
NAS – 11 = 3654
10 YR YLD - .04 = 2.60%
OIL – 1.12 = 104.18
GOLD + 4.70 = 1288.30
SILV + .11 = 19.69

Remember back in late May when Ben Bernanke hinted that the Fed might not continue Quantitative Easing forever; there might actually be a time when the Fed stopped pouring $85 billion into mortgage backed securities and Treasuries. The stock market took a hit on the whim of a whisper of a hint that the punchbowl might be removed. Bernanke did some backtracking, and the markets rebounded to hit record highs on the Dow and the S&P, and we all enjoyed milk and cookies.

This week, we've seen several Fed officials talking about QE again, and again the markets are pulling back; down for three days. On Monday, it was Dallas Fed Bank President Richard Fisher; yesterday it was Charles Evans, president of the Chicago Fed Bank, and Dennis Lockhart, President of the Atlanta Fed Bank.

Today, Federal Reserve Bank of Cleveland President Sandra Pianalto said that the central bank would be prepared to scale back asset purchases if the labor market remains on the stronger path followed since last fall. Pianalto said that there have been "clearer signs of a more sustained recovery" in the labor market in the last few months. "In light of this progress, and if the labor market remains on the stronger path that it has followed since last fall, then I would be prepared to scale back the monthly pace of asset purchases." She did not provide any timetable for Fed action.

Taper talk, markets down. It is becoming so predictable that it even has it's own little name, a “taper tantrum”.

Over the past two months, the 10-year Treasury yield has climbed from around 1.75% to 2.75%. Consequently, mortgage rates have jumped nearly 100 basis points as well. Investors are rightfully concerned and asking how this will impact the economy and their portfolios.

And it certainly appears the Fed is playing the markets like a violin. The ongoing tapering talk is deliberate and designed to accomplish two things: one, establish a new trading range for rates and observe the markets and economic reaction to the rise in rates, and two, begin getting investors numb to the talk of tapering and rising rates so that when it does finally occur, the reaction will be muted.

The reaction is indeed muted. President Obama is going around talking about how we need to do things to improve the economy and regulate to avoid another crisis because there will be no more bailouts. But wait a minute. Remember back in 2008 when the Federal Reserve and the Treasury got together to cough up $80 billion in cash and $65 billion in loan guarantees to keep insurance giant AIG alive. What an outrage!

So, here we are, the Fed has gone through QE 1 at a cost of about $700 billion, QE2 at a cost of about $1.2 trillion, and QE 3 at a cost of $85 billion per month and counting. If you want to see where the stock market is headed, just look at the Fed's balance sheet, which is also hitting record highs; just don't call it a bailout.

Well, even the Fed understands that massive bailouts can't continue forever, even if you don't call it a bailout. Problem is, the stock market is hooked on QE, just like a junkie looking for a fix. And so we have Federal Reserve officials making the rounds, calmly reminding Wall Street that they need to step away from the crack pipe.

By the way, the President’s plan was to get Fannie Mae and Freddie Mac on the hook for mortgages, without government backing up everything. He talked about a bunch of rules and guidelines that need to be established that are actually critical to getting credit flowing to creditworthy borrowers that are shut out of the system by confusion and nervousness among lenders about how these rules will turn out.

Take "put-backs," for example. When banks originate a mortgage loan, they then typically sell it to a secondary buyer, which these days means Fannie or Freddie. But if something is wrong with the documentation, the appraisal, or the underwriting procedure of the loan, the current holder of the security can insist the bank take it back in a forced repurchase.

These put-backs have become a lot more common in recent years, as we've learned that the banks had a habit of putting bad things in the documentation. One problem is that there's a real lack of clarity as to what constitutes a "put-back-able" offense, and that's led nervous lenders to lend only to those with the pristine credit scores. Getting the regulators to fix this should be quick work. Loan are going to be more standardized, and if you can check all the boxes, it should be easier.

