Monday, August 11, 2014 - Dog Days

Dog Days
by Sinclair Noe

DOW + 16 = 16,569
SPX + 5 = 1936
NAS + 30 = 4401
10 YR YLD + .01 = 2.42%
OIL + .20 = 97.85
GOLD – 1.20 = 1308.90
SILV + .10 = 20.11

It was actually a quiet day on Wall Street; not much economic data today; we’re winding down earnings reporting season. It is a Monday, so there was some M&A action, but for the most part a slow day; we used to call them the dog days of summer. On a day like this, you can claim whatever you want for whatever market movement there is.

NATO sees a "high probability" of a Russian invasion of eastern Ukraine as some 20,000 Russian troops massed on the nearby border. Kiev had the number at 45,000 Russian troops. The Kremlin announced it had sent a convoy of humanitarian aid to Ukraine under the auspices of the International Red Cross. Western governments are generally opposing, in advance, any Russian aid missions, which they fear could serve as a pretext for a military incursion to support pro-Russian separatists fighting the Ukrainian Army in the country’s southeast. The European Commission issued a statement warning “against any unilateral military actions in Ukraine, under any pretext, including humanitarian.”

Ukraine, the United States and European nations have repeatedly warned Russia against mounting a stealth invasion under the disguise of humanitarian aid, and have looked on with growing alarm as Russian officials have spoken in ever-stronger terms about the humanitarian plight of eastern Ukrainians.

Meanwhile, the US continues its bombing-slash-humanitarian mission in Iraq. The United States launched a fourth round of airstrikes Sunday against militant vehicles and mortars firing on Irbil as part of efforts to blunt the militants' advance and protect American personnel near the Kurdish capital. Reinvigorated by American airstrikes, Kurdish forces retook two towns from Sunni militants. U.S. warplanes and drones have also attacked militants firing on minority Yazidis around Sinjar, which is in the far west of the country near the Syrian border. The US has begun providing weapons to Kurdish forces; the move to directly aid the Kurds underscores the level of  concern about the ISIS militants' gains in the north.

Iraq's president named a new prime minister to end Nuri al-Maliki's eight year rule, but Maliki refused to go after deploying militias and special forces on the streets of Baghdad. But Maliki's Dawa Party declared his replacement illegal, and Maliki's son-in-law said he would overturn it in court. Washington delivered a stern warning to Maliki not to "stir the waters" by using force to cling to power. Maliki himself said nothing about the decision to replace him.

Maliki's opponents accuse him of  keeping key security posts in his own hands instead of sharing them with other groups, alienating Sunnis in particular by ordering the arrest of their political leaders. Islamic State fighters were able to exploit that resentment to win support from other Sunni armed groups. Maliki's Shi'ite State of Law bloc emerged as the biggest group in parliament in the April election, but does not have enough seats to rule without support from Sunnis, Kurds and other Shi'ite blocs, nearly all of which demand he go. Maliki also appears to have alienated his supporters in Iran. Obama says a more inclusive government in Baghdad is a pre-condition for more aggressive US military support against ISIS.

Israeli and Palestinian negotiators resumed indirect talks mediated by Egypt today, as a 72 hour ceasefire appears to be holding, at least for the first few hours.

So, we still have geopolitical hotspots, but for today, they are smoldering rather than exploding; although that could change in a heartbeat.

Stanley Fischer, who took over as vice chairman of the Fed in June, deliver a speech in Stockholm today.  Fisher says economists and policy makers had been repeatedly disappointed as the expected level of growth failed to materialize: “Year after year, we have had to explain from midyear on why the global growth rate has been lower than predicted as little as two quarters back.”

Fischer said it was difficult to determine how much of the slackness was because of cyclical factors and how much represented a more fundamental, structural change in advanced economies. He warned of 3 headwinds to growth: a weak housing market, cuts in federal government spending and weaker global growth that reduced demand for American exports. Fischer also questioned whether the recent weak growth is a temporary problem or a more long-term structural problem. 

