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.

Tuesday, June 17, 2014 - What Could Go Wrong?

What Could Go Wrong?
by Sinclair Noe

DOW + 27 = 16,808
SPX + 4 = 1941
NAS + 16 = 4337
10 YR YLD + .06 = 2.65%
OIL - .30 = 106.60
GOLD un = 1272.70
SILV + .09 = 19.86

The FOMC, the Federal Open Market Committee started two days of meetings today; tomorrow they are expected to announce more of the same. The FOMC is largely expected to taper its asset purchase program by $10 billion to $35 billion. Effective July 1, the Fed is expected to lower its asset purchases to $15 billion in agency mortgage backed securities (MBS) and $20 billion in Treasuries. The Fed is also expected to maintain its current forward guidance language on federal funds rate support; in other words, they will keep telling us that rates might increase sometime next year.

The committee is likely to make some upgrades to its description of the economic outlook in its economic projections. The committee will probably need to reduce its 2014 real GDP growth forecast to take into account the Q1 disappointment, and we can probably expect the committee to reduce its unemployment rate forecast and lift its inflation forecast slightly.

The consumer-price index climbed a seasonally adjusted 0.4% in May from a month earlier. It marked the fastest increase since February 2013 and doubled the pace of economists' forecasts. Excluding food and energy components, so-called core prices increased 0.3%, the fastest pace since August 2011. From a year earlier, core prices were up 2%, the most since February 2013, and now match the Fed's target.

Another inflation measure closely watched by the Fed, the core personal-consumption expenditure, has stayed far below 2%. Inflation at wholesale level unexpectedly dropped by 0.1% in May, but remember the PPI rose 0.6% in April, so this is just a leveling out process. Wage pressure remains stubbornly low and consequently, the pace of the economic growth remains uneven. In May, the real average hourly wage fell 0.2%. Real wages have fallen three straight months even as inflation has picked up slightly.

The average hourly wage for a typical American worker registered just $10.28 in May, adjusted for inflation and measured in constant dollars. The real hourly wage totaled $10.31 in June 2009, the last month of the 2007-2009 recession. This is part of a trend that stretches back about 30 years.

Still, with core prices up 2% on an annual basis, the Fed will need to address the topic of inflation tomorrow. Let’s hope they also mention the lack of wage gains.

Another report today shows housing starts posted a bigger-than-forecast 6.5% decline. Housing starts declined to an annual rate of 1 million units last month from 1.07 million in April. What’s more, permits for new construction fell by 6.4% in May to a 991,000 annual pace, the slowest in fourth months.

The situation in Iraq is still bad. The ISIS rebels are about 40 miles north of Baghdad and seem intent on the idea of attacking the capitol city. Or they might attack the major source of revenue for the ruling government, and that means oil. One of three major oil refineries has now fallen under control of ISIS; the other two are in Baghdad and the south and not considered to be threatened at this time. About 2.5 million barrels of oil a day are exported from Basra, Iraq’s main port, located in the south.

The world consumes about 92 million barrels a day, so that would be a major disruption, and it would not be surprising to see prices jump; with price levels increasing along with the severity of the given scenario, running anywhere from a few dollars per barrel to a worst case of $200 a barrel.

Not too long ago, Iraq was claiming that it would be producing 12 million barrels a day by 2017. That now seems a little too optimistic.  At best, the ISIS rebellion guarantees that any potential additional Iraqi oil output gains are not going to materialize in the near future. No oil companies are going to invest in Iraq until and unless the situation stabilizes.

Although the consequences for Iraqi oil production of what has happened so far appear to be minimal, all this comes at a time when the earlier and still ongoing conflicts in Libya and Syria have already disrupted nearly 2 million barrels a day in world oil production. If Iraq’s recent 3 million barrels a day was also taken out, we would be talking about a significant disruption in world oil supplies, and likely an oil price in excess of $150 a barrel.

The worst case scenario sees a regional conflict break out that pits the Middle East’s Shiites (Iran) against the Sunnis (Saudi Arabia), leading to a compromise of the Strait of Hormuz. Forty percent of the world’s exported oil is transported through this waterway.

And if that isn’t enough, focus you attention on Ukraine. Yesterday, Russia announced it was cutting off natural gas shipments to Ukraine; today an explosion destroyed one of Ukraine’s main pipelines for gas headed to Western Europe.

EU-brokered talks failed to reach a compromise between the countries, which remain far apart on a “fair” price for gas. Ukraine’s state-run gas operator filed a suit in an international arbitration court, claiming $6 billion in overpayment for gas since 2010. Its Russian counterpart filed a suit of its own, alleging unpaid debts worth $4.5 billion on gas delivered since 2009. Until these cases are resolved, Ukraine will receive only gas it pays for upfront, and must not impede the flow of gas destined for the EU, which gets around 15% of its gas via pipelines that pass through Ukraine. There is another pipeline running from Russia directly to Germany, but still, the global energy picture looks less and less stable.

On Friday we reported that Tesla, the electric car company started by Elon Musk, was freeing up its patents, making its technology available to competitors. Now Nissan and BMW are considering negotiations for cooperation on charging networks; basically using and enlarging Tesla’s existing network of 97 charging stations in the US. Nissan already produces the electric Leaf and BMW last week unveiled the electric i8 in Germany.

So, why design new chargers and invest in building a whole new infrastructure for BMW and Nissan drivers? The Tesla network already stretches from coast to coast and is expected to expand rapidly over the next year. And Tesla leads in battery technology, with a gigafactory planned to start production in 5 years, which will be the biggest battery making facility in the world, producing 500,000 lithium-ion battery packs per year; more than enough for Tesla and its competition.

SolarCity, the largest US installer of residential solar panels whose largest shareholder is entrepreneur Elon Musk, announced that it plans to acquire solar panel maker Silevo and expand into manufacturing with new panel factories, likely including the world’s largest high efficiency solar panel plants in New York. At a conference call announcing the move, Musk said: "We expect to have to install 10 gigawatts [of high-efficiency panels] a year. If you look at the current capacity in the world, we're not able to do that right now."

