Wednesday, July 16, 2014 - The Color of the Day is Beige

The Color of the Day is Beige

by Sinclair Noe

DOW + 77 = 17,138
SPX + 8 = 1981
NAS + 9 = 4425
10 YR YLD - .01 = 2.53%
OIL + 1.38 = 101.34
GOLD + 6.20 = 1300.80
SILV + .07 = 20.89

A record high close for the Dow; the 15^th record high close of the year for the Dow. The S&P 500 did not take out the old high from July 3^rd. We have a few economic reports to cover, plus Fed Chair Yellen continued testimony on Capitol Hill, and lots more.

Industrial production increased 0.2% in June to 103.9. This is 24.1% above the recession low, and 3.1% above the pre-recession peak. For the second quarter, industrial production advanced at an annual rate of 5.5%; so the quarter was good but the month of June was less than expected.

The Commerce Department reports producer prices increased by a seasonally adjusted 0.4% last month, above forecasts for a 0.2% gain, after falling 0.2% in May. Year-over-year, the producer price index rose at an annualized rate of 1.9% in June. The core rate, stripping out food and energy prices, was up 0.2%.

This afternoon, the Federal Reserve released its Beige Book, a collection of reports from the 12 Fed districts. The general consensus is that economic growth was moderate to modest. Most Districts were optimistic about the outlook for growth. Consumer spending increased in every district. Retail sales grew modestly in most districts. Auto sales, which have been on the upswing for more than a year, continued to stand out as particularly brisk support for the economy, but broader retail sales were more subdued. Labor market conditions continue to improve with all districts reporting slight to moderate employment growth. Several districts reported "some difficulty" finding staff for skilled positions, however there doesn’t seem to be any pressure on wages. Here’s a hint, if you can’t find skilled workers, try offering higher wages. The report gave a mixed appraisal of the US housing market. Conditions "varied" across the country, with some regions suffering from weak demand.

Fed Chair Janet Yellen returned to Capitol Hill to deliver her second day of Humphrey Hawkins testimony. The prepared remarks were the same as yesterday, then they open up for a Q&A. Some of the key points from today’s hearing:

Yellen said she is optimistic about the economy, “We had a very surprising negative growth in the first quarter, which is a number that in a way doesn't seem consistent with the underlining momentum in the economy and many indicators of spending and production. And I do think the economy is recovering and that growth is picking up and that we have sufficient growth to support continued improvement in the labor market."

Yellen said threats to financial stability are moderate “and not a very high level.” She again weighed in on valuations, saying: "Some things may be on the high side and there may be some pockets where we see valuations becoming very stretched but not generally. The use of leverage is not broad-based, it hasn't increased, and credit growth is not at alarming levels by any means."

Yellen did not single out specific sectors today. Yesterday she said biotech and social media looked a bit over-valued. That had some talking heads complaining; the funniest rant came from Jim Cramer, who said: “Next time, Fed Chief Yellen, it might pay to point out that there are plenty of cheap stocks out there, too. At least that way you can help us make money, not just lose it.” Maybe someone can tell Cramer the Fed is not in business to help him make stock picks, no matter how much help he needs. The Fed has been incredibly accommodative to Wall Street, and Cramer still complains. The Fed doesn’t issue a price target on Twitter. But if you read between the lines, Yellen was likely saying that there are no plans to raise the margin requirements on brokers.

There were some questions about a bill in the House that would require the Fed to follow a mathematical rule for when to raise or lower interest rates. Yellen didn’t like that idea; she said there is no magic formula for raising rates. Yellen again expressed confidence the Fed can exit when the time comes. The Fed has a variety of tools it can use to raise interest rates. In the distant future, the Fed’s balance sheet will shrink in size.

The best line from the Fed did not come from Yellen; Dallas Fed President Richard Fisher was speaking today at the University of Southern California. Fisher said ending asset purchases this fall isn’t enough; the Fed should start to taper the reinvestment of maturing securities in October. Fisher said: "Monetary policy is a bit like duck hunting. If you want to bag a mallard, you don't aim where the bird is at present, you aim ahead of its flight pattern. To me, the flight pattern of the economy is clearly toward increasing employment and inflation that will sooner than expected pierce through the tolerance level of 2%."

Meanwhile, it’s earnings reporting season. Bank of America said profit declined 43% as it spent $4 billion to cover litigation costs, including a mortgage settlement with AIG. There seems to be a trend developing in banks’ earnings reports; they are making money on investment banking and some other areas, but results are weak for mortgage originations, and they are setting aside big chunks of earnings to pay for legal settlements.

Bank of America and the Department of Justice are reportedly negotiating a mortgage securities settlement, which could cost the bank around $13 billion.

Intel was up more than 9% after a very strong earnings report after the close yesterday. Yahoo fell today following weaker than expected earnings. EBay posted lower than expected 2Q results and even though sales were up this month, EBay cut its outlook for the third quarter.