A new report from the US Conference of Mayors looks at the weakness of earnings in the recovery. Jobs growth in the US since the 2008 recession has been undermined by lower wages, with workers earning an average 23% less than earnings from jobs which were lost. The average annual salary in sectors where jobs were lost - particularly manufacturing and construction - during the 2008-9 financial crisis was $61,637; Job gains through the second quarter of 2014 in comparative sectors showed average wages of $47,171, implying $93 billion in lower wage income. The report also showed that 73% of metro areas had households earning average salaries of less than $35,000 a year. American workers, on average, earned $24.45 an hour in July, up only a penny from June. Over the last year, wages have grown just 2%, in keeping with where they have been stuck since late 2009. The study also found a continuing accumulation of wealth among the top 20% of the nation's earners. From 2005 to 2012, the highest income bracket was responsible more than 60% of all income gains in the country.

The pipeline group Kinder Morgan, the biggest of the master limited partnerships, announced yesterday that it would acquire its three associated companies and reorganize as one corporation based in Houston. The new Kinder Morgan will have an estimated enterprise value of about $140 billion, $100 billion of market value and $40 billion of debt, making it the third-biggest energy company in the United States, after Exxon Mobil and Chevron. Kinder Morgan, which encompasses a huge network of oil and gas pipelines across North America, will acquire its two related M.L.P.s ‒ Kinder Morgan Energy Partners and El Paso Pipeline Partners ‒ and a third related company, Kinder Morgan Management, for $71 billion. Kinder Morgan will pay a premium for each company and use mostly stock to finance the purchases, allowing shareholders of the three targets to essentially continue their ownership.

Under the existing structure, Kinder Morgan’s related companies were obliged to pay out a majority of their profits to investors, including significant payments to Kinder Morgan itself. The distributions had grown so large in recent years that Kinder Morgan was lending money back to the related companies so they could fund growth. It was a profitable arrangement, but became overly complex and ultimately constricted the combined companies’ growth. The move is expected to free up cash for the company to invest in new capital expenditures needed to accommodate new reserves of natural gas being tapped across North America. It’s also expected the move will allow Kinder Morgan to become more acquisitive.

Last week, Bank of America reportedly agreed to a settlement deal with the Department of Justice for $16 billion, with $9 billion in cash fines, and $7 billion in soft dollar relief to borrowers. We still haven’t heard confirmation; but that would break the record for the largest bank settlement in history, set less than a year ago by a $13 billion agreement between Justice and JPMorgan Chase.

The numbers that accompany these deal announcements always seem impressive. But how large are they, really? That depends on your point of view. Bankers fraudulently inflated a housing bubble. They became extremely wealthy as a result, but the housing market lost $6.3 trillion in value when the bubble burst. It had only recovered 44% of that lost value by of the end of 2013. That's more than $3 trillion still missing from American households. As of the first quarter of this year,  9.1 million residences - 17% of mortgaged homes - were still "seriously underwater," which means that homeowners owed at least 25% more on the home than it was worth.

And homeowners weren't the only ones hurt by banker misdeeds. When the bubble burst, it took the economy with it. Unemployment and underemployment remain at record levels, even as the stock market surges and corporations enjoy record profits. Payments on those 9.1 million underwater mortgages are a form of wealth transfer from Main Street to Wall Street, as homeowners continue to overpay the bankers who inflated those mortgages in the first place - or risk losing their homes to them. If this added burden harms their credit score, they'll pay banks more for other forms of borrowing as well.

And yet, these settlements do not require banks to provide principal relief for these underwater homeowners. They don't ask banks to return homes that they wrongfully took from their owners. They don't ask banks to forfeit every penny of earnings received through forgery or perjury. They don't even ask them to restore the credit ratings of defrauded customers. What's more, there's very little reason to believe that these large sums will be paid in full. Much of the "consumer relief" in past deals has turned out to be nothing more than gamesmanship with numbers. Banks modify loans in ways that are advantageous to them, offer deals they almost certainly would've offered anyway, and then count them against their "settlement" obligations. What's more, it hasn't been announced whether this deal will be tax-deductible. If so, Americans will get shortchanged at the federal level, too.

Bank of America is a repeat offender with six violations since November 2011, but there have been no criminal prosecutions of big-bank executives, an omission that Federal Judge Jed S. Rakoff lamented in a recent speech. Rakoff called the lack of prosecutions from the Justice Department and the Securities and Exchange Commission "technically and morally suspect" and characterized the excuses they've given for failing to prosecute as "hollow" and "lame."