It's not just a supply question. Solar panel prices have been falling in recent years thanks to a production boom in China; and the panels getting produced, though cheap, aren't terribly efficient and prices have begun bottoming out anyway. Prices might start climbing soon. Government subsidies for renewables start getting phased out in 2016, and the political environment for rebooting subsidies remains unstable at best. Plus, recent moves by the US to slap tariffs on Chinese panels likely served as a catalyst for looking into building the Silevo plant.

According to a study by two professors at the Stern School of Business at New York University and one professor from McGill University, a quarter of all public company deals may involve some kind of insider trading. The professors examined stock option movements, when an investor buys an option to acquire a stock in the future at a set price, as a way of determining whether unusual activity took place in the 30 days before a deal’s announcement. They determined statistically that the odds of the trading “arising out of chance” were “about three in a trillion.” [...] But, the professors conclude, the Securities and Exchange Commission litigated only “about 4.7 percent of the 1,859 M&A deals included in the sample.”

The study also says: “While the SEC has taken action in several cases where the evidence was overwhelming, one can assume that there are many more cases that go undetected, or where the evidence is not as clear-cut, in a legal/regulatory sense.” Plus another finding from the abstract: “Historically, the SEC has been more likely to investigate cases where the acquirer is headquartered outside the US.”

A new survey by Greenberg Quinlan Rosner, on behalf of Better Markets, finds voters regard Wall Street and big banks as “bad actors. A 64% majority believes the “stock market is rigged for insiders and people who know how to manipulate the system. Another 55% believes “Wall Street and big banks hurt everyday Americans by pouring money into ’get rich quick schemes’ rather than real businesses and investments. A 60% majority favors “stricter regulation on the way banks and other financial institutions conduct their business” and just 28% oppose. Support for stricter regulations inspires bipartisan support; most notably voters who own stocks are more likely to support stricter regulation than voters overall. And there is urgency in the issue because 83% of voters believe another crash is likely in the next 10 years.

Friday, June 13th, 2014 - Infallible Source Predicts Economic Collapse!

Infallible Source Predicts Economic Collapse!
by Sinclair Noe

DOW + 41 = 16,775
SPX + 6 = 1936
NAS + 13 = 4310
10 YRYLD + .02 = 2.60%
OIL + .38 = 106.91
GOLD + 2.80 = 1276.90
SILV + .15 = 19.77

For the week, the Dow was down 0.9%, the S&P fell 0.7 percent and the Nasdaq was down 0.25%. The week's decline was the first after three weeks of consecutive gains on the S&P 500. For the year, the broad market index is up about 4.8%. So, it was a rough week, but a good Friday the 13^th.

The Producer Price Index measures prices at the wholesale level; the PPI was down 0.2% in May. The decline was driven lower by cheaper food and gas, and follows two months of strong gains. In the past 12 months, producer prices have risen 2%, matching the Federal Reserve's inflation target. That's down from an annual gain of 2.1% in April. Excluding the volatile food, energy and profit margin categories, (for all you people who don’t eat food or drive in cars) core producer prices were unchanged in May. Inflation, as measured by the consumer price index, has been mostly below 2% for the past two years.

Of course, that might change, at least for people who eat and drive cars. The price of oil has jumped the past few days, now standing at $106.91 a barrel, mainly on fears of a civil war in Iraq. The International Energy Agency played down fears over the possible loss of oil exports from Iraq in its monthly Oil Market Report, writing: "Concerning as the latest events in Iraq may be, they might not for now, if the conflict does not spread further, put additional Iraqi oil supplies immediately at risk." Oil futures in New York rose 4.1% this week.

A very nasty group of rebels known as ISIS is closing in on Baghdad. ISIS stands for the Islamic State of Iraq and Syria, or the Islamic State of Iraq and Levant, and they are made of Sunnis. The government of Iraq is controlled by Shi’ites. ISIS has taken over the second largest city of Mosul; they have surrounded the largest oil refinery in the country, and they are moving to the capitol of Baghdad. So far, the Iraqi soldiers have been running away, but today a message from the Grand Ayatollah Ali al-Sistani, who is the highest religious authority for Shi'ites in Iraq, said people should unite to fight back.

In an interesting twist, before ISIS started ramping up the fight in Iraq, they were fighting in Syria, against the government of Bashar al Assad.

President Obama told reporters at the White House he would not send US troops back into combat in Iraq but had asked his national security team to prepare "a range of other options" to help Iraqi security forces. He specifically did not rule out the use of military action, which might include the possibility of air attacks to slow the rebel advance.

Pope Francis says the global economic system is near collapse. In an interview with la Vanguardia, the Pope said he was especially concerned about youth unemployment, and he denounced the influence of war and the military on the global economy, saying: “We discard a whole generation to maintain an economic system that no longer endures, a system that to survive has to make war, as the big empires have always done. Since we cannot wage the Third World War, we make regional wars. And what does that mean? That we make and sell arms. And with that the balance sheets of the idolatrous economies -- the big world economies that sacrifice man at the feet of the idol of money -- are obviously cleaned up."

The pope said there was enough food to feed all the world's hungry, and people’s needs should be at the heart of the economic system.

Following the elections in the European Union, France issued a report on debt, which contained several key findings, including the idea that the rise in the state’s debt in the past decades cannot be explained by an increase in public spending. The report also says that no one actually knows who holds the French debt. And the big conclusion of the report is that some 60% of the French public debt is illegitimate. An illegitimate debt is one that grew in the service of private interests, and not the wellbeing of the people. Therefore the French people have a right to demand a moratorium on the payment of the debt, and the cancellation of at least part of it.

Goldman Sachs and Bain Capital have agreed to pay a combined $121 million to settle a lawsuit that accused them and other firms of colluding to drive down the prices of takeovers before the financial crisis, according to a court filing on Wednesday. The deal, if approved by the court, would bring closure for Goldman and Bain of a seven-year-old lawsuit filed by former shareholders of the acquired companies, who claimed that private equity firms teaming up to do deals were partners in an illegal conspiracy to reduce competition.