We know the world economic pattern we have been used to in years past–world population grows, resource usage grows (including energy resources), and debt increases. The economy grows fast enough that paying an interest rate a little higher than the inflation rate “works” for both lenders and borrowers. Borrowers are able to handle the required interest rate, because their wages are rising fast enough to buy homes and cars at prevailing interest rates. Unemployment is not too much of a problem because jobs grow with population and resource usage. Governments do fairly well, too, because they can tax the growing wages of the population sufficiently to get enough taxes to pay the benefits they have promised to constituents.

This model “works” fairly well, as long as the economy is growing fast enough–population continues to grow and resource extraction continues to grow as planned. In a finite world, we know that this model cannot work forever. At some point, we can expect to start reaching limits.

What do these limits look like?  I would argue that in the case of resource extraction, these limits look like increasingly high cost of extraction. We need to extract resources from increasingly deep locations, in increasingly out-of-the way places, using increasingly more energy intensive techniques. For a while, improved technology is sufficient to keep costs down, but eventually the cost of extraction begins to rise. 

When the cost of extraction begins to rise, it is as if we are pouring more manpower and more resources of many types (steel, fracking fluid, jet fuel, electricity, diesel fuel) into a deep pit, never to be used again. When we put more resources in, we get the same amount of resource out, or even less than in the past. If we want to continue to increase the amount we extract, we have to further increase the quantity of resources used in extraction. Obviously, if we put more manpower and other resources into this pit, we have less for other purposes.

A recent example of resources hitting limits is oil. World oil prices started increasing about 2004. If the sales price of oil rises, to what extent will this increase adversely affect the economic growth oil importing economies? While the cost of oil extraction is expected to continue to rise, can the sales price of oil really increase to match this higher extraction cost? If oil price can’t rise because of affordability issues (low salary growth, low growth in debt, or cutbacks in government transfer payments), then there is likely to be a crisis of a different kind.

Agencies such as the International Energy Agency use projected GDP growth in estimating future demand for energy products, including oil. Growth in oil usage would also be expected to mirror GDP growth, but at a slightly lower rate of increase than growth of energy use in general. This is the case because oil is the most expensive of the major energy products. Consequently, there is a strong incentive to switch to cheaper energy products or to increase efficiency. 

So, as we look at the Federal Reserve, and which way they are blowing on the issue of QE, keep in mind oil prices.

This is the 68^th anniversary of the nuclear age. August 6, 1945 the US dropped the bomb on Hiroshima. The news came in the form of a little more than 1,000 word press release. The first few sentences of the statement set the tone: “Sixteen hours ago an American airplane dropped one bomb on Hiroshima, an important Japanese Army base. That bomb had more power than 20,000 tons of TNT.…The Japanese began the war from the air at Pearl Harbor. They have been repaid many fold…. It is an atomic bomb. It is a harnessing of the basic power of the universe.”

One thing the press release did not talk about was the long lasting consequences of radiation.

In 2011, Japan was hit by an earthquake and tsunami which resulted in massive damage, including a nuclear energy plant. Now, Japan's nuclear watchdog says the crippled Fukushima nuclear plant is facing a new emergency caused by a build-up of radioactive groundwater. The Nuclear Regulatory Authority warns that a barrier built to contain the water has already been breached. This means the amount of contaminated water seeping into the Pacific Ocean could accelerate rapidly. It's not a surprise; there have been multiple water leaks at the plant. Its operator, Tokyo Electric Power Company (Tepco), has been criticised heavily for its lack of transparency over the leaks.

Tepco admitted for the first time last month that radioactive groundwater had breached an underground barrier and been leaking into the sea, but said it was taking steps to prevent it. However, the head of a Nuclear Regulatory Authority task force, says the countermeasures were only a temporary solution, and the situation is now considered an “emergency”.