Thursday, March 06, 2014 - Energy as Arsenal

Energy as Arsenal

by Sinclair Noe

DOW + 61 = 16,421
SPX + 3 = 1877
NAS – 5 = 4352
10 YR YLD + 4 = 2.74%
OIL + .45 = 101.90
GOLD + 13.60 = 1351.40
SILV + .28 = 21.54

The Standard & Poor's 500 index closed at another all-time high. The number of people who filed for unemployment benefits last week fell more than expected. That's a sign fewer workers are being laid off. Tomorrow we have the monthly jobs report and we’ll see.

Does a string of weak economic data in recent months represent a genuine slowdown in US economic growth, or is it just weather-related noise? The February jobs report might not provide much clarity because the reference week for the household survey coincided with a mid-February storm that dumped ice and snow (again) on much of the eastern US. Federal funding for extended unemployment benefits expired at the end of December, so we’ll be watching the jobs data to see what happens to people who have been out of work for more than six months.

Of course, the jobs number is hugely important because it supposedly plays into Federal Reserve monetary policy. Fed officials have signaled they’re on track to trim the central bank’s bond-buying program in $10 billion increments this year. The jobs report probably would need to very ugly to change their minds. Of course, the past two months of jobs numbers have been ugly but that was dismissed as weather related. Maybe the February report will be affected by weather as well. One bad report can be explained away, but three starts looking like a trend, despite the weather.

The situation in Ukraine is stable but escalating. Today, Crimea's parliament voted to join Russia and its Moscow-backed government set a referendum in 10 days' time. The EU condemned Russian actions in Crimea as illegal, voiced support for Ukraine's territorial integrity but took only minor steps suspending talks with Moscow on visas and a new investment pact while warning of tougher steps if there is no negotiated solution within a short period. President Obama announced plans to punish Russians and Ukrainians involved in what he called "threatening the sovereignty and territorial integrity of Ukraine".

The US and EU allies unveiled a coordinated set of sanctions to punish Russia for occupying the Crimean peninsula, imposing visa restrictions on individuals. The White House said its visa bans will affect an unspecified number of Russian and Ukrainian individuals immediately, with the threat of asset seizures and bans doing business in the US hanging as a deterrent against further escalation in Ukraine. The EU agreed to suspend visa and investment talks with Russia and held out the prospect of a full-blown trade and economic conflict with Russia unless there was a diplomatic breakthrough. Secretary of State John Kerry continued meetings with Russian foreign minister Sergei Lavrov in Rome.

Specifically, the sanctions would target people who undermine Ukraine's democracy and new government; threaten the country's peace, security, stability and sovereignty; are linked to misappropriations of government assets; and try to assert governmental authority over any part of Ukraine without the consent of Kiev. They would also prohibit US citizens from doing business with those who have been sanctioned. The sanctions plan, outlined in an executive order, lays the legal groundwork for the Treasury Department to impose financial penalties on offenders.

The EU and the US have struggled to coordinate a response to Russia’s military moves. EU-Russia trade volumes, including vast gas imports and engineering exports, are 15 times the level of US-Russia trade. Washington has far less to lose from a trade war, and has been talking tougher. The White House rejected criticism that sanctions risked escalating the crisis.

 President Obama said there is a way for Russia to defuse the situation:  “While we take these steps I want to be clear that there is also a way to resolve this crisis that respects the interests of the Russian as well as the Ukrainian people,” repeating calls for international monitors to be allowed into the Crimea and other parts of the Ukraine to ensure Russian interests are not threatened. But Obama’s rhetoric was more combative than of late and he accused Russia of not just “violating sovereignty and territorial integrity” of the Ukraine but of “stealing the assets of the Ukrainian people”.

While the Ukraine story plays out, the European Central Bank met today to determine monetary policy. The ECB left interest rates on hold and unveiled no other measures to bolster a euro zone recovery. The ECB left its main interest rate at 0.25% and held the deposit rate it pays banks for holding their money overnight at zero. ECB President Mario Draghi also described as "relatively limited" the benefits of one technical option for loosening lending conditions, suggesting the bank will either do nothing or else take bold policy action should the outlook deteriorate.

