Monday, July 28, 2014 - You Might Not Like the Solution

You Might Not Like the Solution
by Sinclair Noe

DOW + 22 = 16,982
SPX + 0.57 = 1978
NAS – 4 = 4444
10 YR YLD + .02 = 2.47%
OIL - .52 = 101.57
GOLD – 4.80 = 1304.50
SILV - .18 = 20.67

This will be a busy week for economic reports. Today’s reports included the National Association of Realtors’ index of pending home sales for June; it dropped 1.1%. This index looks at contracts signed, and usually about 80% of signed contracts result in a sale within 2 months. The pending home sales index is up 9% from February, but it is down 7.3% compared to June a year ago. The blame can be placed at the usual suspects: tough credit requirements, rising home prices, and weak wage growth.

In a separate report the Markit preliminary services Purchasing Managers Index for July was 61, unchanged for June; a reading above 50 indicates expansion. The services sector continued to add employees, though at a slower pace. The employment index fell from 56.1, the fastest rate on record, to 52.8 in July.

Wednesday morning brings the first estimate of second quarter gross domestic product. It is widely anticipated the economy grew at about a 3% pace in the second quarter, following a 2.9% contraction in the first quarter, largely blamed on bad winter weather combined with the expiration of long term unemployment benefits and working through excess inventory accumulation. So, the first quarter and second quarter will kind of cancel each other out and result in a flat first half. If the economy can maintain 3% growth for the next couple of quarters, it will result in annualized growth a little below 2%. Wednesday’s GDP report will include revisions to output for the past 3 years.

A few hours after the GDP report, the Federal Reserve FOMC will wrap up a 2 day meeting on monetary policy, and issue a statement. However, the Fed will not update its economic forecast, nor will they hold a press conference until the September 17^th FOMC meeting; so don’t expect any major changes to Fed policy this week. Still, Fed watchers will look for nuances to the Fed statement for any hint of policy changes, specifically when the Fed will start to raise interest rates.

Friday brings the non-farm payroll report for July. It is expected the economy added about 235,000 net new jobs in July; anything close is in the ballpark; anything under 200,000 or over 300,000 would shock the markets. The unemployment rate is expected to drop to 6%, but the unemployment rate has quite a few variables to consider, including the participation rate – the percentage of the population still looking for work or working. The participation rate has dropped from 65.8% in 2007 to 62.8% last month. This means that a lot of people have dropped out of the labor market. If some of those people re-enter the labor market and start looking for jobs, the unemployment rate could move higher, even if the economy adds a bunch of new jobs.

We kick off the week with a Merger Monday. Zillow will buy Trulia for $3.5 billion. Zillow and Trulia are No. 1 and 2 in the online real estate market, followed by No. 3 Move Inc. Zillow reported nearly 83 million monthly unique visitors in June. Trulia reported 54 million. The combination would create something like a monopoly in the online home hunting market.

Dollar Tree has agreed to buy Family Dollar Stores for $8.5 billion. The deal was pushed forward by investor Carl Icahn, who had built up a 9.5% stake in Family Dollar, and with the bump up in price from the merger, Icahn pockets a cool $150 million increase this weekend. The new Dollar Tree, or maybe Dollar Family Tree, would keep operating separate chains, but would have about 13,000 locations across the US and Canada, with 145,000 employees and about  $18 billion in revenue.

Tesla and Panasonic have reached a deal for Panasonic to invest in Tesla’s gigafactory. The initial Panasonic investment will be about $200 to $300 million, but could grow to $5 billion. The gigafactory would make battery packs for cars. Panasonic is the main supplier of battery cells for Tesla. Tesla has said it is evaluating sites in Arizona, California, Nevada, New Mexico, and Texas to place its massive battery factory. The electric car maker would break ground on the gigafactory later this year. Tesla is scheduled to report earnings on Thursday.

Lloyds Banking Group has agreed to pay $370 million to US and British regulators to resolve investigations into manipulating interest rates or Libor rate rigging. There were 2 main issues with Lloyds: rigging Libor, for which seven other institutions have already been punished; and for the first time, manipulating another rate, known as the repo rate. This repo rate was used to calculate the scale of the fees paid to the Bank of England for its special liquidity scheme (SLS), which was created in April 2008 to cheapen the prices at which money could be obtained by banks as the credit crisis unfolded; in other words, Lloyds manipulated their own bailout. The British lender is the latest big bank to admit criminal wrongdoing, and they entered into a deferred prosecution agreement. Under that agreement, Lloyds will avoid criminal charges if it stays out of trouble for the next two years.

Plenty of banks have entered into deferred prosecution agreements but I have never heard of one that violated a deferred prosecution agreement; and it isn’t because the banksters keep their nose clean; it’s because the regulators never apply the DPA.

Taking a look at geopolitical hotspots. Israel had agreed to a 12 hour ceasefire, but Hamas continued to fire rockets into Israel, so the ceasefire is off. Palestinian fighters launched a cross-border raid. Israeli Prime Minister Netanyahu is now warning of a protracted war in Gaza.

The Ukrainian government said today its troops had taken more territory from the rebels and were moving towards the site of the Malaysian airlines crash which international investigators said they could not reach because of the fighting. Meanwhile, US and European leaders agreed to impose wider sanctions on Russia's financial, defense and energy sectors.

Separately, an international arbitration court at The Hague ruled that Russia must pay $50 billion for expropriating the assets of Yukos, the former oil giant. Finding that Russian authorities had subjected Yukos to politically-motivated attacks, the panel made an award to a group of former Yukos shareholders that equates to more than half the entire fund Moscow has set aside to cover budget holes. The ruling hit back at decisions made under President Vladimir Putin's rule during his first term as president to nationalize Yukos and jail Mikhail Khodorkovsky, who had criticized him. The hardline approach was seen by Kremlin critics at the time as a stark message to oligarchs to stay out of politics. Khodorkovsky, who used to be Russia's richest man, was arrested at gunpoint in 2003 and convicted of theft and tax evasion in 2005. Yukos, once worth $40 billion, was broken up and nationalized, with most assets handed to Rosneft, an energy company run by an ally of Putin.

And don’t forget Libya. Two rival brigades of former rebels fighting for control of Tripoli International Airport have been throwing bombs at each other’s positions; then somebody bombed a huge nearby fuel depot, and that is now burning out of control. The conflict has forced Tripoli International Airport to shut down. Airliners were reduced to smoldering hulks on the tarmac and the aviation control center was knocked out. Libya's government has asked for international help to try to contain the disaster at the fuel depot on the airport road, close to other tanks holding gas and diesel. With Libyan security deteriorating, the United States evacuated its embassy in Tripoli on Saturday; British, Italian, Philippine, and Australian embassies have followed suit.