JPMorgan Chase announced today that it is being investigated by civil and criminal divisions of the Department of Justice over offerings of mortgage-backed securities. The civil division gave the company a notice in May that it had preliminarily concluded that the firm violated federal securities laws in offerings of subprime and Alt-A residential mortgage securities during 2005 to 2007. The company made the disclosures in a quarterly filing with the Securities and Exchange Commission. The criminal side is apparently new, and long overdue. Interesting that they get a notice of the investigation.

Meanwhile, we told you about how Goldman Sachs has a subsidiary which warehouses aluminum in Detroit. And Goldman has been hoarding the aluminum, creating supply imbalances to drive up prices, and then trading on the information. The lawsuits are starting to fly. Last week, Goldman and the LME were named as defendants in a Detroit lawsuit. Today, a new lawsuit filed by Florida-based aluminium user Master Screens and an individual plaintiff, expands the geography and number of companies being sued: Glencore Xstrata and JPMorgan Chase are also named. The Florida lawsuit alleges "manipulation of the aluminium market through supply price fixing," among other practices, and is seeking class action status. 

Monday, January 7, 2013 - I Went on Vacation and Not Much Changed

I Went on Vacation and Not Much Changed

by Sinclair Noe

DOW – 50 = 13,384
SPX – 4 = 1461
NAS – 2 = 3098
10 YR YLD -.01 = 1.90%
OIL + .21 = 93.30
GOLD – 9.90 = 1647.90
SILV - .02 = 30.26

Forty years ago, Yale Hirsch at the Stock Traders Almanac, created the January Barometer. The idea was simple: as the S&P 500 goes in January, so goes the year. This market prediction tool has been correct 89% of the time since 1950, suffering only seven major setbacks. Since 1950, stocks have finished lower for the year only three times after posting gains in January. When the Dow is positive in January, then the rest of the year is positive 83% of the time, averaging additional gains of 9.59%. Compare that to the Dow’s performance when January is negative. In those years, the February-December returns are positive just half of the time, with an average gain of 2.04%.

As with the full-year results, a positive January typically leads to a positive February. When the Dow closes higher in January, February goes on to average a return of 0.57%, and is positive 63% of the time. When January is negative, February is negative more than half the time, and averages a loss of more than 1%. However, an outsized return in January has not necessarily translated into a bigger return for February. If January is up more than 3.5%, the average February gain is not as big as if January is simply positive.

Price movement in January is also a pretty good predictor of price movement in February for individual stocks; not a perfect predictor but usually moving in the same direction about 80% of the time.

Many investors look to the first five days of January as a gauge of where the markets are going for the rest of the year. During the last 40 years when those five first days were gainers, the markets were up for the entire year 85 percent of the time. For example, last year the S&P 500 Index gained 1.2 percent in the first five days of January. As a result, the S&P 500 Index was over 13 percent. That was close to the historical average. Over the last 39 years, the markets gained an average of 13.6% when the first five days of January were gainers.

Conversely, when the first five days are negative the markets were down for the year, but only 47.8% of the time. The indicator therefore, does not work as well on down periods. You should be aware that, in general, during post-election years the markets have not done well. Only 6 out of the last 15 post-election years saw gains in the first five days of the year. It looks like 2013 will be an exception. Maybe, maybe not. That's why they play the game.

The fiscal cliff is behind us, sort of; there are still the actual implications of the implementation of the changes. Then, we have the debt ceiling, which will be the next catastrophic, OMG, here comes another massive economic sky-is-falling event, they'll shut down the government if they don't get cookies for lunch, political tantrum. Before we move to the next news cycle, let's review briefly the fiscal cliff calamity that was narrowly averted, specifically $205 billion in corporate tax breaks, subsidies and tax loopholes. One of the most egregious giveaways included in the New Year's Eve fiscal cliff deal is an extension of a loophole that allows corporations to book US profits in overseas, tax-free accounts. US companies have about $2 trillion in these offshore accounts.

Another corporate tax benefit included in the fiscal cliff deal is a provision known as bonus depreciation, which allows companies that invest in costly equipment to account for depreciation expenses much faster than they otherwise could. In other words, companies can deduct more in expenses now, lowering their taxable income.

