I Don’t Know, They Don’t Know
by Sinclair Noe
DOW – 166 = 16,245
SPX – 20 = 1845
NAS – 47 = 4079
10 YR YLD - .03 = 2.69%
OIL - .44 = 100.70
GOLD – 5.40 = 1297.90
SILV - .09 = 19.97
SPX – 20 = 1845
NAS – 47 = 4079
10 YR YLD - .03 = 2.69%
OIL - .44 = 100.70
GOLD – 5.40 = 1297.90
SILV - .09 = 19.97
The biggest 3 day drop in the markets in about 2 months.
All of the sudden we start hearing the Wall Street stock peddlers waxing
enthusiastic about the prospects for a correction or a crash or whatever will
scare you. Fear sells; with talk about a 1987-like stock market crash,
geopolitical unrest in Ukraine and the risk of a debt crisis in China,
investors are starting to get jittery. I don’t know, they don’t know.
The big pullback so far has been in the Nasdaq, and
especially biotech stocks. As always, you want an exit plan in place before you
ever get into a trade; and if you don’t have an exit plan, get one now. You don’t
make money by letting profits slip through your fingers.
Earnings season gets underway this week. Expectations
have been ratcheted down; at the start of the year, S&P 500 companies were
projected to have grown earnings at 6.5%, now that estimate has slipped to
1.2%. We could see companies beat diminished expectations and start a fresh
rally or miss expectations and the markets could get a bit ugly. The simple
rule of thumb is that when the trailing P/E ratios hit 10, the S&P 500 is likely
undervalued; when the P/E hits 20, the market is likely overvalued and that
means the market is vulnerable to pullback. Guess where we are on the scale? Does
that mean that stock prices are about to roll over and play dead? Not
necessarily. All we have to do is add some earnings to the P/E ratio and …
The S&P 500 recently, as in last week, tested highs,
even though fewer than 10% of its components were making new highs individually.
Despite the fact that the S&P touched new high territory last week, the
average stock in the big index is actually down 7%. Then, you can look at
volume; down on up days; up on down days, like today. Toss in the presidential
election cycle, toss in the old but true idea of “sell in May”, and there are
plenty of reasons for caution.
The past couple of years have been easy; buy the dips;
buy good names with momentum and ride that pony to profits. Easy. But easy
doesn’t last forever. The momentum names look like they’re rolling over.
Investors are rolling over into safer sectors. We’ve gone nearly 2 years
without a correction of at least 10%, so it just seems like we’re due. So,
while there may be value to be found, this does not seem like a good time to
load up when high flyers dip. They may bounce back, but they don’t have to;
there is no law that requires a bounce. When a momentum play turns, it tends to
turn fast and furious.
This continues to be a tale of two markets. While the
high flyers stall, the safety of bonds has been drawing bids, and yields have
dipped over the past few days, despite the Fed's clear intention to pull back
on Quantitative Easing and bond buying. The utility sector has been
outperforming, which might be a signal of future volatility. Emerging markets
have seen inflows; maybe this is the idea that the US has been the cleanest
dirty shirt in the hamper, but the other shirts aren’t ready to be scrapped;
call it a reversion to the mean.
Maybe it’s just time to pause and ask why US stocks have
priced in so much optimism. Job growth continues but it is not robust and it is
not enough to propel the economy to escape velocity; the taper is underway;
fiscal policy remains a mess and there is little hope for stimulus from DC.
Corporate America is sitting on a mountain of cash,
somewhere between $1.6 and $1.9 trillion, but it’s offshore; they’re afraid to
touch it because they might have to pay tax. They could bring that money back
home and put it to work, but that would require innovation and sweat and labor.
Much of corporate leadership is short-sighted and lazy, and besides, the
offshore cash is still good enough to secure a bonus.
One of the key signs of a true recovery is sufficient
business confidence to start investing more into their own operations. Many
companies have shied away from investing in the future growth of their
companies. Too many companies have cut capital expenditure and even increased
debt to boost dividends and increase share buybacks. If you’re waiting for
capital expenditures to revive the economy, don’t hold your breath.
Larry Fink is the CEO of Blackrock, the largest money
manager, he says: “Companies only have a finite amount of cash to invest.