The typical American household has been losing ground. According to a new study by the Russell Sage Foundation the inflation-adjusted net worth for the typical household was $87,992 in 2003. Ten years later, it was only $56,335, or a 36% decline. Even as the average American household’s wealth declined, the net worth of wealthy households increased substantially. The average wealth of the American household in the 95th percentile was $1,192,639 in 2003, and $1,364,834 ten years later, an increase of 14%.

The authors of the study said the reason for the disparity was that affluent households were able to ride the success of the surging stock market after the 2008 crash, while middle class families were severely impacted by the decreasing value of their homes. Wealth declined for everyone in the aftermath of the Great Recession, but better-off families were able to rebound. Households at the bottom of the wealth distribution, on the other hand, lost the largest share of their wealth.

So, as we look at the economic news this week, the GDP estimate and the jobs report, it’s a little hard to imagine sustainable economic growth without a strong middle class. The lesson of the past 10 years, and we might even say the past 30 years, is that pumping up the upper echelons of the economy and hoping it trickles down to the rest, doesn’t work. The middle class gets clobbered, small businesses are being knocked out of the competition; in the early 1980s small business startups accounted for 50% of all business growth, but that dropped to 35% by 2010, and more small businesses are closing than are being created; and yes, that equates to fewer jobs being created by small businesses.

Back in 1929, the top 10% earned nearly 50% of the income. Today, income inequality is even wider. In 2012, the top 10% surpassed 50% of the total US income for the first time, and the problem has only grown in the past 2 years. Wealth disparity alarms often coincide with major financial peaks, such as 1929, 1999, 2007, and today; that’s because wealth disparity and income inequality are not sustainable, and there are only 2 solutions: the first is to grow the middle class, encourage small business, lift people out of long term unemployment; the second solution, is that the wealth distribution problem tends to be solved by falling markets.

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.

Friday, March 14, 2014 - The Circle of Life

The Circle of Life

by Sinclair Noe

DOW – 43 = 16,065
SPX – 5 = 1841
NAS – 15 = 4245
10 YR YLD - .01 = 2.64%
OIL + .81 = 99.01
GOLD + 10.90 = 1383.00
SILV + .29 = 21.56

In economic news, the early-March consumer sentiment index fell to 79.9. That’s down from a final February reading of 81.6 but the latest number is within the range of numbers posted since November.

A separate report from the Labor Department shows the producer price index dropped o.1% last month. The PPI measures inflation at the wholesale level. Final demand for goods rose 0.4% in February. Final demand for services dropped 0.3%. Producer prices excluding volatile food and energy costs fell 0.2%. In the 12 months through February, producer prices increased 0.9%, the smallest one-year gain since May 2013. Inflation is not a concern. The economy is still too sluggish to generate inflation.

There are two big news stories of the day: Flight 370 and Ukraine. We don’t know anything about either. A total absence of actual information about the missing Malaysian flight is not in any way hindering 24 hour news coverage of the story. Facts have given way to fantastic fantasizing about everything from terrorism to hidden island airstrips to alien abductions. The news networks have been gathering tons of erroneous and conflicting reports which they immediately pass to their viewers. They must think we’re all morons.

Secretary of State John Kerry and his Russian counterpart Sergei Lavrov wrapped up meetings in London by announcing they have no common vision on the crisis in Ukraine. Russia will go forward with a referendum vote on Crimean sovereignty on Sunday. Monday will be a strange day as we watch the markets try to weave a narrative.

The Swiss bank UBS said it will conduct an internal review of its precious metals business amid expanding regulatory investigations into potential manipulation of interest rates and the price of commodities and currencies. European regulators began looking at other benchmark rates, including for gold and silver, as part of an outgrowth of its investigation of rigging of the London interbank offered rate, or Libor, and other global interest rate benchmarks. The process of setting the benchmark price for gold in London dates to 1919. It is set twice a day by five firms that serve as market makers; those market makers are: Barclays, Societe Generale, Deusche Bank, Scotiabank, and HSBC.

The Hong Kong Monetary Authority said that after an investigation of nine banks that were part of the local consortium making daily submissions to determine the Hong Kong Interbank Offered Rate, which is used as a benchmark to price corporate loans, household mortgages and other types of debt; only UBS was found to have tried to manipulate the rate, but the regulators conclude that they were not good at rigging the rate, so no fines have been levied.

Today the Federal Deposit Insurance Corp sued 16 of the world's largest banks, accusing them of cheating dozens of other now defunct banks by manipulating the Libor interest rate. The big global banks broke certain swaps contracts they had entered into with the now-closed banks by separately colluding to rig the Libor rate to which the contracts were tied. Some of the big banks have already paid fines to resolve the charges; but the big banks are also being sued by investors and other who claim they lost money due to the manipulation.

A federal judge last March dismissed many of those claims that were based on antitrust law, but has yet to rule on cases that rely on the "breach of contract" theory used by the FDIC.

The Inspector General for the Department of Justice has released a report that basically says the crackdown on mortgage fraud is a joke. In 2010, Attorney General Eric Holder said, “mortgage fraud crimes have reached crisis proportions, but we are fighting back.” The only problem is it didn’t happen. More money was given to the FBI, but the inspector general’s report shows that the FBI considered mortgage fraud to be its lowest-ranked national criminal priority.

Holder announced in 2012 that prosecutors had charged more than 530 people over the previous year in mortgage fraud related cases, but the new report says the actual number of cases was 107. Yep, the regulators are now cooking the books.

Yesterday we reported that Wall Street bonuses grew 15% last year to more than $26.7 billion, or an average of $164,000 per employee, according to the New York Comptroller; it marked the third highest bonus payout on record. The average salary including bonuses in 2012 was $360,700, or more than five times greater than the rest of the private sector. The average Wall Street bonus is now 7 times larger than it was 30 years ago. Meanwhile the median household income has been stagnant for the past 30 years.

People who park their savings in these big banks accept a lower interest rate on deposits or loans than they require from America’s smaller banks. That’s because smaller banks are riskier places to park money. Smaller banks won’t be bailed out if they get into trouble; big banks are too big to fail. That implied government protection is like a hidden subsidy for the big banks, and it affords them a competitive advantage, and allows them to rake in more profits than smaller rivals.