Congress has extended the provision each year since 2008 in an effort to spur business investment during the economic downturn. Bonus depreciation is expected to cost $35 billion this year, according to the Joint Committee on Taxation, and those costs are predicted to rise significantly if Congress keeps extending the benefit. The Congressional Research Service issued a report saying that accelerated depreciation is a “relatively ineffective tool for stimulating the economy.”

I guess that avoiding the fiscal cliff is a good thing; it shows the politicians can do something; even if it's the same old, same old.

New Year, things change, but not much. Let's see what the banksters have been up to. Once again the banks are body slamming the banking regulators. The banks have beaten down the tough parts of Basel III bank-capital standards. The global liquidity standards were designed to ensure banks had sufficient capital on hand to survive another Lehman-like crisis, as well as require that capital be high-quality and liquid. There was a lot of fanfare from regulators when the regulations were first announced in 2010, and then the banks started to chip away at the regulations which might require a little cushion against a downturn. The regulators succumbed to pressure. We're all shocked, shocked I tell you. The new capital rules have been expanded to change the definition of what constitutes safe bank capital to include stocks and AAA rated mortgage backed securities.

Now, you're probably asking yourself, “Self, weren't stocks and mortgage backed securities really dangerous and excessively risky investments that were a big part of the financial crises of the recent past?” And of course the answer is – yes. “Self, didn't those risky gambles lead to a freeze on the credit markets and the near collapse of the global financial system?” And again, the answer is – yes. And then you ask: “Self, does this mean we'll see Hank Paulson getting down on his knees to beg Nancy Pelosi to save him from his errors?” And the answer is no; that's not going to happen again, but clearly we haven't learned our history lessons.

In a world of Too Big to Fail banks that have only gotten bigger, the regulators decided that if the banks were to face a crisis, like the recent crisis, the banks would only have to prepare for a world in which they lose 3 percent of their retail deposits, down from 5 percent originally proposed. Complete amnesia when it comes to Northern Rock or IndyMac. And then the banks have four years to gradually phase in the new, scaled down 3-percent requirements, down from the 2-year requirement originally proposed. The banks argued that if they were forced to provide a 5-percent cushion and do so within two years, it would be too much of a burden and they wouldn't be able to do any lending, which might actually help the global economy.

Meanwhile, federal bank regulators announced an $8.5 billion settlement with 10 large mortgage companies in a deal that will end a near worthless foreclosure review program in favor of a new program that authorities say will distribute aid to homeowners "significantly more quickly."

Under the deal, announced by the Office of the Comptroller of the Currency and the Federal Reserve, the mortgage companies will make $3.3 billion in direct payments to "eligible borrowers" whose foreclosures were handled improperly, and will make $5.2 billion available in other assistance to struggling borrowers, such as loan modifications.

This new deal is separate from the $25 billion mortgage settlement to which five large banks agreed earlier this year, though many of the allegations of misconduct are the same. Homeowners have complained for more than five years that the mortgage companies made widespread errors in the management of their home loans, and that in some cases those errors pushed them into foreclosure.

This new settlement replaces a deal struck in April 2011 that established the Independent Foreclosure Review; that program was supposed to give homeowners an unbiased third-party review before the banks could foreclose, and might even determine if homeowners qualified for a cash payout because of mortgage related bank abuses. So, that program never really happened, and today's announcement is basically saying the Independent Foreclosure Review was a complete failure.

What went wrong? Part of the problem is that the third-party independent reviewers actually worked at the banks' beck and call. So, ten different banks will pay out $8.5 billion to end the foreclosure reviews.

But wait, there's more!

Bank of America announced today that it will spend $10 billion to settle mortgage claims resulting from the housing meltdown. BofA will pay $3.6 billion to Fannie Mae and buy back $6.75 billion in loans that the bank and its Countrywide banking unit sold to the government agency from Jan. 1, 2000 through Dec. 31, 2008. That includes about 30,000 loans.