The settlement deal also raises the stakes for the remaining defendants, which include some of private equity’s biggest firms. The Blackstone Group, Kohlberg Kravis Roberts, TPG Capital, Silver Lake and the Carlyle Group are scheduled to head to trial in November. Now the $121 million dollar settlement is fairly small, but now that Goldman and Bains have broken ranks with the other defendants, the lawyers for the plaintiffs may gain additional bargaining power. The plaintiffs are seeking billions of dollars in damages, but because of the mechanics of antitrust law, the defendants could be liable for a multiple of that amount if they lose at trial.

The Justice Department has asked Citigroup for more than $10 billion to settle a probe into the bank’s sale of mortgage-backed bonds before the 2008 financial crisis. Prosecutors broke off talks with Citigroup earlier this week and are preparing to sue the bank after it offered less than $4 billion ($1 billion cash and the rest in consumer relief) to resolve the matter. The Justice Department could file a lawsuit as early as next week.

The department is taking a similar approach with Bank of America. Prosecutors also halted talks with the bank June 9 after it offered to pay more than $12 billion, short of the department’s $17 billion request. And then there is the outstanding case against BNP Paribas, where prosecutors are believed to be calling for more than $10 billion in fines for money laundering and sanctions violations. And this all follows on the heels of the Credit Suisse $2.6 billion fine and criminal guilty plea in a tax evasion case. No word whether prosecutors are looking at criminal charges against BofA or Citigroup. What we are seeing is that the fines are getting larger, but somehow with billions of dollars of penalties and multiple billions of dollars of wrongdoing, nobody ever goes to jail.

If you wonder why the prisons aren't filled with banksters, just follow the money from Wall Street to Capitol Hill. Earlier this week we saw one of Wall Street's favorite politicians of the decade, Eric Cantor, destroyed by a random teabagger who railed against him endlessly for pushing through Bush's TARP bailout of the big banks. Just this cycle, the financial sector had contributed $1,396,450 to Cantor's campaign coffers. And Cantor was just one of the politicians getting their wallets fluffed by Wall Street, a quick list of Wall Street favorites includes John Boehner, Spencer Bachus, Jeb Hensarling, and Democrats including Charlie Rangel, and Heny Stoyer. We have finally found one thing in Washington that is bipartisan – bribery, or should I say campaign finance…no, it’s bribery.

Elon Musk has announced that Tesla will let other companies use its inventions under an open-source-inspired agenda at the company. Here’s how Musk put it in a blog post:”Tesla will not initiate patent lawsuits against anyone who, in good faith, wants to use our technology.”

Tesla has hundreds of approved patents, and many pending applications, for all manner of inventions tied to electric-vehicle technology. Tesla pioneered innovations that lowered the cost and increased the safety of battery packs. Its cars recharge much faster than others on the market, thanks to connector, software, and power-management advances. Now this public company will offer these smarts up to its rivals and ask nothing but goodwill in return.

And while it sounds like a radical idea, it might be a very smart business move. One thing that is required for electric cars is charging stations, as ubiquitous as gas stations. And even though Tesla has patents on battery technology, and they have some of the best batteries around with longer range and faster recharging, they still need to improve the technology. And Musk apparently isn’t concerned with the competition, saying: “You want to be innovating so fast that you invalidate your prior patents, in terms of what really matters. It’s the velocity of innovation that matters.”

Here’s an amazing statistic, compliments of a Tweet from Bill Gates. From 1901 to 2000, the United States built millions of miles of roads and interstate highways, plus Hoover Dam, plus many other damns, plus an incredible number of building; and during that 100 year period, we used 4.5 gigatons of concrete. In the past 3 ½ years, China has been on a building boom that has consumed 6.6 gigatons of concrete.

Wednesday, May 07, 2014 - On the Mend, Not Too Big, No Reason to Jail; Not Exactly

On the Mend, Not Too Big, No Reason to Jail; Not Exactly

by Sinclair Noe

DOW + 117 = 16,518
SPX + 10 = 1878
NAS – 13 = 4067
10 YR YLD un = 2.59%
OIL  + 1.35 = 100.85
GOLD – 18.00 = 1290.90
SILV - .25 = 19.40

Federal Reserve Chairwoman Janet Yellen testified before the congressional Joint Economic Committee today. Here’s the quick summary: taper from QE is on track, after the Fed exits QE asset purchases they will look at the possibility of raising interest rates – maybe 2015 or 2016, they will hold almost all of the mortgage backed securities they purchased on their books to maturity, the labor market is getting better but there are still some areas of concern such as long-term unemployment and underutilized workers and the participation rate, the housing market has flattened but she expects it will pick up again, it would be better if Congress was part of the solution rather than part of the problem, the economy paused in the first quarter but we’re on the mend.

That’s a couple of hours of testimony and Q&A in a nutshell. I just saved you a lot of time. You’re welcome.

There is a lot of talk about a stock market bubble, almost everywhere you hear someone with an opinion, but of course no one knows for sure. You could look at many indicators that seem bubbly: high margin debt, Shiller PE Index at the highest levels since 1929 and 2000, frothy M&A activity, IPO activity has been or was hot for a while, just like back in the dot.com days.

Just look at the recent bloodbath for Twitter, following the six-month lockup combined with a bad earnings report; high flying tech stocks plummet back to earth in 140 characters or less. If you want frothy, look at Tesla, which reported a $50 million dollar loss after the close of trade today; and even though revenue increased, share prices took a hit. It’s that kind of action that makes it feel like a bubble, but that doesn’t mean it is a bubble; not today anyway.

Venture capital certainly was one of the culprits driving up stock market prices in 1999 and 2000. Then, as now, low interest rates also played a part. In fact, the bursting of the bubble was related to the Federal Reserve raising interest rates six times between 1999 and 2000.

