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.

Friday, September 14, 2012 - Much More Than a Film

Much More Than a Film

-by Sinclair Noe

DOW + 53 = 13,593
SPX + 5 = 1465
NAS + 28 = 3183
10 YR YLD +.11 = 1.87%
OIL + .69 = 99.00
GOLD + 3.30 = 1771.50
SILV un=34.78
PLAT + 25.00 = 1714.00

One crazy little film that never even made it into theaters is all it takes to start World War 3. Go figure. I don't really think it will be WW3 but you never know. I mean, I can understand how people get passionate and caught up in any film featuring Cindy Lee Garcia of Bakersfield, California. How many Oscars has she won? And any movie produced by Sam Bacile, you know it has a certain production quality. Say it slowly S A Mbacile (Is a Embicile). And you just have to think somebody is behind this otherwise very obscure movie. Authorities now believe the filmmaker is a guy in Cerritos Californa named Nakoula Nakoula, who just recently got out of prison after pleading guilty to bank fraud in 2010. Maybe this guy is a complete idiot or maybe he's a puppet; I'm guessing the latter. Someone who has interests somewhere was pulling the strings.

The results are nowhere near obscure. The bodies of 4 US diplomats killed in Libya were returned to US soil today at Andrews Air Force Base. Flags across the country are at half-staff. There are protests against the US in at least 18 countries in the Middle East, Africa, and Asia. About 50 Marines landed in Yemen after the US embassy there was stormed. In Khartoum, Sudan the German embassy was overrun; although US embassies seem to be the main targets. Libya closed airspace over the Benghazi airport for a while because of heavy anti-aircraft fire by Islamists aiming at US drones flying over the city. Some 25,000 took to the streets of Gaza City. About 10,000 people held a protest in the Bangladeshi capital.  There were also protest in Malaysia, Nigeria, Jordan, Kenya, Bahrain, Qatar, Bangladesh, Pakistan, Iraq, and Iran.

Yesterday the Fed announced QE3 to infinity and beyond; it's an open ended bond buying program. They vow they won't stop till the economy gets enough. And even though the initial $40 billion a month in mortgage backed securities seems smaller than Qe1 and 2, since it is open ended, the numbers could eventually grow much bigger.

Amidst the shuffle and flurry you might have missed their economic forecast. The Fed expects the economy to expand between 1.7 percent and 2 percent this year, down from their June projection of growth between 1.9 percent and 2.4 percent. The officials continued to predict that the unemployment rate would not fall below 8 percent. In other words, they don't expect their new QE plan to have any effect this year, or at least not enough effect to be positive; or maybe they are saying the economy is in such rotten shape that it would much, much worse without their action.

And a big part of the problem with the Fed's QE plan is that it doesn't get the money out into the economy. There are three things that can happen with the money the Fed prints.

First, it can go back to the Fed; the banks park the reserves and earn a quarter of a percent; this helps to make the banks look like they have sufficient capital cushion; this should scare everyone because the banks are probably not capitalized. If the banks were adequately capitalized, the Fed could have cut the payout. If you wonder why the Fed isn't pushing the banks to get more money into circulation, the worry isn't inflation, the problem is the balance sheets of the banks.

Next, the banks can take the money from the Fed and put it into high risk, high reward. This is very profitable for the bankers, and the Fed will backstop most or possibly all of their losses.

Next, the banks can make loans. The banks can make high interest credit card loans; they can make high interest consumer loans; they can and do make outrageously high interest rate payday loans (yes, the big banks are among the very biggest payday lenders); they can make guaranteed student loans; they can make mortgage loans and turn around and sell those mortgages back to the Fed. The Fed now buys almost all mortgages, in one form or another. This might seem to carry some level of risk.

QE to infinity and beyond seems a little desperate. If you accept the basic idea behind the Fed's actions, that propping up asset prices will also lift up consumption and lift the entire economy, you might just want to sit back and let the stock market rally and the housing recovery do their trick. “Let them eat stocks and housing” has not been terribly successful. Even with super low rates, it has also taken massive sequestering of inventories for the housing market to have the appearance of stabilizing. We have low household formation due to young adults facing high unemployment, low paying jobs with generally short job tenures, and heavy student debt burdens. On top of that, we have generational headwinds as boomers hit retirement age and want or need to downsize. Keeping money on sale is not going to induce banks to lend more if they can’t find enough qualified borrowers. And the consumer deleveraging story is not as positive as the statistics would lead you to believe. A lot of it is involuntary, meaning driven by foreclosures. Toss in the Zero Interest Rate Policy war on savers.