How large is this hidden subsidy? Two IMF researchers have calculated it’s about eight tenths of a percentage point; and based on the total amount of money parked at the 10 biggest Wall Street banks that works out to a subsidy of about $83 billion a year. The top 5 banks account for $64 billion of the $83 billion subsidy; and that pretty much equals the top 5 banks average annual profits. Bottom line, no subsidy, no bonus pool.

Meanwhile, I almost missed this story from Tuesday. In Vermont, 15 towns have voted to support the creation of a public bank in Vermont, calling for the state legislature to establish such a bank and urging passage of legislation designed to begin its implementation. The specific proposal under consideration, Senate Bill 204, would turn an existing agency, the Vermont Economic Development Authority, into a public bank that would accept deposits and issue loans for in-state projects.

Currently, the only state in the US to maintain a public state bank is North Dakota. However, since the financial downturn of 2008, other states have looked into replicating the North Dakota model as a way to buck Wall Street while taking more control of state and local finances.

Here’s how the public bank in North Dakota works: All state revenues must be deposited with the state public bank by law.  The bank pays no bonuses, fees or commissions; does no advertising; and maintains no branches beyond the main office in Bismarck. The bank offers cheap credit lines to state and local government agencies. There are low-interest loans for designated project finance. The Bank of North Dakota underwrites municipal bonds, funds disaster relief and supports student loans. It partners with local commercial banks to increase lending across the state and pays competitive interest rates on state deposits. For the past ten years, it has been paying a dividend to the state.

An economic study on a public bank in Vermont suggests the plan would create 2,500 new jobs and increase the gross state product by more than $340 million, with no new appropriations or bonding to establish the bank.

And we wrap up with this; today is Pi Day. March 14, or expressed another way 3-14, which happen to be the first 3 digits of pi, that Greek letter that has come to be defined as the ratio of a circle’s circumference to its diameter; in other words the ratio of the linear distance around the edge of a circular object to its measure of a straight line going through the center of a circle connecting two points on the circumference. So, if you want to know the circumference of a circle you could just multiply the diameter times 3.14 (pi). This also happens to be the birthday of Albert Einstein, which just makes both all the more intriguing.  A year from today, the date will be 3-14-15, which happens to be the first 5 digits of pi; it’s a once in a lifetime event.

Pi is, of course, an irrational number, which means it cannot be expressed as a ratio. It’s a decimal that’s neither finite (like 2.0 or 2.2) nor repeating (like 3.3333) nor periodic (like 9.1818). It just keeps going past 3.14159 for as long as you’d like to take it. Some people have done the calculation out to more than 2 trillion decimal places, with the help of computers. And so we consider pi to be infinite.

Another way to consider this is that there is no perfect circle. Or we might say that since pi is an infinite, non-repeating decimal every possible number combination exists somewhere in pi’s infinite sequence of numbers, and if you were to convert it to ASCII text, somewhere in that infinite string of digits is the name of every person you will ever love, or even meet, plus the date, time and manner of your death, and every question and every possible answer, and all the mysteries of the universe are contained in this infinite sequence of digits, and the only way we can wrap our minds around it is to think of it as a circle.

Celebrate safely.

Monday, February 10, 2014 - Set the Tone

Set the Tone

by Sinclair Noe

DOW + 7 = 15,801
SPX + 2 = 1799
NAS + 22 = 4148
10 YR YLD + .03 = 2.69%
OIL + .12 = 100.00
GOLD + 7.90 = 1276.00
SILV + .07 = 20.18

A little bit of follow up to last Friday’s jobs report, which you recall came in at 113,000 jobs added in January and the unemployment rate dropping to 6.6%. There was a huge discrepancy between the household survey and the business establishment survey; the household survey showed 616,000 new jobs. The household survey can be a bit volatile and is considered less reliable. There is also a discrepancy between the establishment survey and a couple of earlier reports from ISM and ADP. The Institute for Supply Management services index came in at 56.4% in January, indicating a strong month for service jobs. The ADP, or Automatic Data Processing, employment report indicated 160,000 private sector service jobs were created in January, or about 100,000 more jobs than the government reported. It will be very interesting to watch revisions to the jobs report next month.

The major stock indices just loved the lousy jobs report, and this is a head scratcher for many people. Why would bad news on jobs be good news for stocks? Well, a weak job market gives employers the upper hand because most workers will accept lower wages, which translates into higher profits for corporate America. I know that is short sighted because the workers are also customers, but in the short term world of Wall Street, it makes sense.

The other reason is the Fed; and the Fed will likely continue its Zero Interest Rate Policy (ZIRP) as long as the labor market is lethargic. Continued low interest rates encourage corporations to borrow money to buy back their own shares, pushing up values and prices. Buy backs are the last refuge of innovation challenged companies unwilling to invest in research and development in favor of short-term stock performance.

The low interest rate environment also leads to a fairly straightforward comparison between stocks and bonds, with the nagging idea that low rates don’t pay anything now, and when rates go up, prices will go down. And finally, in a bad job market the Fed will be slower to back away from quantitative easing, and Wall Street just loves to see the free flow of easy money.

And so, we’ll all be watching the new Fed Chair, Janet Yellen this week as she goes before Congress for her first Humphrey Hawkins testimony tomorrow before the House and Wednesday before the Senate, and we’ll try to determine if the need for extraordinary measures has abated or not. Likely, we’ll hear something along the lines of, steady as she goes. Don’t expect any big changes, but as a new Fed Chair, she may set the tone a bit.

Before Yellen’s testimony tomorrow, House Republicans will hold a meeting tonight to address raising the debt ceiling. House Republican leaders will try to use the meeting to sell their members on voting for a bill that raises the debt limit but also reverses changes to military retirement benefits. Reversing these changes would add to the deficit, so Republicans would have to find ways to pay for it. One way Republicans are considering paying for the change is to extend the sequester for mandatory spending for one more year. Senate and House Democrats have been firm in demanding a clean debt limit bill — one without additional policy concessions.

There isn’t much time. On Friday, Treasury Secretary Jacob Lew said extraordinary borrowing measures aren’t likely to last past Feb. 27. And the House adjourns Wednesday so Democrats can go to their annual issues retreat. Lawmakers don’t return for a full workday until Feb. 26.

Earnings season has moved into its latter stages, with 54 S&P 500 companies expected to report results this week. Of 343 companies in the S&P index that have reported earnings through Friday, 67.9% beat Wall Street expectations against 67% over the last four quarters, and ahead of the 63% rate since 1994.