Maybe the Fed learned a lesson. While an overvalued stock market seems related to the Federal Reserve’s monetary policy and a chart of the S&P 500 is almost a mirror image of the Fed’s balance sheet, one of the goals of "Quantitative Easing," the Fed's program of buying treasuries to increase monetary supply and reduce the value of bonds, was to bolster other assets relative to bonds. With interest rates still so low, bonds are a lousy alternative to generate return, leaving more money in the stock market than if we were to have higher interest rates.

Fed Chair Yellen seems to be cautious with statements about interest rates and well aware that raising rates could reawaken the sleeping bear. Plus, we still have about $15 trillion in debt constantly rolling over, and if interest rates tick higher, that debt turns ugly fast. The stock markets know this and keep prices high. Of course, even with this knowledge, the business cycle hasn’t been repealed and the exit from QE and a Zero Interest Rate Policy remains fraught with peril.

Fed chairwoman Janet Yellen said, “many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter.” The question is whether that pickup in output is being accomplished through better productivity or more hiring and longer workweeks. We got data on that issue this morning from a Labor Department report showing productivity fell at a 1.7% pace in the first quarter.

Some of the first-quarter drop reflects the drag on output caused by the harsh winter. But looking longer-term, productivity growth has slowed. Compared to a year ago, productivity is up a weak 1.4%. Of course, the demand for labor has not revved up much in recent quarters, so the growth in unit labor costs is also muted, up just 0.9% in the year ended in the first quarter. Part of the problem is that companies have been involved in relentless cost cutting, and after a while you can’t get any more water out of that well.

Of course, we haven’t recovered fully from the financial crisis. Ordinary Americans took huge balance sheet hits in the crisis: the loss of home equity, which only in some markets has come all the way back; job losses and pay and hours reductions, which led many to run down savings as they readjusted; declines in stock market portfolios; the flip side of ZIRP, the Zero Interest Rate Policy, is lower income thanks for retirees and other income-oriented investors.

Before the crisis, if someone was hit with a financial emergency, like an accident or sudden job loss, those who had houses could often draw on home equity. Yesterday we reported that negative equity is falling; bit by bit over the years, homeowners have been climbing out of that hole, and new data from Black Knight Financial Services show that borrowers are approaching a threshold that will see only one in 10 US borrowers underwater on home loans.

Of course, the main reasons why negative equity has dipped is a combination of slightly higher prices, but also because foreclosures wiped away the mortgages of many of the most indebted. In January 2010, 10% of borrowers owed at least 50% more than their homes were worth. By January 2014, that number fell to 2% of borrowers.

With that home equity piggybank depleted or non-existent, the last-ditch financial fallback is accessing retirement savings; not complete liquidation, but just dipping in with an early withdrawal or a loan. Borrowing is limited to a maximum of half of plan assets or $50,000, whichever is lower. While the borrowing is interest free, the funds need to be repaid in five years. Early withdrawals typically carry a 10% penalty.

A Bloomberg story details how prevalent 401(k) withdrawals have become. For the latest year in which data is available, 2011, 4% of all households paid early withdrawal penalties. A Federal Reserve study found that 9.3% of taxpayers with retirement accounts paid early withdrawal penalties, an increase from 7.9% in 2004. Adjusted for inflation, the government collects 37% more money from early-withdrawal penalties than it did in 2003. Meanwhile, the amount of home equity loans outstanding was $704 billion in 2013, down 38% from the 2007 peak.

In addition to the lack of recovery from the financial crisis, we still haven’t fixed the underlying problems. Bank of America is holding its annual shareholder meeting. Not surprisingly, the hot topic dealt with some missing money; $4 billion, more or less; an accounting error that resulted in not enough capital to pass the Federal Reserve stress test, consequently dashing the buyback program and halting any dividend increases and sending share prices down 5% so far this year.  

The error, unearthed by a bank employee earlier this month, stemmed from how Bank of America calculated certain losses on bonds that it acquired when it bought Merrill Lynch in the depth of the financial crisis. The bank had been making the same mistake for several years. As a result of the error, Bank of America has $4 billion less capital than it had represented to the Federal Reserve on this year’s stress test.  The bank still faces billions of dollars of legal costs to settle cases with federal prosecutors over its mortgage lending practices. Executives have declined to detail how much they are reserving for those cases because it could hurt their negotiating position. Not surprisingly, many shareholders are opposed to increasing executive compensation packages this year.

Charles Holiday, the Chairman of BofA said: “I believe very strongly that this bank is not too big to manage.’’

James Gorman is CEO of Morgan Stanley; speaking at a conference in New York, Gorman said he didn’t believe more bankers should have gone to jail for the financial crisis. At first blush, Gorman makes a good argument, but there are some holes. Gorman said, “Bad judgment, incompetence, negligence, greed: these might be socially unacceptable… but they’re not criminal offenses.” And that’s true, and I don’t believe any Wall Street bankers  have been criminally charged with bad judgment or for being greedy; in fact, no major Wall Street banking executive has been criminally charged… with anything. However, fraud, conspiracy to commit fraud, aiding and abetting fraud, forgery (as in robo-signing), perjury (as in false documentation), intentional misrepresentation or lying publicly about securities (as in securities fraud), violation of Sarbanes-Oxley, and a few other things that took place – those are indeed criminal offenses.

Gorman also said Glass-Steagall should not have been repealed, even though he doesn’t think it played a role in the financial crisis. Again, not exactly correct. Glass-Steagall  was the depression-era law that kept securities underwriting and trading separate from commercial banking; in other words, investment banks could be involved in speculative trading, they just couldn’t use depositors money for their gambling. Glass-Steagall was repealed in 1999 in a sneaky bit of legislative legerdemain that was written by and allowed the merger of Travelers and Citicorp to create Citigroup. Since then, the US government has been forced to rescue Citigroup 3 times. The repeal of Glass-Steagall might not have caused the financial crisis but it certainly played a role.

Gorman now joins some interesting company calling for the reinstatement of Glass-Steagall. Former CEO’s of Citigroup John Reed and Sandy Weill now regret the repeal and recognize the dangers. Politicians from both sides of the aisle have introduced legislation over the past few years to reinstate Glass-Steagll and effectively break up the big banks to protect taxpayers and restore confidence in the financial system.