Draghi said the latest economic information suggested recovery was on track and needed no extra push for now. The biggest concern right now for the ECB is inflation, or rather the lack thereof. The ECB’s primary goal is to maintain inflation at just below a target of 2%. But inflation has run at less than half of the target rate for some time, raising fears that the euro zone could tip into Japan style deflation. Draghi has said that inflation under 1% is in the “danger zone”. In 2016, the ECB reckons inflation will average 1.5%, or roughly double the current rate; and GDP growth was upgraded to 1.2% for this year; so, according to Draghi, everything is on track.  

According to the ECB’s forecast, the euro zone economy is in pretty good shape, all things considered. Although growth is weak and inflation is lower than the ECB would like, the bank believes that these indicators will continue to drift in the right direction. After each of the three rate-setting meetings so far this year, Draghi has said that the bank stands ready “to take further decisive action if required.” Based on his reading of the economy, he hasn’t yet seen the need to change course.

The situation in the Ukraine could change all that. Despite a few improvements, both European economic prospects and credit markets are showing signs of another slide. Unemployment remains high, financial indicators are moving south, and the likelihood of another interruption in Russian natural gas is hardly encouraging for either the residential or industrial end user.

This is anything but an abstract concern. Think of Ukraine as Russia’s fuel tank, or at the very least Russia’s pipeline to Europe. During the last Russian-Ukrainian spat, back in January 2009, during one of the continent's coldest snaps in recent history, a disagreement broke out between Gazprom and the Ukrainian national gas company Naftogaz Ukrainy. Before that, the Russians shut natural gas supplies in 2008 and 2006, resulting in a complete halt of the Russian gas pass-through across Ukraine, and some very cold folks further west.

Russia has always used gas as an instrument of influence. The more you owe Gazprom, the more they think they can turn the screws. Prices of some LNG cargos to Europe jumped above $30 per million British thermal units as a result of the disruption in 2009. Curtailing supplies now would be less disruptive to the market than in past years because a mild winter has kept Europe’s gas inventories 11% higher than at the same time last year.

The crisis has escalated a State Department initiative to use a new boom in American natural gas supplies as a lever against Russia, which supplies 60 percent of Ukraine’s natural gas. Europe, in turn, depends on Russia for 40% of its imported fuel. The administration’s strategy is to move aggressively to deploy the advantages of its new resources to undercut Russian natural gas sales to Ukraine and Europe, weakening such moves by Putin in future years. Although Russia is still the world’s biggest exporter of natural gas, the United States recently surpassed it to become the world’s largest natural gas producer.

The United States does not yet export its natural gas. But the Energy Department has begun to issue permits to American companies to export natural gas starting in 2015. American companies have submitted 21 applications to build port facilities in the United States to export liquefied natural gas by tanker. The agency has approved six of the applications. Even if the Energy Department approves all the pending permits from companies seeking to export natural gas, the fuel could not begin flowing overseas for at least a few years. Most American natural gas export terminals are in the early stages of construction.

In 2011, the Secretary of State Hillary Clinton created the State Department’s Bureau of Energy Resources for the purpose of channeling the domestic energy boom into a geopolitical tool to advance American interests around the world. It has been working, helping to lower Ukraine’s dependence on Russia for natural gas supplies to 60%, down from 90%. Now, there is a renewed push to allow nat gas exports.

This is not the first time energy resources have been used to gain geopolitical advantage. In 2012, in response to Iran’s nuclear program, the United States urged the Europeans to impose financial sanctions that greatly limited Iran’s ability to sell oil on the world market. Other countries feared that the move would raise prices, but officials assured other nations that a surge in American oil production would keep prices stable.

If you’re looking for companies involved in nat gas exporting, start with Cheniere Energy (LNG), Kinder Morgan (KMI) and Sempra Energy (SRE); but don’t forget other energy providers, especially in the renewable or green energy arena, for example the Solar energy ETF (TAN). These are not recommendations, only ideas for research.

Even after taking into account all the transportation, infrastructure, and storage costs, U.S. natural gas can easily compete with Russia's in terms of price. EU countries would probably be willing to pay a slight premium for US natural gas if it ensures energy security. It also serves American geopolitical interests.

The world is changing and energy runs the world.