Of course, when you hear anything about earnings, you must take it with a grain of salt, or maybe you should just buy a great big salt lick. Public companies are notorious for lowering earnings guidance so they can claim to beat the easier targets. Toss in little tricks like stock buy backs and the earnings season looks less and less like a buying signal and more and more like a management ruse to increase already lofty pay levels.

The dark side of earnings season can be found in the revenue growth numbers. For 2013 it looks like the healthcare sector led the way for revenue growth, up 7.6%; consumer discretionary grew revenue by 3.8%; consumer staples grew revenue by 1.9%.  Industrials up 2.3% and utilities up 4.2%. Technology, the high-growth sector where American ingenuity is still leading the world, revenues rose just 5.4%. And telecom services eked out a barely visible 2.2% revenue gain. Not exactly breath-taking growth figures. Then there were the third and fourth largest sectors: revenues in the energy sector dropped 3.4%; and in the financial sector, they plunged 11.4%.

So, while inflation was 1.5%, the S&P 500 companies that have reported so far, all put together, triumphed with year-over-year revenue growth of 1%. Revenue growth was negative when considering inflation. And don’t forget that last year the S&P 500 was up nearly 30%; it was a great year, as long as you don’t look at top line growth, or lack thereof. Ingenious accounting is one element, financial engineering another. Corporations can borrow nearly unlimited amounts of money in the short-term markets and through bond sales, at little cost, thanks to the Fed’s policies, and load up their balance sheets with borrowed cash, that they then plow into share buybacks.

The doctored EPS growth, and particularly the analysts’ estimates for doctored EPS growth for distant future quarters is bandied about as illusory justification for the gravity-defying ascent of stocks. Eventually the double digit estimates for future quarters is ratcheted down right before earnings are reported, and then the companies can beat the diminished expectations.

Business success, as defined by growth in revenues and net profits and not by financial engineering and fabricated EPS, is crucial to the economy. But for a quarter of a century, corporate profits have been rising at a faster rate than GDP and are now “dangerously elevated by all reasonable measures.

Remember that $13 billion settlement JPMorgan Chase worked out with the Justice Department last November? At the time, we raised some questions about how the deal was worked out between JPMorgan CEO Jamie Dimon and Attorney General Eric Holder. The $13 billion was a record fine for a bank, but just a fairly small fine compared to JPMorgan’s profits, and even though the settlement does not release JPMorgan from potential criminal liability over the mortgages it packaged into bonds, Jamie Dimon seemed eager to act like the matter was a thing of the past; the board of directors at JPMorgan even voted him a big fat bonus, apparently for navigating the legal challenges.

Well, now the non-profit group Better Markets has filed a lawsuit against the Justice to block what it called an "unlawful" $13 billion settlement with JPMorgan Chase over bad mortgage loans sold to investors before the financial crisis. They say they are appalled that the settlement gave the bank "blanket civil immunity" for its conduct without sufficient independent judicial review. In effect, the DOJ acted as investigator, prosecutor, judge, jury, sentencer, and collector, without any check on its authority or actions. And because the DOJ has declared its intention to use the Agreement as a “template” in future similar cases, it is imperative that the DOJ’s unlawful and secretive approach in the settlement process be subjected to judicial review.  

In its complaint, Better Markets alleges the settlement with the bank lacks critical facts that can help justify the deal, such as failing to name any individuals responsible for the wrongdoing, how much damage investors suffered or even "which specific laws were violated."

Of course, this is not the only bad behavior by JPMorgan Chase. A confidential email has emerged that shows a top Chinese regulator directly asked Jamie Dimon, the bank’s chief executive, for a “favor” to hire a young job applicant. The applicant, a family friend of the regulator, now works at JPMorgan. The email was one of several documents that JPMorgan recently turned over to federal authorities as part of an investigation into hiring at the bank. Federal authorities are now investigating whether the hiring at JPMorgan and at least six other big banks, was done explicitly to win business from Chinese companies. The authorities could decide to bring charges against individuals or a bank if they find such activity to be in violation of anti-bribery laws, in connection with the Foreign Corrupt Practices Act.

In recent months five top insurance companies with headquarters in mainland China or Hong Kong have become JPMorgan clients, although there is no direct link between the hiring and the new deals. Until now, it was unclear whether any well-connected job applicants ever met JPMorgan executives in New York.

Meanwhile, the really big investigations are still underway. Remember the Libor rate rigging scandal?  Well maybe something will eventually happen there, but already the investigations have moved over to the Forex, foreign currency exchange markets. The British FCA, or Financial Conduct Authority, are heading up that investigation, as the Forex is centered in London; the FCA says 10 banks are now cooperating in the investigation into how Forex traders colluded in setting certain key exchange rates in the $5.4 trillion a day forex market. The FCA says the allegations are every bit as bad as they have been with Libor.  

Wednesday, December 04, 2013 - The Defining Challenge

The Defining Challenge

by Sinclair Noe

DOW – 24 = 15,889
SPX - 2 = 1792
NAS +0.80 = 4038
10 YR YLD + .05 = 2.83%
OIL + 1.25 = 97.29
GOLD + 19.00 = 1244.30
SILV + .54 = 19.82

December can be a cold, cold month. At least that's how the equity markets are starting the month; four losing sessions. Part of this might be the big institutional investors, the big hedge funds and money managers, looking around and realizing the market is up 30% or so, and that would be a good year, so why no lock in a few profits. No need to worry about the budget battle in Washington; no need to worry about the Federal Reserve surprising people with a premature taper; no need to worry about a strong jobs report on Friday. In this crazy market where good economic news gets traders worried about the Fed taking away the punch bowl, today we had some reasonably decent economic news and another drop in the markets.

Let's start with the economic reports. ADP, the payroll processing firm, has a monthly report on private jobs; they issue the report just before the monthly official government report on jobs, the BLS non-farm payroll report. The ADP report is not great at predicting the government report, but its one of the better guidelines we have. Today, ADP reported companies added to their payrolls by a net 215,000 in November, and they revised the October number higher to 184,000.

Manufacturers, builders and other goods-producing industries increased headcount by 40,000, the most this year. Employment in construction climbed by 18,000. Factories also added 18,000 jobs, the biggest gain since February 2012. Trade, transportation and utility companies created 45,000 jobs last month. Companies employing 500 or more workers added 65,000 jobs. Medium-sized businesses, with 50 to 499 employees, took on 48,000 workers and small companies expanded payrolls by 102,000.

ADP typically underestimates the number of jobs added to the economy. The government jobs report is Friday morning; the average estimate is for 180,000 net new jobs in November.