Wednesday, March 12, 2014 - The Next 25 Years

The Next 25 Years

by Sinclair Noe

DOW – 11 = 16,340
SPX + 0.57 = 1868
NAS + 16 = 4323
10 YR YLD - .04 = 2.72%
OIL – 1.96 = 98.07
GOLD + 17.70 = 1368.20
SILV + .43 = 21.42

Let’s run through some of the economic and business news and then we’ll get to today’s anniversary.

Stocks were flat. People are still trying to make heads or tails of this mixed up world. The situation in Ukraine is not improving. The EU agreed a framework for its first sanctions on Russia since the Cold War. Protesters battled soldiers in the streets of Caracas, Venezuela; two more protesters were shot; dozens were injured. Riot police clashed with demonstrators in several Turkish cities for a second day as mourners buried a teenager wounded in protests last summer.

The Senate Banking Committee announced an agreement on legislation to wind down the government-owned mortgage financiers Fannie Mae and Freddie Mac. Share price cratered.

Herbalife says the Federal Trade Commission has opened an inquiry into the company. The FTC confirms the inquiry, but not the nature of the inquiry. Share price cratered.

Copper prices dropped to the lowest level in almost 4 years; this goes back to China, and is a canary in the coal mine for industrial demand. China is one of the metal’s biggest customers and there has been recent poor trade data out of China. Two Chinese solar companies have defaulted in the past week. The general risk from here is that this move in metals prices further destabilizes the Chinese financial system and will raise concerns of a hard landing in China if the authorities can’t get ahead of the pressures and potential contagion effects this move is generating.

A Senate subcommittee plans to hold a hearing in early April on GM's recall last month of more than 1.6 million vehicles with the faulty ignition switches which have been linked to 12 deaths. Most of the affected cars were sold in the United States. Even after the long delayed recall, GM says drivers should not use big, heavy key rings. Not a good repair job.

It is illegal for Tesla to sell cars in New Jersey, other than traditional auto dealerships, which is not the Tesla business model. Guess who pushed that law through the New Jersey legislature; this, even though Tesla does not limit the number of keys you can safely have on a key ring.

Citigroup recently discovered they had made $400 million in fraudulent loans to a company in Mexico, now they’ve uncovered three new sets of problems loans, each at about $10 million.

Fabrice Tourre, the Goldman Sachs trader convicted of defrauding investors in a subprime mortgage product that failed during the financial crisis has been ordered to pay a fine of $825,000. The SEC accused Tourre of concealing from investors how Paulson & Co, the hedge fund of billionaire John Paulson, had helped put together a fund of subprime mortgages called Abacus, and had bet it would fail.  Paulson made a cool $1 billion by shorting Abacus, while investors lost the same amount. Goldman, the company, in July 2010 reached a related $550 million settlement with the SEC. It did not admit wrongdoing but acknowledged and expressed regret that its marketing materials were incomplete. Tourre resigned from Goldman in December 2012, and is pursuing a doctorate in economics at the University of Chicago.

Boeing says the missing 777 Malaysia Airlines jetliner was not subject to a new US safety directive that ordered additional inspections for cracking and corrosion on certain 777 planes. They still have no idea where the jet is.

This week, we’ve been looking at anniversaries: the 5^th anniversary of the bull market, the 14^th anniversary of the bear market, the 3^rd anniversary of the Fukushima disaster. Today marks the 25^th anniversary of the World Wide Web. This is actually a somewhat questionable anniversary; not because of the malware, the misinformation, the internet trolls, the time wasting, and the tedious social media that passes as actual human interaction.

No, this is a questionable anniversary because the world wide web must be differentiated from the internet and even after we had the web, we waited until 1993 to actually have a web page. The web was built on top of the internet. On the internet, the connections are between computers using cables and other physical links; on the web, connections are hypertext links. The web is a way to present information from a software application known as a web browser using Hypertext Markup Language or Hypertext Transfer Protocol, HTML or HTTP. The web was based on a proposal written on March 12, 1989 by Sir Tim Berners-Lee, and then we had to wait until December 1990 for Berners-Lee to release the first web browser, called the WorldWideWeb.

So, what will the web look like in the next 25 years? That is part of the question posed on this anniversary by none other than Berners-Lee in an interview published today in the Guardian; he believes the web should be "accessible to all, from any device, and one that empowers all of us to achieve our dignity, rights and potential as humans." He hopes to re-invent the Web through the "Web We Want" initiative, which would create a universal "Internet Users Bill of Rights"; think of it as an online Magna Carta.

The initiative would build support for national and regional campaigns to create a world where everyone is online and free to participate in the flow of knowledge, ideas, collaboration and creativity over an open Web. Without an open, neutral Internet, we can't have an open government, good democracy, healthcare, connected communities and a diverse culture. And Berners-Lee says: "It's not naive to think we can have that, but it is naive to think we can just sit back and get it."

Among the obstacles to an open, neutral internet, Berners-Lee cites principles of privacy, free speech, responsible anonymity, the impact of copyright laws, and the overhaul of how security services are managed especially in light of American and British spy agency surveillance of citizens.

The web has become an indispensable tool for communications, science, education, health, democracy, entertainment, finance, advertising, and commerce. It has been well argued that the internet is the most significant contribution to spreading knowledge since the introduction of Gutenberg’s printing press, but this web is much faster; Martin Luther’s 95 theses can now be pinned on someone’s Facebook wall and travel round the world in the blink of an eye. The growth of the web has been exponential; actually that is not a strong enough word to describe the growth.

The Web has brought tremendous innovation, but how do we measure innovation’s impact on our standard of living? We can look at the web and easily see that it has been very profitable for many; fortunes have been made, and lost. The most recent fortune will likely go to the innovators behind the Candy Crush game, King Digital; today they announced an initial public offering that values the company at $7.6 billion; and Wall Street analysts immediately started whining that the valuation was low based on trailing 12 month PE of 13.3. This is for a video game. What is the net contribution to economic growth from a video game?