Whatever gets spent on buybacks and dividends is that much less available to be
spent on investments in employees, research and development, and capital
expenditure. It's basic arithmetic. When will the next round of capital
investment begin in earnest? As soon as you figure out the answer to that
question, you will have gained significant insight into the direction of the
economy as well as the next phase of this stock-market rally.”
Meanwhile, let’s look at banks behaving badly. Private
banking is a staple of the Swiss economy and for decades, as wealthy Americans
concealed their assets through clandestine accounts, US regulators turned a
blind eye.
In 2011, federal prosecutors indicted 7 Credit Suisse bankers
for abetting tax evasion, but the investigation into Credit Suisse dragged on.
The quirks of international law prolonged the inquiry, requiring Swiss courts
to review Credit Suisse documents before releasing them to the Justice
Department. Ultimately, the Justice Department gained access to many of the
documents and interviewed bank employees.
And by the time the Senate subcommittee convened its
hearing in February, the Justice Department was closing in on a case. Bracing
for a settlement, the bank announced last week that it had set aside roughly
$528 million for legal expenses. In addition to the Justice Department
investigation, Credit Suisse paid $200 million to settle a case with the SEC in
February. In a separate matter, in late March the bank agreed to an $885
million settlement to resolve claims that it sold questionable loans to Fannie
Mae and Freddie Mac. Apparently a slap on the wrist and a fine haven’t served
as a deterrent.
Now, Benjamin Lawsky, New York State’s top financial
regulator, has requested documents from Credit Suisse and is expected to demand
additional records this week to try to determine if Credit Suisse lied to New
York authorities about engineering tax shelters. In the Senate subcommittee
hearings in February, Credit Suisse executives apologized for the misconduct
and they also argued that the problems stopped in 2008 and were contained to a
few low-level rogue bankers. The bank, which said it voluntarily adopted a
number of controls against tax evasion, reported that there was no evidence
that executive management knew of the problems.
Lawsky has also petitioned a Senate subcommittee for
internal Credit Suisse documents. The
subcommittee questioned bank executives at a hearing in February, and produced
a scathing report exposing “a classic case of bank secrecy.” In late March, the
Senate agreed to release the internal Credit Suisse documents.
The escalating Credit Suisse probe, along with some
recent shifts in international law, might also provide momentum to the
government’s uneven effort to collect taxes and punish the banks involved.
Typically the punishment has been a fine and a slap on the wrist, but that has
drawn scrutiny from politicians lately, and so maybe this will be something
more.
Meanwhile, federal authorities have opened a criminal
investigation into a recent $400 million fraud involving Citigroup’s Mexican
unit, one of a handful of government inquiries looming over Citi.
The investigation, overseen by the FBI and prosecutors
from the United States attorney’s office in Manhattan, is focusing in part on
whether holes in the bank’s internal controls contributed to the fraud in
Mexico. The question for investigators is whether Citigroup ignored warning
signs, as other banks have been accused of doing in the context of money
laundering.
Federal prosecutors in Massachusetts have sent subpoenas
to Citigroup, to examine whether the bank lacked proper safeguards against
clients laundering money. Citi also faces a parallel civil investigation from
the SEC. And it was just 2 weeks ago that Citi fell short in the Federal
Reserve’s stress test. The Fed rejected Citi’s plan to increase its dividend
based upon questions about the reliability of Citi’s financial projections.
And that brings us to the tale of Kenneth Lewis, the
former chief of Bank of America. Back in 2008, as the global financial meltdown
imploded, Bank of America rushed in to acquire Merrill Lynch. Lewis called it
the “strategic opportunity of a lifetime” and he said the Fed did not pressure
him into the deal. He later admitted he lied. Merrill Lynch was bleeding cash
while paying huge bonuses. Bank of America required 2 bailouts from Treasury
plus extraordinary lending from the Fed. It is a crime to knowingly deceive
shareholders about the financial condition of your company.
Bank of America has paid several fines related to cases
brought by various regulators, and there is still an outstanding suit, but the
case of Kenneth Lewis wrapped up last week. Mr. Lewis agreed to pay $10
million, which was provided by Bank of America. He is barred from being an
executive or director of a public company, but he already retired with a
sizeable golden parachute. He did not have to admit or deny wrongdoing.