In a separate report, contracts signed to buy newly built homes jumped 25% in October month to month. Now let's dig into the numbers, because the numbers are a bit unusual. In September, contracts to buy new homes dropped 6% from August. So there was a big drop in September and an even bigger bounce up in October. A couple of theories behind the numbers. First, is the idea of pent-up demand; the government shutdown caused potential buyers to wait, and also interest rates have been climbing, pushing potential buyers to jump now rather than wait for higher rates later. The other theory is that there's a large margin of error in this report and we'll see the number revised next month.

Meanwhile, the Institute for Supply Management's non-manufacturing index dropped to 53.9 in November from 55.4 in October. A reading above 50 indicates expansion in the services sector of the economy, but clearly expanding a little slower. The ISM manufacturing index, released Monday, showed an increase to 57.3 from 56.4.

Meanwhile, the Federal Reserve released its Beige Book this afternoon. The Beige Book is a business survey, which contains anecdotal reports from the 12 Fed district banks, and it's published two weeks before the officials meet to set monetary policy at the FOMC meeting. It's called Beige Book because it has a beige cover, although I suspect it is also descriptive of the writing style.

Anyway, here's the synopsis: consumer spending increased in most of the country, with retailers expressing optimism about holiday sales; hiring showed a modest increase or was unchanged; manufacturing activity continued to expand in most districts, with gains noted in the motor-vehicle and high-technology industries; demand for professional business services experienced stable to moderate growth, especially in computer technologies.

And the Commerce Department reported this morning that the October trade deficit decreased to $40 billion. Total October exports came in at $192 billion compared to imports of $233 billion, resulting in a deficit of $40 billion, down from $43 billion in September. Oil prices were just under $100 in October, down from $102 in September, and prices will likely be down even further in November. The petroleum deficit has generally been declining and is the major reason the overall deficit has declined since early 2012.

Meanwhile, remember the budget negotiations? That's where each political party draws a line in the sand, and a bipartisan committee dances around the line and no later than December 13^th, they are supposed to come up with a deal that nobody could love. There is broad agreement that a portion of the sequester should be replaced with targeted cuts to discretionary spending. But Democrats demand revenues in the mix and Republicans categorically reject new taxes. The dance of legislation is reportedly close to finding some syncopation, which would involve an agreement to set a spending level for the next fiscal year above the $967 billion in place under current law.

Also, it appears that both sides are getting closer to agreement on $80 billion in savings to replace the cuts from sequestration over the next 2 years; shared among defense and non-defense programs alike. Other items being considered to pay for it include selling off the broadband spectrum in auction (essentially a government yard sale), increasing TSA fees (in other words, it'll cost more for an airline flight), plus changes in postal service and some reform to federal pensions but no structural changes to entitlement programs.

If the budget committee can't reach a deal by the December 13 deadline, House Speaker John Boehner has said that he will push for a continuing resolution to fund the government past Jan. 15 at the $967 billion level. Apparently both sides realize that shutting down the government is not a popular idea, but short-term stopgap continuing resolutions are getting a bit stale as well.

Somewhere, in the vague and distant past, I remember hearing something about closing loopholes and reforming the tax code but that would require roll up your shirt sleeves, honest work, and we know that Congress has nasty aversion to that four letter word.

Some things never change.

Banks cheat. They get caught sometimes. They pay a fine. It's the cost of doing business.

EU antitrust regulators have fined six financial institutions including Deutsche Bank, Royal Bank of Scotland, Citigroup, Societe Generale, JPMorgan and brokerage RP Martin a record total of $2.3 billion for rigging financial benchmarks. The penalty is the biggest yet to be handed down to banks for rigging the benchmarks used to determine the cost of lending; the benchmarks involved are the London interbank offered rate, or Libor, the Tokyo interbank offered rate and the euro area equivalents. They are used to price hundreds of trillions of dollars in assets ranging from mortgages to derivatives.

EU Competition Commissioner Joaquin Almunia said in a statement: "What is shocking about the Libor and Euribor scandals is not only the manipulation of benchmarks, which is being tackled by financial regulators worldwide, but also the collusion between banks who are supposed to be competing with each other."

Yes, I'm shocked, shocked to find that gambling is going on in here!

Authorities around the world have so far handed down a total of $3.7 billion in fines to UBS, RBS, Barclays, Rabobank and ICAP for manipulating rates, while seven individuals face criminal charges.

UBS paid a record fine of $1.5 billion late last year to the US Department of Justice and the UK's Financial Services Authority for rate-rigging. EU fines can reach up to 10 percent of a company's global turnover. UBS blew the whistle on the Libor and Tibor cases and will not be fined as a result. Barclays will escape a fine in the Euribor case because it alerted the Commission to the offence.

The European Commission said it would continue to investigate Credit Agricole, HSBC, JPMorgan and brokerage ICAP for similar offenses.

And by the way, I don't know how the regulators come up with the amount they decide to fine the banksters. I guess they pull a number out of the hat. I'll check on that.

Moving on. Now that the government has fixed the healthcare.gov website and Obamacare is experiencing smooth sailing. Huh? What? Squirrel...

Anyway, President Obama turned his focus today to the pocketbook issues that Americans consistently rank as a top concern, arguing that the dream of upward economic mobility is breaking down and the growing income gap is a "defining challenge of our time."

"The basic bargain at the heart of our economy has frayed," the president said in remarks at a nonprofit community center a short drive from the White House in one of Washington's most impoverished neighborhoods.

The president vowed to focus the last three years of his presidency on addressing the discrepancy and a rapidly growing deficit of opportunity that he said is a bigger threat than the fiscal deficit. Obama said increasing income inequality is more pronounced in the United States than other countries. He said Americans should be offended that a child born into poverty has such a hard time escaping it, saying: "It should compel us to action. We're a better country than this." Obama did not propose any new policy initiatives in the speech.

The speech comes amid growing national and international attention to economic disparities — from the writings of Pope Francis to the protests of fast-food workers across the country. The president cited the pope's question of how it isn't news when an elderly homeless person dies from exposure, but news when stock market loses two points.

Monday, August 05, 2013 - ISDAfix

ISDAfix

by Sinclair Noe

DOW – 46 = 15612
SPX – 2 = 1707
NAS + 3 = 3692
10 YR YLD + .04 = 2.64%
OIL - .38 = 106.56
GOLD – 9.70 = 1304.80
SILV - .18 = 19.81

We've talked on several occasions about the various banking scandals that have cropped up over the past couple of years. It's a long list and includes everything from municipal bond rigging to robo-signing, predatory loans to insider trading, derivatives stuffing to energy price manipulation including oil markets and electricity markets. Last year we heard about what appeared to be the biggest scandal, at least in dollar volume; the Libor rate rigging scandal.