Another way of looking at innovation is price. It is fairly easy to assess the value of innovation if it lowers the price of something, such as a car or food. How do we measure an improvement in quality for something that already exists? The internet has provided people with tremendous information on health and medicine; surgery is more likely to be successful now than before this information was available. How do we measure that?

The financial industry has claimed to embrace innovation. Yes, you can get your bank statement online and businesses can accept digital payments online, but it also led to bankers devising better ways of manipulating markets and the so-called innovation of the vast world of ticking time bombs known as derivative. You can also make the case that the net social contribution from so-called financial innovation was negative.

And for all the good things that we get from the internet, you have to wonder if we’ve squandered this gift of technology. So much effort has gone into advertising and marketing and targeting customers; this makes sense because you have to make money in order for the technology to be viable, but has this emphasis detracted from directing our efforts to improve our standard of living? How can we compare Facebook and Twitter and Candy Crush with the invention of powered air flight, the development of the interstate highway system, the polio vaccine?

This is not to say that social media has a negative social contribution (I’ll leave that distinction to the bankers). Social media can do amazing things: a spike in Twitter posts about upset tummies can alert the doctors to a salmonella outbreak, an amber alert on my phone may save a child’s life, there are massive online campuses that can provide an education comparable to the best universities, great thoughts abound on Redditt, the libraries of the world are now available at the click of a button, and the great cacophony of millions of voices may someday come together in crowd sourced harmony to create beautiful music.

In the past 25 years, we’ve seen some amazing innovation, lots of cool stuff, lots of silly stuff, and a fair amount of bad stuff on the internet. In the next 25 years, maybe we’ll do better.

Tuesday, March 04, 2014 - Everybody Clap Your Hands

Everybody Clap Your Hands

by Sinclair Noe

DOW + 227 = 16,395
SPX + 28 = 1873
NAS + 74 = 4351
10 YR YLD + .08 = 2.69%
OIL – 1.57 = 103.35
GOLD – 15.90 = 1335.40
SILV - .27 = 21.24

Ukraine has not exploded. The situation has not escalated, nor has it de-escalated. Apparently Russia and the West have both figured out that conflict has the potential for mutually assured destruction, not along the lines of the old nuclear Cold War, but potentially painful for both sides; and so today, everything is on hold. Vlad Putin said he sees no immediate need to invade Ukraine; the Obama administration is trying to put together $1 billion in loan guarantees.

Secretary of State John Kerry visited Kiev and there is still talk of sanctions if things don’t de-escalate. Putin says sanctions would be cause for retaliation. The Ukrainian military has shown remarkable restraint, adopting a Gandhi-like non-violence stance in the face of overwhelming firepower. And for the moment, there is a standoff but not a truce. That could change tomorrow.

A story in Politico today says the Russians no longer respect or fear Western leaders. Why?

“Russia thinks the West is no longer a crusading alliance. Russia thinks the West is now all about the money.”

Quite so. More specifically,

“Putin’s henchmen know this personally. Russia’s rulers have been buying up Europe for years. They have mansions and luxury flats from London’s West End to France’s Cote d’Azure. Their children are safe at British boarding and Swiss finishing schools. And their money is squirrelled away in Austrian banks and British tax havens.

“They have seen firsthand how obsequious Western aristocrats and corporate tycoons suddenly turn when their billions come into play.

“They know full well it is European bankers, businessmen and lawyers who do the dirty work for them placing the proceeds of corruption in hideouts from the Dutch Antilles to the British Virgin Islands.

“We are not talking big money. But very big money. None other than Putin’s Central Bank has estimated that two thirds of the $56 billion exiting Russia in 2012 might be traceable to illegal activities. Crimes like kickbacks, drug money or tax fraud.

“The Kremlin thinks it knows Europe’s dirty secret now. The Kremlin thinks it has the European establishment down to a tee. The grim men who run Putin’s Russia see them like latter-day Soviet politicians. Back in the 1980s, the USSR talked about international Marxism but no longer believed it. Brussels today, Russia believes, talks about human rights but no longer believes in it. Europe is really run by an elite with the morality of the hedge fund: Make money at all costs and move it offshore.”

Wall Street went to work today, and it seems they were heartened by the fact that Ukraine had not exploded and possibly a few traders looked at a map and discovered the Ukraine is about 4,000 miles from the corner of Wall and Broad; and Ukrainians don’t buy enough iPhones to move the needle. Keep calm and carry on.

So, it was back to the bull market behavior that got us here. Everything is copasetic. Corporate profits are absolutely smashing; the systemically important big banks posted profits of about $76 billion last year, just a smidge off their pre-crisis bubble era peak. There’s a small cap rally underway. Take a look at the Russell 2000, which was screaming for the month of February. There’s a biotech bubble; it’s enough to take your breath away, but they have a new drug for that; 11 of this year’s 14 best performing Russell 2000 stocks are biotechs, 7 of the top 8. The Nasdaq biotech index has gained 18%, since the start of the year.

That’s cool but not as cool as Tesla, which has doubled since Thanksgiving. One analyst recently said that Tesla’s pursuit of commercializing battery packs and cheaply storing green energy is a game changer, but the Elon Musk scheme to make a self-driving car is utopia. I always thought we’d have flying cars in utopia, but the future never unfolds exactly as we imagine.

Merger and acquisition activity is exciting again and it’s creating liquidity events. Apps are selling for $19 billion. Home thermostat companies bring in a cool $3.2 billion. Warren Buffett is on the prowl for something as good as Heinz catsup. Google is buying a company called Deep Mind, which does something in the way of artificial intelligence, which means that in the near future we won’t even have to think anymore.

Stocks are challenging all-time highs. The S&P 500 is hitting new highs. Almost every sector is moving up, with the possible exception of Bitcoin. Global central banks are printing money with abandon. Corporate bonds and junk bonds and Treasury bonds are all moving higher. Precious metals are moving higher. Greek stocks are moving higher. And the big winner so far this year, in terms of performance and the ability to attract investors, is not the bond market or the stock market; it’s commodities. To everything there is a season. Commodity ETFs are up $887 million in inflows for February.