Merger and acquisition activity has been wild lately. Today’s M&A stories revolved around Rupert Murdoch’s plan to buy Time Warner for $85 a share, or about $75 billion. Time Warner says it isn’t interested in exploring a sale, but if they sell, there are other potential suitors. General Electric is in talks to sell its household appliances business; that’s a part of the company that’s been around since 1905, when they invented the electric toaster. Yesterday, the number 2 tobacco company, Reynolds American agreed to buy the number 3 tobacco company, Lorillard for $25 billion.

One of the motivating factors behind mergers lately has been something called inversion, basically merging with an overseas company to avoid corporate taxes in the US. Members of the House and Senate have made proposals to curb the inversion trend in recent months, and the president included a provision in the budget he presented to Congress this year that would have effectively banned the move. But none of these efforts have yet gained traction. Today, Treasury Secretary Jack Lew called on Congress to enact legislation to halt inversion, effective immediately and retroactive to May.  Making any new legislation retroactive through May could disrupt several megadeals that have already been struck, such as the Medtronics deal.

Global M&A volume in the first half was the highest since 2007. One of the side effects of the M&A frenzy back in 2007-2008 was the frenzy of pink slips that followed. Deals are sold to investors on the basis of “creating value” with terms like “efficiencies” and “synergies”; code words for cost cutting and mass-layoffs. Acquisitions, layoffs, and cost-cutting are the simplest things to do for a CEO, as opposed to inventing things and boosting sales organically, which is hard. Analysts love M&A, investors too, and of course the investment bankers promote it as the best thing since sliced bread, or maybe electric toasters.

Last year, Microsoft acquired Nokia’s mobile phone business and promised $600 million in cost saving and efficiencies and synergies. Now, Microsoft employees are bracing for up to 12,000 layoffs, the biggest ever for Microsoft. The layoff news will come before the company holds its post-earnings conference call after the market closes July 22.

Leaders of the five BRICS nations agreed on the structure of a $50 billion development bank by granting China its headquarters and India its first rotating presidency. The leaders also formalized the creation of a $100 billion currency exchange reserve, which member states can tap in case of balance of payment crises. Both initiatives, which require legislative approval, are designed to provide an alternative to financing from the International Monetary Fund and the World Bank, where BRICS countries have been seeking more say.

Thursday, February 13, 2014 - The Popsicle Economy

The Popsicle Economy

by Sinclair Noe

DOW + 63 = 16,027
SPX + 10 = 1829
NAS + 39 = 4240
10 YR YLD - .02 = 2.73%
OIL - .02 = 100.35
GOLD + 11.00 = 1303.80
SILV + .25 = 20.59

According to the latest AAII Investor Sentiment Survey, over the last week the number of self-described bulls jumped to over 40% while bears plunged from over 36% to 27%. Did all those people suddenly become timing experts or is this an indication that it’s time to take profits?

The number of Americans who applied to receive unemployment benefits rose last week and the gradual decline in claims since last year appears to have halted. Initial jobless claims climbed by 8,000 to a seasonally adjusted 339,000 in the seven days ended Feb. 8.

RealtyTrac reports monthly foreclosure filings — including default notices, scheduled auctions and bank repossessions — reversed course and increased 8% to 124,419 in January from December. One month does not make a trend, but the foreclosure rebound pattern is not only showing up in judicial states like New Jersey, where foreclosure activity reached a 40-month high in January, but also some non-judicial states like California, where foreclosure starts jumped 57% from a year ago, following 17 consecutive months of annual decreases. As a whole, 57,259 US properties started the foreclosure process for the first time in January, rising 10% from December but still down 12% from last year.

On a monthly basis, retail sales decreased 0.4% from December to January (seasonally adjusted), and sales were up 2.6% from January 2013. Sales in November were revised down from a 0.2% increase to a 0.1% decrease.

In its monthly budget report, the Treasury Department said that the deficit for January was $10.4 billion. For the period from October through January (the first four months of this budget year), it totaled $184 billion. That is down $106 billion from the same period a year ago and puts the country on track for a further improvement in the budget deficit.

The Congressional Budget Office is projecting that the deficit for the current budget year will decline to $514 billion. That would be the smallest imbalance in six years. The deficit last year was $680 billion. The CBO's deficit projection for this year would represent a drop of 24% over the 2013 deficit. The CBO's latest forecast issued earlier this month projected that the deficit will decline to $478 billion in 2015 before starting to rise again in 2016 and keep heading higher for the rest of the decade.

As we know, Congress agreed to approve a suspension of the federal debt limit through March 2015. If it sounds like a bipartisan agreement, that doesn’t really describe what happened; more like a game of chicken taken to extremes, and hope for avoiding another head on collision. Ted Cruz’s best efforts notwithstanding, the United States will not dabble in first-time debt defaulting until next year, at the earliest.

Dallas Federal Reserve Bank President Richard Fisher made a speech the other night and blamed Congress for the sluggish economy. Fisher said: “For far too long, the greatest obstacle to our nation’s prosperity, has resided in this building right here: the Congress of the United States.”

Fisher said Congress has repeatedly failed to develop a tax or fiscal policy that would boost the economy. He pointed out an editorial in the Financial Times this week that concluded – ”Fiscal policy is still not an ally of U.S. growth,” and then added, “Fiscal policy is not only not an ally of U.S. growth, it is its enemy.”