And don't forget, the Fed has given no indication they have even considered an exit strategy. A mere 1% increase in interest rates, from 3.5% to 4.5%, increases mortgage payments on a 30 year fixed rate mortgage payments by 13%. That will translate into a meaningful dent in housing prices. And where does the Fed go if a financial crisis or other shock occurs?

If you're looking for ways to play the Fed move, just look at past performance. Here's a partial list of ETFs that were the big winners during QE2: silver (SLV), oil equipment (IEZ), oil services (OIH), oil/gas equipment and services (XES), oil & gas exploration and production (XOP), energy (XLE), coal (KOL), metals and mining (XME), natural gas (FCG), global energy (IXC), agriculture (RJA), small cap growth (IWO), Russia (RSX), semiconductors (SMH), and private equity (PSP). This is not intended as specific recommendations, just some ideas. No guarantees that these will repeat their QE2 performance. For example, the agriculture ETF may be more influenced by drought than QE. The common theme is that the ETF's represent commodities.

Another possible play is the US dollar. The Dollar Index hit a high in late July and it has been dropping in anticipation of QE3 and now in the announcement of QE3. So, we had a failed breakout from a long base, and a breakdown to challenge the lows of the year around 78.10. While I don't expect a straight down breakdown, this is a fairly powerful move that might challenge the lows of May 2011. If you look at the charts of the Dollar Index, you would find the mirror image in charts of the CRB, which peaked in May of 2011 and bottomed earlier this summer. Whenever the printing press is cranked up, you can expect a move in tangibles.

In prior QE scenarios we've seen stocks and commodities jump higher, then a minor sell-off followed by consolidation for a couple of weeks. I would expect the same, but this time it might be more pronounced, in part because of the bailouts in Europe, and also the unrest around the world. So, we are seeing global stocks moving to a 13 month high, the dollar moving to a four month low, oil at a four month high, gold at a 6 month high, and the S&P 500 right around 5 year highs.

Now, one of the big movers in past QE's was oil, and we've seen oil moving up to around $100 a barrel. And the violence in Libya will not bode well for Libya's oil production ambitions. Libya was never a huge producer, but this might affect up to one million barrels a day. While that obscure movie is being upheld as the root cause of the intensifying protests and the death of the US envoy to Libya, it has only served to give added momentum to another more important development. The most likely key to all of this is al-Qaeda’s second in command, Abu Yahya al-Libi, who was killed by a US drone attack in Waziristan on 4 June. The catalyst for the attack in Libya and the unrest that has spread to Yemen, was a lengthy video released by al-Qaeda leader Ayman al-Zawahiri, marking the anniversary of 9/11 and admitting to the death of al-Libi, who is Libyan. This was a very powerful call to avenge al-Libi’s death and it came only 24 hours before the attack on the US consulate in Benghazi. Osama bin laden is dead but Al-Qaeda is still alive.

As big as QE3 is here in the US, the situation in Europe may be bigger. Former European Central Bank President Jean-Claude Trichet said today “The Europeans have a special responsibility because we are the epicenter of the worst crisis since World War II. And that, of course, calls for highly responsible decisions." He said all the advanced economies are undergoing their first major adjustment since the Second World War.

Trichet said that policymakers had naive beliefs that the developed world's financial and economic systems were resilient and stable. Last week, the ECB rolled out its bond-buying program, known as Outright Monetary Transactions, or OMT, which will buy the bonds of struggling countries if yields rise to levels that might make borrowing costs unsustainable. Trichet said governments now have to use the time provided by these measures to work hard to restore their economies to health. He says it's not just the struggling peripheral economies which need to deliver, but also the stronger economies which have to prop them up. Germany , the euro zone's biggest economy, was the only member of the ECB to vote against the plan for OMTs last week.

Actually, there were several concessions to the Germans in last week's deal. Perhaps the most important was the dropping of the ECB's previous aim to cap the bond yields of euro-zone members. Instead, the previously openended buyer of last resort commitment was replaced by greater selectivity and far stricter conditions. Those conditions include a formal application from any euro-zone member nation seeking support. Also, any applicant country will have to agree to German style reduction and economic restructuring programs; in other words, submit to German directed austerity. And it only applies to shorter term bonds, and it only applies if the ESM and the ESFS commit funds in parallel.

What this really means is that the Germans are demanding more of the austerity programs that have been a resounding failure so far.

Also, the Netherlands held an election yesterday, the far right, anti-Euro-union, pro-austerity parties lost.

Meanwhile, Spain isn't ready to submit to German austerity. Catalonia, a once prosperous region of Spain is now ready to get out from under the constraints of the Spanish government. An estimated 1.5 million Catalonians took to the streets in protest for independence.

We hear about all these other protests, what about 1.5 MILLION people on the streets?