Bank of America said that the loans involved in the settlement have an aggregate original principal balance of about $1.4 trillion. The outstanding principal balance is about $300 billion. Fannie Mae and Freddie Mac, which packaged loans into securities and sold them to investors, were effectively nationalized in 2008 when they nearly collapsed under the weight of their mortgage losses. So, all in all, BofA gets off really cheap.

Fannie Mae issued a statement saying they had “diligently pursued repurchases on loans that did not meet our standards at the time of origination, and we are pleased to have reached an appropriate agreement to collect on these repurchase requests."

And so, there is $8.5 billion for ten banks, and $10 billion in fines for BofA, and you might think that's real money, and it almost is, but keep it in perspective. The six biggest US banks are expected to pay employee bonuses of $38 billion for the past year.

Bank stocks led all other major stock sectors in 2012. The KBW Bank Index rose more than 30% compared to just over 13% for the S&P 500, and Bank of America shares surged 109%--more than doubling in price. And according to a new report from ProPublica, many banks are still trading below book value, despite the gains in share prices, and much of the gain is due to hedge fund speculation.

And so, you're probably asking yourself: “Self, wasn't hedge fund speculation a big part of the near meltdown of the global financial system? Isn't this just part of the multi-trillion dollar derivatives casino? Isn't this the same sort of risky stuff that the London Whale was betting on and which led to $2 billion in trading losses, or $5 billion, or $6 billion in gambling losses?” And the answer is – yes.

A funny thing is happening in the copper markets. The SEC has paved the way for investors to take a direct stake in commodities, rather than through commodities futures. The agency gave the green light to JP Morgan to launch a fund whose shares would be backed by warehoused copper. In practical terms, the SEC handed traders at JP Morgan control over 20 to 30 percent of the copper available for immediate delivery from the London Metals Exchange — the commercial market where companies that use copper go to procure last-minute supplies.

The investors purchasing shares in J.P. Morgan’s fund won’t be buying copper to use, but to store. The intricacies of the fund are complex, but its underlying rationale is straightforward: the more shares investors buy, the more copper is taken off the market. And the more copper that is taken off the market, theoretically the more valuable the copper and the shares become.

Moreover, it’s a no-brainer that this JP Morgan “innovation” will lead to the creation of copycat fund in other markets, most troublingly those for agricultural products.

The SEC asserts that its own study showed that changes in inventory levels at the LME did not have a price impact. If you've ever heard a little theory known as supply and demand, you might reach a different conclusion than the SEC.

The question regarding the LME would be to define what a normal level of inventory would be (a certain level is necessary to handle routine transactions); amounts in excess of this buffer level would be seen by economists as proof that prices were above the true market clearing price unless you had a good explanation as to why not.

Companies that use copper strongly oppose the new fund, and argue that allowing investors to hoard the metal will lead to supply shortages, create substantial price volatility, and distort the market. A group of copper users wrote to the SEC in August, saying: “The implications of this practice would be grave for our companies, our industry, and, indeed, for the U.S. Economy.”

The SEC is undermining provisions in Dodd Frank calling for the CFTC to rein in undue speculation in critical commodities. You might remember that commodities prices moved up in a coordinated manner in 2008. Remember when oil prices jumped up near $150 a barrel? It looked like a speculative bubble, and was, since prices collapsed in the second half of the year. Well, there was similar behavior in other commodities.

Here, you’re allowing investors to intervene with physical supplies. BlackRock has petitioned the agency to launch its own copper fund, one that would be twice as large as JPM’s and will get an answer by February 22. Given that its proposal is identical to JPM’s, it is well nigh certain to be waved through. If the nay sayers are correct, that hoarding by investors will drive prices up, we should see the impact, although the mere announcement of the JPM approval, particularly in light of the pending BlackRock application, may have led speculators to bid up prices in anticipation of the funds’ launch. That too should be measurable, but if the next few months proves the SEC analysis to be wrong, you can bet the agency won’t admit its error and halt the creation of more funds.