This week when Janet Yellen testified before House lawmakers we learned more about how she's thinking about the labor market. In her prepared remarks she pointed to concerns including the long-term jobless as well as part-time workers who would like more work. And during her testimony, she indicated she believes the increase in unemployment since the financial crisis is cyclical, related to the business cycle and related to demand.

The reason that's important is if you think it's cyclical, then you think monetary policy can help. That's opposed to structural unemployment which is longer-term and due to fundamental shifts in an economy, which would require fiscal and regulatory policy response.

Another key aspect of the labor market story is the decline in the labor force participation to a 35-year low. Yellen told lawmakers while a significant part of this decline is structural due to demographics, she said some of it may be cyclical. The difference between unemployment and being out of the labor force is not just statistical: if you are unemployed you are job ready, if you're out of the labor force it takes a big effort to get back in the labor force.

America’s real job creators are consumers, whose rising wages generate jobs and growth. If average people don’t have decent wages there can be no real recovery and no sustained growth. If the Fed and/or Congress wants to see economic growth, it starts with jobs.

Comcast is acquiring Time Warner Cable. It's a $45 billion deal that would combine America's top two cable TV companies for a total of about 30 million subscribers, who are already among the least-happy customers in all of Corporate America. When it comes to customer satisfaction cable companies rank very low, and Comcast and Time Warner rank among the worst. The history of mergers suggests customer service might only get worse for these two companies. Coupling companies typically struggle to knit together their massive systems, and customers get lost in the process. When Comcast bought AT&T Broadband for $50 billion in 2002, customer billing problems led to such a backlash that the company ultimately launched a "Think Customer First" training program.

A BusinessWeek study of 28 mergers between 1997 and 2002 found that customer-satisfaction ratings dropped significantly after the unions, with the effect lasting for years. Cable companies suffered some of the biggest drops in that study. If there's any reason to hope, it's that both companies are suffering from the broader long-term trend of customers dropping cable subscriptions in favor of other alternatives. One of those alternatives is broadband Internet, which both companies also offer. Maybe they can learn from their mistakes. Yeah, that’s not going to happen.

After years of lamenting the factory sector’s diminishing role in the American economy, many American firms are counting on the domestic energy boom, rising overseas labor costs and stronger domestic demand to revive the long-stagnating manufacturing sector. The International Monetary Fund, the iMF, has just published a paper that says a US manufacturing renaissance is probably not gonna happen.

Manufacturing has become an increasingly smaller share of U.S. economy for the better part of a century. At the end of World War II, more than a third of all U.S. workers held manufacturing jobs. That figure fell below 10% in 2008 and manufacturing employment has failed to rebound to prerecession levels, according to Labor Department data.

After the Great Recession, a depreciating dollar, falling natural gas prices and declining unit labor costs boosted U.S. manufacturing production, the IMF economists write. Recent data shows that several durable goods sectors have rebounded strongly after the recession, potentially foreshadowing a strong manufacturing presence in the global marketplace, they said.

In 2010, the manufacturing sector grew by 6.8%, outpacing the nation’s growth in gross domestic product of 2.5% that year. Increasing consumer demand in the U.S. and abroad propelled factory output. Exports grew 11.5% in 2010.

Manufacturing exports could provide “non-negligible growth opportunities” for the American economy, especially as new technology allows energy companies to tap massive domestic deposits of natural gas and oil reserves, IMF economists added. The shale energy boom could add up to 0.3 percentage point a year to growth by 2020.

But a surge in manufacturing — as a share of the U.S. economy — has failed to materialize. Growth in the manufacturing sector trailed the overall economy in 2011 and 2012, according to Commerce Department data released last month. The pace of export growth has tapered off since 2010 and  manufacturing employment increased more slowly than total U.S. payrolls the past two years.

Still, the IMF economists said that the U.S. energy jolt, combined with further dollar depreciation and swelling consumer demand from China, India and other emerging markets could gradually increase U.S. manufacturing output over the longer term.

Despite the boost from energy, the researchers found the U.S. is unlikely to be able to significantly offset the gains made in many emerging markets as companies move their operations where manufacturing is less expensive.

Paul Krugman writes: Bloomberg reports on the soaring prices of trophy apartments in Manhattan. The biggest sale so far was former Citigroup head Sandy Weill’s apartment, which he sold for $88 million to the daughter of a Russian oligarch. But $100 million listings are out there.

For a bit of perspective: the median full-time worker in the United States makes about $40,000 a year. So it would take the typical worker 2,000 years to earn enough to buy the Weill apartment.

Still, people like Weill are exemplars of the free market at work. They work in an industry that delivers clear value to the economy, and has never relied on government bailouts. Oh, wait.

Even if you have a pricey Manhattan apartment, it’s still snowing in New York. More than 700,000 people, including residents of Georgia and South Carolina hit by a heavy blast of ice a day earlier, were without power as the storm made its way up the coast, closing much of Washington and threatening to drop up to 18 inches of snow in some areas.