The scandal surrounding the London interbank offered rate (Libor), against which it's estimated more than $300 trillion worth of products are priced, everything from derivatives to mortgages to credit cards and … well almost everything that might be bought or sold, has become a symbol for the brazen arrogance with which some in the financial industry have pursued their own interests. Libor rate rigging has cost individuals as well as municipalities, including Baltimore, Houston, San Diego, Sacramento, and others; maybe even Detroit. The US municipalities claim that they lost money when they received lower interest rate payments than they should have, or had to pay artificially inflated rates because of the alleged manipulation. In other words, the banksters ripped them off coming and going.

In London, the Libor investigation is ongoing and they've recently announced plans to make charges, possibly criminal charges within a couple of months. The Serious Fraud Office, or SFO has leveled criminal charges at three relatively junior-level individuals in connection with the scam. Three banks, including Barclays, RBS, and UBS have agreed to pay around $2.6 billion to date to secure civil settlements with UK and US regulators; we don't yet have confirmation that the fines have been paid. More than a dozen more banksters were involved in Libor, including Citigroup, JPMorgan, Deutsche Bank, HSBC, Bank of America, Credit Suisse, Rabobank, ICAP, Teullet Prebon, and Royal Bank of Canada.

The prosecutors say it will be difficult;they are outmanned and outgunned; the banksters hit back with counter-suits against prosecutors. Plain and simple, the banksters have more money to spend on litigation. And we all know that justice isn't about justice, it boils down to who has the most money to push around the other party. Also, pushing beyond the judicial system, the banksters have managed to infiltrate the the legislative process, watering down regulations and laws; new efforts to toughen the laws since the Financial Crisis might be too late to find those culpable of causing the crisis to face criminal penalty. Also, much of the correspondence, such as emails, that can be admitted as evidence rarely makes it to the top floor of the corporate suites.

Still those emails reveal the  high pressure on brokers trying to win business from traders is a big incentive to curry favor in extraordinary ways. According to the Wall Street Journal, gifts of expensive dinners, ski trips, strip clubs, and prostitutes are particularly common in London where there is no regulation on the amount of money brokers can lavish on traders. “Some brokers appear to see entertainment as part of explicit favors-for-business exchanges. Such profits, however, have been at the expense of investors, retirees, taxpayers, regular bank customers, pension funds, cities, and public works programs; to the point where even a regular bus rider pays for the transgressions of the banksters.

You might imagine that it would be hard for the banksters to do much worse than manipulate the most widely used interest rate which affects hundreds of trillions of transactions, but then you'll recall that the Financial Crisis of 2007-2008 was not so much the failure of subprime mortgages as it was the failure of the derivatives written on mortgages. There would never have been the sheer volume of toxic loans in the first place, except that the banksters had figured out a way to package all the garbage and collect fees for doing so, and then bet against the very loan derivative packages they created and marketed to customers. Those derivatives were highly leveraged and ridiculously under-capitalized. When the derivatives failed, that is when Hank Paulson went begging on bended knee for bailouts to prevent a global financial meltdown. You might imagine the banksters had hit their bottommost with the Libor rigging, but wait there's more.

For all the interest rates determined by the rigged process that is Libor, there were side bets in the derivatives markets. And trading in those derivatives is largely conducted through the market known as the ISDAfix, which refers to the International Swaps and Derivatives Association and the fix part of the name is what they chose to describe their marketplace. Sure enough, the fix was in.

ICAP, a major London-based firm, is now being investigated by the US Commodity Futures Trading Commission for falsely reporting the benchmark known as ISDAfix, which provides the standard rates in the $379 trillion market for interest rate swaps. ICAP also maintained trading desks in New Jersey which they nicknamed Treasure Island. Fifteen other banks, including Bank of America, JP Morgan Chase and UBS, have been issued subpoenas for their role in submitting the bids and offers used by ICAP to create the benchmark.

Interest rate swaps refer to transactions that provide customers with greater security on loans, at least that's the theoretical claim. This might valuable if a city or company has a loan with a variable and unpredictable interest rate, which can be “swapped” for a fixed and more secure rate. The reality is that in many instances the swaps create greater risks. The price fixing on both interest rates and interest rate swaps is an example of price fixing corruption layered on price fixing corruption. Ultimately it means we all pay more and get less for everything from a mortgage to a bus ride to a glass of water, so the banksters can gamble in the derivatives casino.

Price fixing of the ISDAfix first came into focus in April. Last Friday, the Commodity Futures Trading Commission revealed that their investigation of the ISDA fix had produced recorded telephone calls and emails. And now Bloomberg is reporting that there is a growing trail of evidence showing price manipulation. The CFTC is sorting through more than one million emails; they are interviewing traders. Remember the guilty verdict last week against Fabrice Tourre, the junior level Goldman Sachs trader convicted of insider trading? You've got to believe the junior level traders in the ISDAfix are familiar with the fate of Fabulous Fab and how Goldman threw him under the bus.

CFTC investigators are piecing together evidence that shows swaption traders at banks worked with rate-swap traders at their own firms to manipulate ISDAfix. The swaption traders told their rate-swap colleagues the level at which they needed ISDAfix to be set that day in order to bolster the value of their derivatives positions before these were settled the next day.

The rate-swap trader would then tell a broker at ICAP, the biggest arranger of the contracts between banks, to execute as many trades in interest-rate swaps as necessary to move ISDAfix to the desired level by the close of trade; the price fixing went by the quaint name of banging the close.

It looks like a violation of the Dodd-Frank Act. The law defines the activity as demonstrating “intentional or reckless disregard for the orderly execution of transactions during the closing period” as to interfere with settlement prices.

Maybe you haven't heard of the ISDAfix price fixing scandal, but at more than $370 trillion, there is a strong probability that it is bigger than the Libor scandal. Just to provide perspective, the Gross Domestic Product of the United States, the measure of all goods and services produced each year is about $16 trillion. The GWP, or Gross World Product is the combined gross national product of all the countries in the world; so, the ISDAfix is more than five times bigger than the value of all goods and services produced in the entire world this year. And for all its size the ISDAfix and the derivatives traded do not produce any goods or services.