Same old, same old. 

Wednesday, October 24, 2012 - Do the Hustle

Do the Hustle

by Sinclair Noe

DOW – 25 = 13,077

SPX – 4 = 1408

NAS – 8 = 2981
10 YR YLD +.01 = 1.77%
OIL - .43 = 88.30
GOLD – 6.20 = 1702.50
SILV + .06 = 31.83
PLAT – 12.00 = 1566.00

Someday, we'll get through a whole week without having to report on the never-ending string of bad behavior by the big banks. I thought this might be the week. There were other things in the news; the Presidential debate on Monday; the Federal Reserve FOMC meeting today. We even had a proxy for the bad banks; the giant insurance company AIG reached a settlement with 39 states for creating a death list, where they would stop paying on annuities when someone died but they wouldn't look for beneficiaries of a life insurance policy. Then to top it off the CEO, Robert Benmosche, said he was indignant that nobody in the government had thanked him for paying back the bailout money that kept the company from total collapse 4 years ago. And over the past couple of weeks, Chase and Wells Fargo were sued for shoddy and virtually non-existent underwriting of mortgages that failed. Who was left?

You might think the big bad banks would take the week off from the news cycle. Yes, someday, we'll break the bonds of this gruesome litany of dirty deeds; someday this war will end. But not today.

The latest federal lawsuit over alleged mortgage fraud paints an unflattering picture of a doomed lender: Executives at Countrywide Financial urged workers to churn out loans, accepted fudged applications and tried to hide ballooning defaults. The prosecutor described Countrywide's reckless lending practices as “spectacularly brazen in scope.”

The suit claims Countrywide introduced a program called the “Hustle” or “High Speed Swim Lane” (lousy acronym)to churn out mortgage loans. No income, no problem. If the computer program raised a red flag, just change the numbers. Bonuses were based on quantity not quality; and later, bonuses were paid on the ability to hide the high number of defaults. We've seen this story before:everyone was incompetent, nobody verified income in the no-income-verification loans, when they found defects they hid them, and there were sleazy changes in procedures and compensation practices whereby Countrywide went from “try to originate lots of good mortgages” to “try to originate even more lots of mortgages with no quality standards whatsoever and also there’s a bonus for steamrolling quality-control checks.” Also it’s got a terrible name – the “Hustle”; one of these days there’s going to be a lawsuit about a mortgage lender called the Fast Underwriting Basis Alternate Rate program. Figure out the acronym for yourself, or make up your own; it's fun.

And after Countrywide wrote the loans and lied about the quality of the loans, they sold the loans to Fannie Mae and Freddie Mac; that's where we all get involved. Taxpayers have spent $170 billion to keep Fannie and Freddie afloat, and it could cost $260 billion more to support the companies through 2014. The lawsuit says that Fannie and Freddie suffered $1 billion in losses because they had to pay for Countrywide's defaulted loans. The lawsuit also complains that Bank of America is refusing to buy back mortgages "even where the loans admittedly contained material defects or even fraudulent misrepresentations."

Bank of America bought Countrywide Financial in 2008 and it’s fair to say it hasn't been a happy marriage; the Murdoch Street Journal totaled up the Countrywide losses at approximately $40 billion, as of last summer. If you held stock in BofA, be sure to thank Hank Paulson and Angelo Mozilo. If you were trying to figure out the maximum past and future losses you might start with the fact that Countrywide Financial originated about $2.25 trillion of mortgages between 2003 and 2007.

The fun fact about today's lawsuit is that it is originating from the Department of Justice; meanwhile, Fannie and Freddie are independently trying to get back money from BofA. Now I don't know if these are overlapping bad mortgages, or a different batch of bad mortgages.