And the valuations in the S&P 500, well, everybody seems to think they’re still more or less fairly valued; it’s not like it was in the late 90s; this time it’s different (lol), especially if the economy grows, which everybody seems to think will happen one of these days.

The latest guesstimate is that the US economy will grow this year at the fastest pace since 2005; that, in turn, will help reduce the annual average unemployment rate for a fourth straight year. So says the White House in forecasts accompanying its 2015 budget plan released today in Washington.  Gross domestic product will expand 3.1% in 2014 after rising 1.9% last year.  The jobless rate will average 6.9% this year, compared with 7.4% last year, and average 6.4% in 2015.

The $3.9 trillion budget anticipates an accelerating economy that’s boosting employment while moving up inflation to levels that would hardly change the pulse rate of the most hawkish Federal Reserve policymakers. The estimates in the budget plan showed the annual average yield on 10-year Treasuries will advance to 3 percent in 2014, from 2.3 percent last year, and increase to 3.5 percent in 2015.

In addition to rosy economic prognostications, the budget plan for 2015 proposes raising about $100 billion in revenue over the next decade through new taxes and restrictions on US multinational companies. The changes would affect digital goods, deductions for “excessive” interest, and hybrid arrangements that can lead to income that isn’t taxed in any country. Obama also wants to make it tougher for US-based companies to move to other countries.

The tax portion of the budget plan also would expand the earned income tax credit for low income workers, exclude Pell grants from income and establish automatic enrollment in individual retirement accounts. Further it would tax private equity managers’ carried interest as ordinary income, limit deductions for high income taxpayers, and end certain subsidies for oil and gas companies.

Most of the proposal will never see the light of day. However this idea on the earned interest carry trade might be something. The money taken in by this would be enough to pay for the Earned Income Tax Credit. Today, Warren Buffett said the tax break for low  income Americans aimed at encouraging work, would actually be the most direct way to help the working poor, with the fewest negative side effects; a better choice than raising the minimum wage. The IRS claims the tax break helped lift 6.6 million people out of poverty in 2011, the most recent year for which full data is available. Currently the credit does significantly more for families with children. Obama’s proposal would expand the EITC for workers without kids.

A July study from the Center on Budget and Policy Priorities estimated that expanding the EITC by lowering the age of eligibility for childless workers would lift an additional 300,000 Americans out of poverty. Expanding the EITC would help reduce poverty in two ways. First, it would give childless low-income Americans who are already working an income boost. And expanding the credit would encourage more people to work.

The White House signaled last month that its new budget would not extend the olive branch to Republicans that was offered in its proposal a year ago. Actually, there is some bipartisan support for some things. For example, the idea of closing the carried interest loophole, which would tax fund manager pay at 35% instead of the current 15% rate, which is somehow based on capital gains because fund managers don’t earn income, just capital gains. But wealthy fund managers pay an awful lot of money to politicians to encourage them to keep the loophole closed. Wealthy fund managers get very, very angry about any effort to take away a tiny bit of their billions. Blackstone Group co-founder Stephen Schwarzman, who made $465 million in 2013, declared in 2010 that Obama's idea of raising taxes on him and his buddies was just “like when Hitler invaded Poland in 1939”. That’s a quote. He went on to say, “It’s a war.”

A reminder that the budget proposal is coming from the White House and is being sent to the Congress, both of which are located in Washington DC, where tax policy has a tendency to become deadlocked in partisan disputes between  the lobbyists who actually write the laws.

By the way, the number one song in America is by Pharrell Williams and the title is “Happy”; the chorus is: “Clap along if you feel happiness is the truth.” It’s a nice song. Go ahead, clap along. 

Tuesday, December 17, 2013 - The Year in Financial Review

The Year in Financial Review

by Sinclair Noe

They say you can't know where you're going if you don't know where you're coming from, so today on the Review, we'll review some of the financial milestones of 2013.

You may recall that 12 months ago, we were headed over the fiscal cliff. The fiscal cliff really started in 2001 with the Economic Growth and Tax Relief Reconciliation Act, also known as the Bush tax cuts; after various extensions, they were set to expire at the end of 2012. And they did. In the end, Congress did not approve an extension of most of the tax cuts until late on New Year’s Day. Because all the Bush tax cuts had technically expired, Republicans could say they had not violated their No New Taxes pledge. The marginal rate on incomes over $400k increased, plus cap gains, and qualified dividends for high-income taxpayers, plus some estate tax changes, and the holiday on the payroll tax ended; just to be sure everybody felt some pain.

President Obama signed the American Taxpayer Relief Act of 2012 on January 2. The ATRA is usually described as a tax increase although technically it might be a tax cut. The confusion arises because there were so many expiring provisions at the end of 2012.  ATRA could be described as either a $618 billion tax increase, relative to maintenance of all of the provisions that had been in place – that is, relative to so-called “current policy”; or a $4 trillion tax cut, relative to the actual law.

It was an inauspicious start to the new year.

Wall Street found comfort in the resolution of the fiscal cliff, and of course the never-ending flow of free money from Quantitative Easing. Equity traders partied like it was 1999. Stock funds took in some $134 billion in the first ten months of this year. The Dow Industrial Average started the new year at 13,100, and never looked back. There were a few minor pullbacks but no significant corrections; just a string of record highs for the Dow, the S&P 500, and even the Nasdaq Comp hit the highest levels in 13 years. Milk and cookies indeed.

Turns out, the stock market wasn't dead,it just needed some juice from the Fed. The Federal Reserve had a major role in propping up Wall Street. The Fed's balance sheet grew by more than $1 trillion just since the start of the year, and not stands slightly north of 25% of GDP. Overlay a chart of the Fed's balance sheet with a chart of the S&P 500; carrots and peas; Fred and Ginger.

Bond markets had been absolutely giddy with QE. The yield on the 10-year note touched 1.39% back in the summer of 2012. Heading into the summer of 2013, Ben Bernanke sent up a trial balloon that the Fed had actually thought about how they might exit QE; not that they had any plans to exit; not that there was anything in reality; just a little contemplation. The bond market freaked, and threw a taper tantrum. In the process, conservative income investors were shocked to learn that bond funds can lose value. Who knew? And that is how the 30 year bond bull died.