Friday, February 07, 2014 - Jobs Report Friday

Jobs Report Friday

By Sinclair Noe

DOW + 165 = 15,794
SPX + 23 = 1797
NAS + 68 = 4125
10 YR YLD - .03 = 2.67%
OIL + 2.21 = 100.05
GOLD + 9.30 = 1268.10
SILV + .07 = 20.12

The best 2 days in a row for stocks in almost 4 months. For the week the Dow was up 97 points, and the S&P 500 was up 15 points on the week. The VIX, the volatility index slipped back down to 15, indicating a general happy go lucky outlook for stocks, with just the slightest hint that the past couple of days were part of a short squeeze; especially considering the lousy nature of the unemployment report.

This is Jobs Report Friday and I tend to get a bit wonkish with the numbers but I think it is important economic data, so here goes.

The Labor Department reported the economy added 113,000 jobs in January while the unemployment rate dropped slightly to 6.6%. The number of jobs added fell short of expectations; analysts had projected job growth of around 185,000.

While weather was believed to have weighed on hiring in December, it did not appear to be a major factor last month. There were strong gains in the weather-sensitive construction sector, and while a survey of households found 262,000 Americans were unable to work due to the weather, the department said that was in line with historical trends.

This comes on the heels of an even weaker December jobs report. Today’s report included revisions to November and December numbers. November was revised from 241,000 jobs up to 274,000, and December was revised from 74,000 to 75,000.  The past two months of job growth have been the weakest performance in 3 years, even with revisions; and well below the average monthly gain of 178,000 positions over the last six months.

The Labor Force Participation Rate increased in January to 63.0% from 62.8% in December. This is the percentage of the working age population in the labor force.  In the past we’ve seen the unemployment rate dropping as the participation rate drops. It’s a pretty simple idea really; as the pool of working age people gets smaller, it would require fewer new jobs to see the unemployment rate drop. In January, however, the pool got bigger and the unemployment rate still dropped. There are many reasons why the labor pool gets bigger or smaller. The pool of labor gets bigger as the population expands and as discouraged workers look for jobs again. It gets smaller because people give up looking for work or slip into the underground economy or retire; a lot of Baby Boomers are retiring and that has some impact on the labor pool.

Since the participation rate declined due to cyclical and demographic reasons, in other words, the bad economy and an aging population, we can look to the key working age group of 25 to 54 year old workers. The 25 to 54 participation rate increased in January to 81.1% from 80.7%, and the 25 to 54 employment population ratio increased to 76.5% from 76.1%. 

The best explanation I’ve seen for this discrepancy is that there was a benchmark revision going back to March 2013 to include certain service sector jobs, specifically for services for the elderly and people with disabilities, and these jobs had previously been uncounted or undercounted. Or maybe the discrepancy is just that the unemployment rate is based on a separate survey of households, and this whole process is slightly imprecise.

This month there was a huge discrepancy between the two surveys. The less-reliable and much more volatile household survey shows employment shooting up by 616,000 positions, and the employment-population ratio increasing by two-tenths of a percentage point. That’s very good news: It shows a stronger economy leading workers back into the labor force.

The more-reliable establishment survey shows employment growing by just 113,000 jobs. So, in many respects, this report raises more questions than it provides answers. However, one thing is becoming increasingly obvious; the unemployment rate (now at 6.6%) is becoming less and less reliable; and less and less representative of the strength or weakness of the economy. The unemployment rate went down last month but this was a bad jobs report. Unless you look at the household survey, which was very good.

Over time, the two surveys generally move in tandem, but over short periods they can diverge wildly. Over the past three months, the household survey says employment has increased by an average of 580,000 per month. The establishment survey says payrolls have increased by just 154,000 per month. So, we either saw the best 3 month stretch since 2000 or the worst 3 month stretch since 2012.

The U-6 measure of unemployment dropped to 12.7%, down from 13.1%. U-6 includes the unemployed plus the underutilized workers; people working part-time because their hours were cut back or they weren’t able to find full-time work.

In the January report, one sector holding back payrolls was the government, which shrank by 29,000 jobs in January. State and local governments lost 17,000 jobs; federal lost 12,000. Excluding that loss, private employers added 142,000 positions, a slightly better showing, and is now 291,000 below the previous peak. Total employment is still 866,000 below the peak in January 2008.  It is possible that private employment will be at a new high in March or April. The public sector has declined by more than 760,000 jobs under the Obama administration, and this has been a significant drag on overall employment. A big question is when the public sector layoffs will end.

Education, health care and retail also lost positions. In December and January together, just 2,600 health care positions were filled. By contrast, as recently as November, nearly 25,000 health care workers were added to payrolls. The retail sector lost 13,000 jobs in January; some of that reduction might be related to excessive hiring for the holidays, but the cutbacks are also likely related to weak performances by several retailers. For example, JC Penney and Loehmann’s and Target announced job cuts last month. Manufacturing and construction sectors led overall employment gains in January, adding 21,000 and 48,000 new jobs, respectively.