Over the years we've seen that when any sector of the economy grows too large, there is readjustment. Remember the energy bubble of 1980? The tech bubble of 2000? The financial bubble of 2007? An easy, though incomplete representation can be found by looking at S&P500 sectors over the years; for most of the time until the 1990s, the financial sector represented 5-10% of the S&P capitalization; the bubble burst at 22% in 2007 and now we are back to about 20%. So, the bubble is inflating and it seems inevitable it will eventually pop. The difference between 5% and 20% is the capital the financial sector sucks out of productive purpose; capital that could be used to produce a much healthier economy. We might consider the financial sector as the lubricant for the engine of commerce, but too much grease just gums up the works.

Unfortunately, when a bubble pops it creates a lot of damage, however that damage rarely falls on the people who created the problem, instead it destroys the 401Ks and pensions and home values and jobs of the middle class. Creative destruction may be effective but it is also painful; the “collateral damage” is real and I hope it can be avoided.

We are now five years past the last meltdown and we have not seen a single arrest or prosecution of any senior Wall Street banker for the systemic fraud that precipitated the 2008 financial crisis – a crisis from which millions of people are still suffering, so it comes as no surprise that we continue to report on one scandal after another. Almost nothing has changed, except the financial sector is growing back to dangerous dimensions.

It's never-ending. Today, BP, the oil company which made a mess of the Gulf coast, today they denied wrongdoing even as the Federal Energy Regulatory Commission (FERC) charged BP with manipulating gas prices in 2008. The scheme in question dates back to Hurricane Ike and how the gas traders tried to manipulate prices during the Hurricane. BP claims that's not what they were doing, that a trader-in-training made a mistake when he tried to explain the scheme to a senior BP official.

Remember last week when Steve Cohen faced all those troubles for insider trading at SAC Advisors, the nearly personal hedge fund run by Cohen. Cohen doesn't face criminal charges himself, but the firm might be shut down as the case proceeds. Well, new week, new hedge fund; this time it's George Soros facing allegations his fund management firm engaged in insider trading before the purchase of a large stake in nutritional supplement company Herbalife.

One of the billionaire investor’s top managers is alleged to have leaked details of Soros Fund Management’s purchase of a near-5% stake in Herbalife before the deal is believed to have been finalised last week.

The claim is part of a complaint reportedly filed with the Securities and Exchange Commission by Bill Ackman, who runs the Pershing Square hedge fund and holds a $1billion short bet on Herbalife.

Jeff Bezos, the CEO of Amazon.com has agreed to buy th Washington Post newspaper company. Bezos is making the deal as an individual and not as part of Amazon, the world’s biggest online retailer. Just thought he'd try his hand at the newspaper business, in the proud tradition of Citizen Cane; and what better place to have a newspaper than Washington DC.

The president of the Federal Reserve Bank of Dallas came up with a catchy name for his speech today: Let me articulate clearly: “Horseshift!” (there is an “f” before the “t”) As always, he is no fan of quantitative easing. Fisher says the Fed is closer to slowing its monthly bond buying. Excerpt: “A corollary of reining in this massive monetary stimulus in a timely manner is that financial markets may have become too accustomed to what some have depicted as a Fed `put.’ Some have come to expect the Fed to keep the markets levitating indefinitely. This distorts the pricing of financial assets, encourages lazy analysis and can set the groundwork for serious misallocation of capital.”

The second quarter reporting season is underway but at the end of the first quarter, according to FactSet, the S&P 500 companies, excluding the financial companies that have complicated balance sheets that would obscure our view, had $1.3 trillion in ready cash – and that's just S&P 500 companies; the corporate cash hoard likely tops $2 trillion. Meanwhile, capital expenditures (building new plants, starting projects, hiring people, leasing equipment) grew at its slowest rate in 3 years. No doubt, cash is nice to have in a storm and the Financial Crisis has hammered home the importance of a rainy day fund, but all of this cash will not sit idle forever.

One little-noticed item in the most recent jobs report is that the biggest jobs-gaining sector was "Financial Activities": banks, insurance companies, real estate companies and related financial services firms. These are the folks who will be making the big play for this money.

The other constituency after that cash are the shareholders who want dividends or for the company to buy their stock. Most big companies are already doing a bit of both. McDonald's, in the news because some of its low wage employees have walked out on strike last week, MickeyD says that, "after investing in our business we are committing to returning all free cash flow to shareholders over the long term." Then, they announce they are cutting expansion funds.

What you don't see, in page after page of earnings reports, is anyone talking about paying workers more. The word "salary" is referred to once by American Express executives saying that salary costs were flat year over year. The word "wage" shows up only in the McDonald's call, as a complaint about costs. The word "hire?" Google is hiring. The word "compensation" is mentioned only in Goldman Sachs' regulator disclosures.

The Transportation Department reports airlines collected $6 billion in fees for checked bags and reservation change penalties in 2012, compared with $1.3 billion in 2007. And that doesn't include what are known as ancillary fees for things like priority boarding. 

Monday, July 08, 2013 - Nothing Recedes Like Progress

Nothing Recedes Like Progress

by Sinclair Noe

DOW + 88 = 15,224
SPX + 8 = 1640
NAS + 5 = 3484
10 YR YLD - .07 = 2.65%

OIL - .17 = 103.05
GOLD + 13.50 = 1238.30
SILV + .18 = 19.18

Took a little break for the Fourth of July, so we have some catching up to do. Friday morning the jobs report showed the unemployment rate holding steady at 7.6%, even as the economy added 195,000 jobs. Better than expected but not good enough; possibly proving the adage that nothing recedes like progress, or at the very least we know that the path of progress is neither swift nor easy. More than 8 million people are working part-time for economic reasons; nearly 3 million are working in temp jobs; more than 4 million are in the ranks of the long-term unemployed; more than one million are considered discouraged, they've just given up I suppose.

If the labor market holds steady and job creation continues at the current rate, the unemployment rate will dip below 7 percent sometime in mid- 2014; by which point the majority of American workers will be part-time. We really should be adding more than 300,000 jobs a month, not fewer than 200,000. As the Economic Policy Institute points out, we would need more than five years of job growth at this rate to get back to the level of unemployment that prevailed before the Great Recession.

Still, the 195,000 new jobs should boost expectations for growth and inflation, which tends to push up bond yields. That happened on Friday; yields on the 10year Treasury note bounced up above 2.6%. The concern is that the Fed will ease up on Quantitative Easing as the unemployment picture improves, and the Fed seems to think the economy is strong enough to handle it. But the feral hogs in the bond market smelled blood and they priced in the Fed stepping back, not caring whether the economy can handle it or not.