Meanwhile, across the Pacific, Japan had been catatonic for 2 decades until Japan's new Prime Minister Shinzo Abe somehow got a hold of the Federal Reserve's playbook; but something was lost in translation. Instead of just applying enough stimulus to prop up the banks, Abe tripled the stimulus, and kicked in fiscal reform and structural reform. He tied a sack of bricks around the yen and tossed it in deep waters. The results were predictable; a smidge of inflation replaced deflation; the Japanese economy will expand about 2% for the year, and Japanese stocks are on pace for more than a 50% gain this year.

Who knew? Certainly not Ken Rogoff and Carmen Reinhart, who unfortunately became famous for their worst work – the sarcastically titled book: “This Time Is Different”. Not exactly. Turns out there was a miscalculation with the Excel spreadsheets and there isn't a real precise line where the ratio of debt to GDP becomes malignant. Simple error by a couple of academic wonks, except their theories had served as a template for economic reforms around the globe, with less than satisfactory results. If you followed the Rogoff-Reinhart Rule, you would have tightened the belt in the face of an economic slowdown; think Greece, Spain, Portugal, and to some extent, the US. The result in the Eurozone was narrowing credit spreads and scary spikes in unemployment; that eventually forced ECB chief Mario Draghi to announce “the ECB is ready to do whatever it takes.”

The Draghi Put sounded good, except to the Germans, and even after the Rogoff-Reinhart spreadsheet blunder became clear, Draghi still hasn't used the OMT, Outright Monetary Transactions, he promised back in 2012, and Euro-austerity has lead to even higher debt to GDP ratios in the most indebted Euro nations, and the ECB and IMF have denounced austerity, but they still haven't dared to experiment as boldly as the Japanese.

Meanwhile. the BRICS, Brazil, Russia, India, China, and South Africa were clobbered. In November, the Organization for Economic Cooperation and Development, the rich world's number-crunching club, lowered its global growth forecast for 2014 by nearly half a point, to 2.7%, because of the slowdown in emerging-market economies. The European Central Bank warned: "Any sharper or more disruptive adjustment in emerging market economies needs to be closely monitored, given the potential for stronger and more persistent euro area impacts." Their fast growth compensated for the developed world's stagnation and their currency reserves funded Western debt. The thirst of emerging market consumers for goods helped tide over Western companies, while their low production costs drove global trade.

Developing economies weren't prepared for a downturn in global trade. The prospect of costlier capital, courtesy of the Fed's taper talk, dried up the flow of hot money that never seemed to find its way to Main Street but did filter to emerging markets. A disinflationary environment also clobbered commodities, and many of the emerging markets rely on natural resources. Investors withdrew from emerging market equities, debt, currencies, and everything else. According to the Commodity Futures Trading Commission, the total value of commodity index-related instruments purchased by institutional investors rose from an estimated $15 billion in 2003 to at least $200 billion by mid-2008. And then the cycle turned; 2013 marks the third year of a downturn in commodity prices. At some point, the cycle will turn again.

And through it all, the United States has emerged as the cleanest shirt in the dirty clothes hamper. The Fed's QE might not have spread the wealth; actually it just concentrated the wealth, but that's not to say it didn't have some impact. The housing market bounced back; not all the way to the highs at the peak, but it helped. Global real estate deals are now back to late 2007 levels. The world population keeps growing, and the institutional buyers can't buy everything; even though they tried. That lead to an increase in rents. If, or when rates move even higher, it will likely dampen the enthusiasm for real estate. Look for a slightly calmer market in 2014.

The high price of oil pushed drivers to switch to more fuel efficient cars. The hybrid Prius is the top-seller in California and the Tesla outsold Audi and Jaguar. GM turned a profit, and completed the terms of its bailout. The US keeps coming up with new technologies, such as 3D printing and robotics. And we've become masters at spying on the rest of the world.

The US is now in its fifth year of economic expansion and economic growth is surpassing some of the emerging markets, which is back to that cleanest shirt theory. One of the big surprises for the US economy has been energy production. Domestic crude oil production is up 18% form one year ago; up 56% from 2007; nat gas production is up 28% from 2007. Oil imports have been dropping and exports of refined petroleum products has increased.

So everything was on track for economic recovery, until the politicians in Washington decided to shut down government. Remember the fiscal cliff deal that started the year? Turns out it was just a stopgap measure, and when it came time to work out a longer-term deal, well, what can I tell you; we've got the best politicians money can buy; which is to say that Congress is a train wreck waiting to happen, and it happened in October. The 16 day shutdown came with a price tag of $24 billion, with nothing to show for it but really bad political theater.

And then that was followed by the biggest municipal bankruptcy in US history. Detroit is on the skids. The BK process is still underway, and there are implications. We have seen an unelected emergency manager take over the governance of a major city. A coup. How will it turn out? I don't know but if this is going to be a template for other struggling cities, it could get ugly.

And finally, perhaps the most important financial development came from a source we didn't even know a year ago; a modest priest from the slums of Buenos Aires; Pope Francis, the new spiritual leader of more than 1.2 billion Catholics – it is a very large contingent. The new Pope published an apostolic exhortation in late November. Pope Francis called for renewal of the Roman Catholic Church and attacked unfettered capitalism as "a new tyranny", urging global leaders to fight poverty and growing inequality. Francis went further than previous comments criticizing the global economic system, attacking the "idolatry of money" and beseeching politicians to guarantee all citizens "dignified work, education and healthcare". He also called on rich people to share their wealth. "Just as the commandment 'Thou shalt not kill' sets a clear limit in order to safeguard the value of human life, today we also have to say 'thou shalt not' to an economy of exclusion and inequality. Such an economy kills," Francis wrote in the document issued on Tuesday. "How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses 2 points?"

I think this, more than anything else, has changed the financial dialogue as we head into the new year.