There are about 3.6 million workers who have been unemployed for more than 26 weeks and still want a job; this is down from 3.8 million in December and this is the lowest level since March 2009. And because off Congressional inaction, about 1.7 million and counting, long-term job seekers are losing emergency unemployment insurance benefits. The Congressional Budget Office estimates that extending those benefits would add 0.2 percent to gross domestic product growth and 200,000 jobs to the economy this year.

According to separate BLS data there are 3 unemployed people for each job opening. The number of people that reported having lost a job involuntarily increased, while the number that reported leaving a job voluntarily and the number re-entering or rejoining the workforce declined. Temporary employment services, often a stepping stone to permanent future employment, added just 8,000 jobs in January.

The average work week remained unchanged at 34.4 hours, and overtime hours notched down to 3.4 hours, meaning that employers have considerable room to increase worker hours before they need to hire additional people.

One mystery arising from today’s report is why employment gains have not kept up with economic growth as measured by gross domestic product, which picked up substantially in the second half of 2013. The annualized pace of expansion was 3.2% in the fourth quarter, and 4.1% in the third quarter. One reason may be that new technologies are allowing employers to make do with fewer workers, for instance the use of automated customer service systems instead of call centers, or Internet retailers’ taking over from brick-and-mortar stores. In other words, the robots are taking over. Maybe.

Or maybe technology has just passed over certain parts of the country. In many cities in central California, unemployment remains about 10%, while on the coast of California the unemployment rate is about the lowest in the nation. In the rust belt regions of Illinois, Michigan, and Ohio, unemployment is very high and may be stuck at high levels as business and industries that supported those jobs in those regions are gone and not likely to return; especially as skill levels erode for the long-term unemployed.

Another possible explanation might be found in a report yesterday on the labor share index. In the fourth quarter of 2013, the labor share index dropped to 95.5, its lowest level since the 1940’s. This might indicate higher demands on worker productivity per unit produced, or labor cost per unit, resulting in a gap between  the work done and the compensation paid. Even though productivity was soft for last year – up just 0.6% last year, the Labor Department reported productivity rose at a 3.2% annual rate in the fourth quarter after increasing at a 3.6% pace in the third quarter. Unit labor costs, a gauge of the labor-related cost for any given unit of output, fell at a 1.6% rate in the fourth quarter, showing weak wage-related inflation pressures in the economy.

This almost certainly should be considered a positive for corporate profits. According to Thomson Reuters data, of the 343 companies in the S&P 500 that have reported earnings through Friday morning, 67.9% have topped Wall Street expectations, slightly above the 67% beat rate for the last four quarters.

And for the Federal Reserve, today’s jobs report probably doesn’t change their thinking. The unemployment rate went down, even for dubious reasons, and so they can continue with their taper. The Fed has committed to taper, and it would take a big jolt to knock that train off its track; or as Dalls Fed President Richard Fisher said today, the Fed won’t be swayed by a single number. Indeed, the focus on the Fed now shifts to interest rates, as we get closer to 6.5% unemployment, which you may recall, the Fed set as a target for their pledge to hold low rates steady.

For whatever reason, Wall Street shrugged off the jobs report, at least for today. 

Wednesday, August 07, 2013 - A Crack in QE

A Crack in QE

by Sinclair Noe

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tuesday, August 06, 2013 - Dog Days

Dog Days

by Sinclair Noe

DOW – 93 = 15,518
SPX – 9 = 1697
NAS – 27 = 3665
10 YR YLD + .02 2.63%
OIL - .86 = 105.70
GOLD – 21.20 = 1283.60
SILV - .23 = 19.58

If the markets are boring you this summer, you just aren't paying attention. August trading in this post-financial crisis landscape has been anything but boring. For the past four years, the market has offered tremendous gains and harrowing losses during the month of August. The boring, flat market many of us have grown to expect just hasn't materialized.

Investors were treated to big gains in August 2009 and August 2012. But in August 2010 and 2011, the broad market coughed up about 5%. In 2010, August ended up marking the final lows of a summer correction. In 2011, the eurozone crisis pulled stocks underwater by as much as 12% during the month of August, only to claw their way back from the brink of a new bear market. So much for the dog days of summer. This time around, nothing should surprise you. 

The US trade deficit declined in June to its lowest level in more than 3-1/2 years as imports fell and exports touched a record high. The Commerce Department says the trade gap fell 22.4 percent to $34.2 billion, the smallest since October 2009. The percentage decline was the largest since February 2009.

May's shortfall on the trade balance was revised to $44.1 billion from the previously reported $45.0 billion. Exports of goods and services increased 2.2 percent to a record $191 billion. The gain in exports was broad based, with food, industrial supplies, capital goods and consumer goods rising. Motor vehicle exports, however, fell in June. The increase in export growth may point toward slightly stronger second half GDP growth for the economy.

I mentioned yesterday that we were expecting some Federal Reserve officials to give some speeches this week. Yesterday, Dallas Fed President Richard Fisher called for an end to QE; no surprise because it's well known that Fisher opposes ongoing QE. Today, Dennis Lockhart, President of the Federal Reserve Bank of Atlanta spoke as part of a panel discussion; and Charles Evans, President of the Chicago Fed Bank spoke to reporters.