Another day another bad bank story. The Royal Bank of Scotland agreed to pay $42.5 million late Tuesday in a settlement with the Nevada attorney general that ends an 18-month investigation into the deep ties between the bank and two mortgage lenders during the housing boom. Most of the money paid by R.B.S. — $36 million — will be used to help distressed borrowers throughout Nevada. In addition, R.B.S. agreed to finance or purchase subprime loans in the future only if they comply with state laws and are not deceptive. The settlement between the bank and Catherine Cortez Masto, Nevada’s attorney general, relates to conduct at Greenwich Capital, the R.B.S. unit that bundled mortgages into securities and sold them to investors. Nevada found that R.B.S. worked closely with Countrywide Financial and Option One.

International Paper has agreed to pay the FDIC to settle a year-old lawsuit stemming from the 2009 collapse of Guaranty Financial Group, an Austin, Texas, company that ranks as the fifth-biggest U.S. bank failure. As part of the agreement, the failed bank’s creditors will get an added $38 million, bringing the total settlement to $80 million. Although International Paper didn’t have any direct connection until this year to the banking industry or to the failed Texas bank, its involvement in the case demonstrates the long tentacles of the financial crisis. International Paper was pulled into the case in February when it bought packaging firm Temple-Inland, which had owned Guaranty for nearly two decades before spinning it off into an independent company in 2007. Guaranty failed less than two years later, weighed down by toxic securities that were backed by adjustable-rate mortgages. It had 162 branches and $13.5 billion in assets. The failure cost the FDIC’s deposit-insurance fund $1.29 billion

Meanwhile, with a splash of irony that would make even Socrates cringe, the Federal Reserve concluded its FOMC meeting today and announced they will keep interest rates at zero and they will stimulate the economy by purchasing $40 billion a month in mortgage backed securities until the economy improves or the cows come home. The Fed went on to say that inflation is not a problem, consumer spending isn't strong but it isn't weak and the economy continues to expand as it is stumbling along and they really didn't say much with two weeks to go before an election. The FOMC meets again in December, just in time to preview the fiscal cliff. For now, job growth has been slow and the unemployment rate remains elevated, so pass the MBS.

Fed Chairman Bernanke is seeking to spur the economy with a third round of quantitative easing, and he says his stimulus works by lowering borrowing costs and encouraging investors to seek higher-yielding assets. Boosting home and equity prices through bond buying will encourage consumers and businesses to spend more. Since these are the same assets that plummeted during the financial crisis after reaching record highs, “is there some risk you could start a new bubble and repeat the whole cycle?

While Federal Reserve Bank of New York President William Dudley acknowledged that current policy “could distort asset allocations and lead to renewed financial-asset bubbles,” this isn’t a risk now, he said in an Oct. 15 speech. Dudley says: “There is little evidence of problems or excesses, but this could change.” Dudley said the Fed’s policies are affecting yields in the bond market though “to say that’s a bubble, I don’t think that’s quite right.” He added that the debt market is a “lever of policy” for the central bank. And we should pay no attention to the man behind the curtain, pulling the levers.

The Standard & Poor’s 500 Index reached 1,465.77, the highest since 2007, on Sept. 14, the day after the FOMC said it would buy $40 billion of mortgage-backed bonds a month without limiting the total or duration of purchases. QE1, QE2, Operation Twist, and the ECB-led Long-term Refinancing Operation which a year ago was a really big deal in unleashing a massive global risk-on trade. But this time around the laws of diminishing returns are setting in. Six weeks after the unveiling of QE3, the market is down 2%. This hasn't happened before. Every economic-sensitive sector is in the red, and even Financials, the one sector that should benefit, have made no money for anybody.

Home prices also have begun to rise, jumping in the second quarter by the most in more than six years. The real question is how does the Fed know whether or not these prices will prove to be justified in the long run? The Fed doesn’t have perfect knowledge about what constitutes a sound long-term price for equities or housing, but this is a risk the Fed is willing to take. I know you don't want to fight the Fed, just be careful when they send you out to hunt high yield.