Ironically, the market's moves could slow down the economy enough to make the market's prediction wrong, by hurting the economy so much that the Fed realizes it can't taper its bond purchases yet. And if the markets don't squash a recovery, then the politicians might. The austerity gang remains staunchly opposed to any deliberate job creation program. The Federal Reserve seems more interested in testing the idea of tapering than any aggressive monetary action.

And as the summer swoons on, it looks less and less likely that there is anything that will finally get us back to full employment. For now, rates are still near historic lows, and the equity markets, after using the Bernanke talking points as an opportunity to take profits, now seems to be focusing attention elsewhere.

Stocks have also been higher again. Maybe it is hope for a stronger earnings reporting season, which kicked off this afternoon with Alcoa reporting a $119 million loss, compared to a loss of $2 million a year ago. Alcoa posted big expenses for restructuring and legal costs. Woo hoo, happy days.

The analysts who analyze earnings seem to live in a mystical land of make believe. Six months ago, they predicted 2Q earnings growth of 8.7%; they've cut that to 1.8%: but they still think S&P 500 index share prices will rise by 8.8%. Getting to their price target would raise the index’s earnings multiple to 16.4; that's not a historically high multiple, but it might not reflect the anticipated slog. After three years of growth, earnings increases are slowing. Income in the S&P 500 advanced an average of 4.3 percent in each of the last five quarters, compared to the 28 percent average for 2010 and 2011.

Also, as we work our way through earnings season and look at the broader economy, GDP has been revised lower; down from 2.2% in 2012 to an estimated 1.9% this year. Data will likely be overhauled at the end of the month, and the expectation is that it will be revised lower. So, earnings growth alone is apparently not enough to reach escape velocity. The International Monetary Fund will probably lower its global growth forecast for the remainder of the year; they already lowered their forecast from the start of the year, down to 3.3% from an earlier estimate of 3.5%. They say they are seeing weakness in emerging countries in particular.

So the bar keeps getting lowered and nothing recedes like progress.

Oil prices moved slightly lower today, but remain entrenched in triple digit territory. Part of that is a risk premium associated with Egypt. At least 51 people were killed when the Egyptian army opened fire on supporters of ousted president Mohamed Mursi, in the deadliest incident since the elected Islamist leader was toppled by the military five days ago. Hundreds more were wounded today.

The Egyptian military has insisted that the overthrow was not a coup, and that it was enforcing the "will of the people" after millions took to the streets on June 30 to call for Mursi's resignation. The US government isn't calling it a coup because that would mean an end to $1.3 billion a year from Washington. That is called aid, but it also serves to pay Egypt to keep the peace with Israel. Apparently, a military coup by any other name is better than a democratically elected Muslim Brotherhood. So, the whole democracy thing is very messy, but the oil is still being transported through the Suez Canal.

The same cannot be said for oil being transported by rail in Canada.

Canadian police are still looking for the remains of people killed when a driverless crude oil train derailed and blew up in a small Quebec town over the weekend. The five locomotives and 72 oil cars had been parked near the town of Lac-Megantic in Quebec; that's not far from Maine. The brakes then somehow released and the train gathered pace as it rolled down a hill into the center of the town early on Saturday morning. It derailed and exploded into a gigantic fireball, flattening dozens of buildings and killing five people. Another 40 are missing and few residents hold out hope that they will be found alive.

Canada's railways have made a determined push to cash in on the country's crude-oil bonanza, painting themselves as a cost-effective alternative to politically unpopular pipelines like the proposed Keystone XL. The Canadian Railway Association recently estimated that as many as 140,000 carloads of crude oil are expected to rattle over the nation's tracks this year, up from only 500 carloads in 2009. That represents a 28,000 per cent increase in the amount of oil shipped by rail in the past 5 years. The Quebec disaster is the fourth freight-train accident under investigation involving crude-oil shipments since the beginning of the year.

So, there are some concerns about the ability to ship oil, whether on rail in Canada or by way of the Suez Canal; still, the recent run-up in oil prices is disconcerting. We've seen a big sell-off in commodities ranging from gold, to industrial metals, iron ore, extending to grains, natural gas and on. We've seen strength in the dollar, which was always a good excuse from the energy experts to explain falling oil prices.. We've seen demand for oil falling. Demand is dropping in China as that economy slows; the IMF is projecting slower and slower global economic growth, and that should mean less and less global demand for oil. Americans are driving less and less, not more and more; and we're driving more efficient cars. There has been a record jump in US domestic oil production, which has grown by more than one million barrels per day over the last year; that's the fastest growth in production in decades.

Some 5 percent of seaborne crude oil passes through the Suez Canal. Not inconsiderable, but its potential cost can be clearly calculated. The closure of Suez would not stop the lifting and shipping of oil cargoes. It would however add approximately 16 days steaming time around Cape Horn to an oil cargo's sea voyage otherwise precluded from using the canal, and the added expense works out to less than 50 cents a barrel.

To fully appreciate the excesses of the oil market one needs to understand that some 80 percent of all contracts bought and sold on the commodity exchanges are not executed by actual producers or crude oil consumers engaged in 'legitimate' hedging strategies, but rather by speculators and gamblers trying to drive oil prices in the direction in which they have placed their bets.

The Commodity Futures Trading Commission (CFTC) was given the authority by virtue of a January 2010 rider to the Commodity Exchange Act, to implement speculative position limits for futures and option contracts of certain energy commodities such as crude oil. To date, no action has been taken by the CFTC other than interminable hearings which one can well imagine have become a cover for the total lack of meaningful process.

In April 2011 the president amidst great fanfare, focused on 'speculation' in the oil market, giving Attorney General Eric Holder a mandate to investigate and announcing the formation of 'The Oil and Gas Price Fraud Working Group.' To date, more than two years later, not a word has been heard from this august commission.

A couple of weeks ago the Federal Trade Commission opened a formal investigation into how prices of crude oil and petroleum-derived products are set, mirroring a European Union inquiry. The investigation, now in a preliminary stage, will probably broaden into a multi-jurisdictional affair like the inquiry into manipulation of the London interbank offered rate, or Libor.

The price of oil is actually set, much like the Libor rates, by a data and news service called Platts. Platts publishes the Dated Brent benchmark that contributes to setting the price of more than half the world’s oil. The EU oil probe, which extends to undisclosed crude-derived products and biofuels, underscores how pricing in some energy markets lacks the transparency of financial products such as stocks and US corporate bonds. It also marks the third time global pricing benchmarks have drawn the regulators’ scrutiny in the past year following investigations into bank manipulation of the Libor, and ISDAFix, the benchmark for the $379 trillion swaps market.

In other words, everything is rigged.