Lockhart said continued improvement in the labor market would be key: "If we see the growth pick up in the second half and if we see a continuation of the job gains that we - not (the) 162,000 number that we saw last month but at a higher range, say 180-200,000 - I think with other fundamentals improving we probably are in a position to remove ... the extraordinary policy program over the medium term - that being the asset purchase program." Lockhart also said that if the economy deteriorates then the exit from QE is not a foregone conclusion.

Chicago Fed President Charles Evans said much of the same: "We are quite likely to reduce the flow of purchases rate starting later this year - I couldn't tell you exactly which month that will be - and it's likely to wind down over time in a couple or few stages."

Both Fed officials think the Fed will stick to a Zero Interest Rate Policy for quite some time. Evans said he expects the economy to grow about 2.5 percent in the second half of this year, and more than 3 percent next year. That rate of growth should generate about 175,000 to 200,000 jobs a month and will probably bring the unemployment rate down to about 7.2-7.3 percent by the end of the year. So, the outlook is rosy, the current conditions, not so much. The Fed doesn't always nail economic forecasts.

All told, Evans said, the Fed's third round of quantitative easing, or QE3, will likely total at least $1.2 trillion since January 2013, double the size of the Fed's prior round of purchases. So, we might question whether we got our money's worth and also if the economic forecasts are good enough. Even if the economy starts averaging 200,000 net new jobs per month, is that good enough, considering the quality of jobs? Is 6.5% unemployment good enough? Remember, the Fed hasn't seen much in the way of fiscal policy to improve the situation.

Another regional Fed policymaker, Narayana Kocherlakota, president of the Minneapolis Fed, has called for the Fed to spur the economy further by lowering its threshold for considering a hike in rates to 5.5 percent unemployment, near the economy's long-term normal rate.

So, the markets were down today, even with good news on the trade deficit because the market is focused on free money from the Fed and fearful they will take away the punch bowl, or the Bernanke “put”, or whatever you want to call it; the Fed has been pumping $85 billion a month into the markets and they would hate to see it go. For the rest of us, that money doesn't seem to filter down from Wall Street to Main Street, but it is turning into the lifeblood of Wall Street, and when it's gone Wall Street will likely respond poorly, and today was just a small indication.

The government filed two civil lawsuits against Bank of America for what the Justice Department and securities regulators said was a fraud on investors involving $850 million of residential mortgage-backed securities.

The Justice Department and the Securities and Exchange Commission filed the parallel suits in US District Court in Charlotte.

The securities date to about January 2008, putting them just at the beginning of the global financial crisis.

Bank of America responded to the lawsuits with a statement: "These were prime mortgages sold to sophisticated investors who had ample access to the underlying data, and we will demonstrate that.

Bank of America had warned in a securities filing on Thursday about possible new civil charges linked to a sale of one or two mortgage bonds.

The two suits accuse Bank of America of making misleading statements and failing to disclose important facts about the mortgages underlying a securitization named BOAMS 2008-A.

"These misstatements and omissions concerned the quality and safety of the mortgages collateralizing the BOAMS 2008-A securitization, how it originated those mortgages and the likelihood that the 'prime' loans would perform as expected," the Justice Department said in its statement. A "material number" of mortgages in the pool "failed to materially adhere to Bank of America's underwriting standards."

Bank of America has announced a series of settlements with investors and the government, including an $8.5 billion settlement with investors in mortgage-backed securities and a $1.6 billion deal with bond insurer MBIA Inc.

Last week, a jury in New York City convicted former Goldman Sachs trader Fabrice Tourre on six civil counts of securities fraud, for selling a toxic mortgage-backed bond to investors without disclosing that an architect of the deal, hedge fund Paulson & Co., also bet on its failure. This victory for the Securities and Exchange Commission signifies a long-awaited measure of justice for the unbridled greed and dirty dealing that sparked the financial crisis, but an exceedingly small one. Tourre was a young, mid-level employee, listed as a “vice president,” but so are hundreds of people at Goldman, not a decision-maker in executive suites throughout Wall Street. The conviction means he’ll pay a fine and probably get barred from the securities industry, an industry he’s already left to pursue a doctorate. This is hardly the level of accountability that practically the entire country demanded to see, especially when you consider that it represents the sum total of legitimate crisis-related convictions, and a non-criminal one at that. The SEC must stop chasing minnows while letting the whales of Wall Street go free.

Despite this, the Tourre case matters. It should lead Washington to rethink the conventional wisdom that financial regulators and Justice Department officials have spread about these cases: that they’re impossible to prosecute. It’s not just critical for how we remember the last crisis; it also shapes how we should think about the next one, whenever it comes to pass.

If you look at all the excuses for the total absence of prosecutions of major bank executives for their roles in nearly crashing the global economy, you find two major themes. First, the financial industry’s conduct was perhaps unethical but not technically illegal, especially since the peculiarities of securities law ensure that well-heeled bank executives will find some loophole to exculpate themselves from guilt. Second, juries will not be able to understand the hopelessly complex intricacies of the law, and will simply punt before agreeing beyond a reasonable doubt on the guilt of the bankers.

The Tourre case proves these both wrong. To say the case discredits a silly argument gives that argument too much weight. There were numerous convictions of accounting fraud in the Enron and WorldCom era, in cases that were at least as complex as the 2008 crisis. Ultimately fraud is fraud. Juries are more sophisticated than people give them credit for. They take their job seriously.

That appears to be the result of the trial of Fabrice Tourre. The jury, which has been interviewed extensively, fully understood that Tourre was something of a scapegoat and not the central decision-maker at the firm. They recognized that senior executives at Goldman Sachs approved the deal, known as Abacus. And they generally discounted the damning emails from Tourre, bragging about selling the toxic bonds to “widows and orphans.”

Instead, they bore down into the details, asking simple questions about whether Tourre’s lack of disclosure to investors about the designed-to-fail quality of Abacus represented securities fraud. They saw through the allegation that the industry generally did not disclose the participation of hedge funds like Paulson in derivatives deals, and focused on whether that constituted a material misrepresentation. And Tourre’s participation in the scheme, not his place on the totem pole at Goldman, was the determinative factor. One juror summed it up this way: “They portrayed him as a cog, but in the end a machine is made up of cogs and he was a willing part of that.” While Toure faced civil charges with a lower burden of proof, these core insights from the jury could have been employed even in criminal financial fraud cases.

Thursday, June 27, 2013 - To Not Trade in Principles

To Not Trade in Principles

by Sinclair Noe

DOW + 114 = 15,024
SPX + 9 = 1613
NAS + 25 = 3401
10 YR YLD - .05 = 2.48%
OIL + 1.35 = 96.85
GOLD – 24.40 = 1201.80
SILV - .01 = 18.61

First some economic news, then we'll head to Ecuador.

Consumer spending rose a seasonally adjusted 0.3% in May, reversing a 0.3% decline in April. So, for the past 2 months, it's a wash. Adjusted for inflation, the numbers are slightly lower. Consumers bought more cars and trucks in May and spent a bit more on gasoline, reflecting higher prices at the pump. They also ate outside the home more often and shelled out extra cash for housing, financial advice, insurance and recreational activities. Since incomes rose faster than spending in May, the savings rate of Americans climbed to 3.2% from 3%. That’s the highest level since December and well above the 2013 low of 2.2%.

In a separate report, the Labor Department reported a 9,000 drop in first-time jobless claims for the last week.

The National Association of Realtors reports pending home sales jumped in May to reach a six-year high, The NAR's pending home sales index climbed 6.7% to 112.3 in May, from a downwardly revised 105.2 in April. The index was up 12.1% from May 2012 levels. 

Freddy Mac reports the average rate for the 30-year fixed-rate mortgage rose to 4.46% in the week ending June 27, the highest rate in a couple of years, and up from 3.93% in the prior week. That gain of 53 basis points is the largest weekly change since 1987. A year ago, the 30-year rate averaged 3.66%.

Earlier this week, Dallas Fed President Richard Fisher likened market participants to “feral hogs” for pushing bond yields higher. Today, three more top Federal Reserve officials took issue with the increase in interest rates. William Dudley, the president of the New York Fed, Fed Gov. Jerome Powell and Atlanta Fed President Dennis Lockhart were less colorful but more pointed.

Dudley said expectations of an earlier rate hike were “quite out of sync” with both FOMC statements and the expectations of most FOMC participants,” and he said any rise in short-term rates “is very likely to be a long way off.”

Powell, in a separate appearance, said the spike in bond yields over the past month is “larger” than would be justified by any “reasonable reassessment” of the path of Fed policy. Powell said that if the market is now pricing in an increase in rates in 2014, “that implies a stronger economic performance than forecast either by most FOMC participants or by private forecasters.”

And Lockhart said that some in the markets appeared to mishear what Bernanke said. The three Fed officials were generally upbeat about the economic outlook despite what Lockhart admitted were “weak inflation readings, mixed vital signs, and choppy quarter-to-quarter growth statistics.”

As expected, the Commodity Futures Trading Commission said it is suing Jon Corzine, who was MF Global’s chief executive, and the firm’s former assistant treasurer Edith O’Brien for the unlawful use of about $1 billion in customer funds that “harmed thousands of customers and violated fundamental customer protection laws on an unprecedented scale.”

The CFTC, cites internal MF Global phone recordings as evidence in alleging that Corzine knew the company was running out of cash and directed it to keep paying out obligations without asking where the money came from. The CFTC cites one MF Global official’s comment that “we have to tell Jon that enough is enough. We need to take the keys away from him.”

CFTC said Corzine is charged with being more than a passive actor in the downfall of MF Global. The CFTC is seeking financial penalties against Corzine and O’Brien and also to ban them from trading and registering to work in the derivatives markets overseen by the agency. MF Global has agreed to settle with regulators and payback any customers who are still owed money as well as pay a $100 million fine. I still have a hard time understanding how this is not a criminal matter.

The SEC is now investigating the relationship between Thomson Reuters and the Institute for Supply Management. ISM manufacturing data was sent out early on June 3^rd to Thomson Reuters high-speed clients, or high frequency traders, and there were trades based on the early release of data; by some estimates more than $28 million in trades in a matter of 15 milliseconds prior to the official release.

Earlier this week President Obama announced his plans to fight global warming. The GOP response was that it would kill jobs. Today, Christine Lagarde, the managing director of the International Monetary Fund, said that climate change will drive job creation. “Climate change will create jobs. It will create disasters before it creates jobs, but it will create jobs.” Clean up on Aisle 3.

Where in the world is Edward Snowden? Right now, it looks like Snowden is doing his best imitation of Tom Hanks in the movie “The Terminal”; remember that Hanks played a guy who's country was lost while he was on an airplane, and when he landed, his passport was no longer valid; he ended up stuck in a no-man's land in the terminal of an airport. The best guess is that Snowden is in the terminal of the airport in Moscow, not quite admitted into Russia. At some point he will leave the terminal. Where will he go?

Well, he's already been in Hong Kong and Moscow; and in each location the governments of China and Russia have refused extradition; certainly a bit of a slap on the diplomatic wrist, but that's China and Russia. And if Snowden were to stay in China or Russia, at some point the State Department would step up pressure, and he might be extradited. So, where will he go?

The possible candidates for an ultimate landing spot include Iceland and Ecuador. Why would either country accept Snowden? Well, for Iceland the thinking is that they've already kicked out the bankers; they have no real reliance on the US or for that matter, on our European allies. Iceland is reverting back to fishing, and they really just don't care. For Ecuador, it's a little bit different.

The US is Ecuador's largest trade partner. Ecuador now sends about 40 percent of its exports to the United States, including crude oil, seafood, fruit and nuts, cocoa and flowers. The nation’s total exports to the United States tallied up to $9.6 billion in 2011. Right now, Ecuador has two major trade deals with the US; the Andean Trade Practices and Drug Eradication Act, which is scheduled to expire this summer; and the General System of Preferences, which gives Ecuador and about 100 other countries duty free entry for certain products.

Today, Ecuador's Communications Minister announced that Ecuador was renouncing trade benefits with the US because of American pressure not to offer asylum to Snowden. He claims the trade pact has become a “new instrument of blackmail” and says Ecuador “does not accept threats from anybody, and does not trade in principles, or submit to mercantile interests, as important as they may be.”

Meanwhile, the Washington Post has jumped into the fray with an editorial accusing Ecuadorian President Correa of suppressing media while aiding the self-proclaimed whistleblower of another country.

President Correa responded with a tweet saying “The nerve! Do you realize the power of the international press? They have managed to focus on Snowden and the 'evil' in countries that 'support' him, making us forget the terrible things done against the American people and the entire world.”

You may recall that Julian Assange, the founder of Wikileaks has spent the past year in an Ecuadorian embassy in London to avoid extradition. What's the deal with Ecuador?

One thing you probably won't hear in the Washington Post is the back story, which involves a 20-year battle against Chevron, the oil company. Texaco, now owned by Chevron, dumped 16 billion gallons of toxic water into streams from the early 1970s until 1992, harming the environment and the people who used them for drinking water, cooking and cleaning. Texaco never tried to prevent this from happening, never cleaned up the contamination or compensated victims. That is a fact even Chevron does not deny.

An Ecuadorian court has held Chevron liable, to the tune of $19 billion. Chevron refuses to pay because it says the Ecuadorian judiciary and American plaintiffs’ lawyers conspired in a vast racketeering plot to extort from the multinational. And rather than pay the Ecuadorian judgment, Chevron sued the Ecuadorian plaintiffs (the indigenous indians) and the lawyers. Chevron itself stripped almost all of its assets from Ecuador in recent years in anticipation of losing the case. And since Chevron has removed all assets from Ecuador, the Ecuadorians are now forced to seek judgment through third countries. That's not so easy.

Chevron has roughly $15 billion in assets in Canada. In Toronto, in an unusual decision without any precedent in Canadian law, a court found that because Chevron operates only through subsidiaries, the case must be stayed. The vast majority of Chevron's assets lie with its subsidiaries, not in its corporate shell. Chevron also operates via its subsidiaries in dozens of countries around the world that could be targeted. The company does not even own its own building housing its headquarters near San Francisco.

Knowing it cannot win the Ecuador battle on the merits, Chevron also exercised improper political influence over governments and courts. In Argentina, after an order to freeze Chevron's assets in that country, Chevron suddenly decided to "invest" $1.5 billion in a large gas field with the local state-owned oil company, YPF; followed by an advertising and a lobbying campaign – freeze lifted.

The battle between Chevron and Ecuador has more twists and turns than a bag full of pretzels; the same could be said of the strange story of Edward Snowden, Booz Allen Hamilton, and the Carlyle Group. What is becoming more apparent is the growing corporate influence on issues which were once considered the purview of governments.