Thursday, May 15, 2014 - A Calm Port in a Stormy World

A Calm Port in a Stormy World

by Sinclair Noe

DOW – 167 = 16,446
SPX – 17 = 1870
NAS – 31 = 4069
10 YR YLD - .04 = 2.50%
OIL - .81 = 101.56
GOLD – 8.90 = 1297.80
SILV - .29 = 19.56

Today, it seems there is a lot going on. Let’s start with international hotspots.

Turks are angry following a deadly mine explosion that has killed at least 300 miners and trapped possibly 100 more; thousands of workers joined a protest strike, demonstrators clashed with security forces, and the discontent threatens the government. An aide to the prime minister was photographed assaulting a protester and there are claims that Prime Minister Erdogan himself struck a teenage girl; that after he was forced to flee an angry crowd and seek safety in a nearby grocery store. Turkish trade unions held a one-day strike over safety standards in the mining industry. Security forces deployed tear gas and water canons against protesters.

Meanwhile, reports of dozens of deaths from an explosion along the border between Syria and Turkey. Also, further allegations of ongoing chemical attacks by the Syrian government. Speaking in London today, Secretary of State John Kerry announced the US, Britain, and European and Arab states are increasing efforts to support rebels fighting to overthrow President Assad. Assad still has the backing of Russia, and that makes already tense relations with Russia even more edgy.

Fears of a civil war in Ukraine are mounting. Nobody wants to jump in with troops, and so there are clandestine forays by unidentified groups or squads of soldiers. And the major powers are only explicit with sanctions. Today, Russia announced it will halt the export of rocket engines crucial to US military defense and space programs. It must be very uncomfortable on the International Space Station these days.

Anti-Chinese sentiment has been running high in Vietnam ever since Beijing deployed an oil rig into disputed waters in the South China Sea on May 1st. There have been encounters including ramming and exchanges of water cannon between Chinese vessels operating near the rig and boats from Vietnam, which wants China out of the area. Today, Cambodia reports hundreds of Chinese nationals had poured across the border from Vietnam to escape riots.

Also, Japan’s Prime Minister, Shinzo Abe, has called for a review of how Japan interprets its pacifist constitution to allow its military to participate in conflicts beyond its borders for the first time since the end of the second world war; this in response to a growing conflict between China and Japan over islands claimed by each country; of course, it’s not just islands but the oil reserves around the islands.

Meanwhile, China issued a bunch of economic data this week, and it mostly points to a real estate slump; home sales fell 18%; housing starts were scaled back by 25%. Moody’s Analytics estimates that the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product last year. That is higher than in the US, Spain or Ireland at the peaks of their housing bubbles. The scale of China’s building boom and the country’s reliance on infrastructure investment for growth is unprecedented. In just two years, from 2011 to 2012, China produced more cement than the US did in the entire 20th century, and it all seems to be on shaky ground these days. Each attempt to rein in China’s $25 trillion credit bubble seems to trigger wider tremors.

Brazil has sent army troops to Recife, the capital of the northeastern state of Pernambuco, after strikes lead to riots. State police walked off the job Tuesday. Schools and universities also closed down because of concerns for student safety. Today, further protests in Sao Paolo and Rio de Janeiro drew tens of thousands to the streets. The protests are centered on cities that will host the upcoming World Cup, the quadrennial global soccer championship games. Huge anti-government protests across Brazil last year overshadowed the Confederations Cup, a warm-up tournament for the World Cup. Some of the demonstrations saw clashes between activists and police, and at least six people were killed.

Many Brazilians are angry at the billions spent to host the World Cup. Protesters have said the government should focus spending instead on improving Brazil's woeful health, education, security, housing, and infrastructure systems. The World Cup starts in less than 30 days, and the whole world will be watching.

In one week, Europeans will elect a European Parliament. It’s the second biggest election in the world, after India. Voters look set to choose more assorted extremists, anti-Europeans and oddballs than ever. The Euroland economy is going nowhere, and with the razor thin exception of Germany, most countries are seeing economic contraction; that tends to lead to strange election results.

There are other hotspots around the World. The president of Yemen has declared all-out war on Al Qaeda militants and army troops are now trying to dislodge Al Qaeda from the Arabian Peninsula. Political violence returned to Bangkok Thailand, and the Thai army killed a handful of protesters and threatened more military action if the protests continue. And of course, the Nigerian crazies, Boko Haram, and the kidnapping of hundreds of schoolgirls. And of course, all the old seething conflicts that haven’t been resolved. And don’t forget, the US is still at war in Afghanistan. I know, it’s easy to forget. Apparently, it’s even easier to forget the veterans that have served our country.

Today, Secretary of Veterans Affairs, General Eric Shinseki went before the Senate Veterans Committee to explain the mess that is the VA; this following revelations that as many as 40 veterans died while waiting for medical care at the VA facility in Phoenix.

Since the allegations arose last month that veterans were forced to wait months for appointments at the Phoenix VA medical center and that VA officials were covering up the problem, Shinseki said he has asked the VA's inspector general to investigate. He said he has also launched an intense investigation of scheduling practices at the VA's other 151 medical centers. Shinseki said he was “mad as hell” and the various Senators all acted very indignant. Of course, it wasn’t very believable theatre.

One of the documents brought forth today was an internal VA memo, written in 2008 by a team of VA managers, listing 25 ways that VA scheduling clerks were cooking the books to make it appear that veterans waiting for medical care actually were being seen on time, when in fact they were being made to wait weeks or months.

And then, 2 years ago, the Government Accountability Office reported that VA schedulers were fudging wait times for veterans seeking outpatient care and avoiding using the electronic waitlist as required. The GAO report includes a response from Shinseki's chief of staff at the time, writing that the VA has "proactively taken steps in response to GAO's findings." Clearly that didn’t happen.

Meanwhile, Southern California is on fire. Actually nine fires are burning in the greater San Diego area and they have already destroyed more than 10,000 acres, forcing evacuation of about 125,000 residents. California Governor Jerry Brown has declared a state of emergency to free up resources. It’s hot, it’s dry, and it’s just the start of the fire season.

The 2014 fire season is repeating a pattern of destruction established over the past decade by a combination of high temperatures, parched vegetation and more people living in wooded areas. Fires feeding on plentiful dry grass, brush and hardwood are requiring more personnel and money to bring them under control. More than twice as many acres burned across the US through May 9 this year than during the same period in 2013.

Last week, 96% of California was considered to be under “severe” or worse drought conditions, with about 4% of the southeastern tip of the state still in “moderate” drought conditions. A year ago, only 46% of the state suffered from “severe” or worse conditions. As of today, the National Drought Mitigation Center reports severe drought conditions now engulf 100% of California.

Meanwhile, former Treasury Secretary Tim Geithner is trying to polish his tarnished image; he’s on a book tour peddling the notion that the Wall Street bailout was a huge success. And while it might be argued it prevented a Great Depression, it is delusional to consider it a success. It was at best an experiment that did not result in a worse catastrophe. It did little or nothing for the tens of millions of Americans who lost billions of dollars in home equity and savings, and the millions more who lost their jobs. The toll was greatest on the poor and the middle class. Nor have reforms been enacted that will help the middle class and the poor the next time Wall Street implodes.

Economic data today showed industrial production in the US unexpectedly declined in April, held back by a plunge in utilities as temperatures warmed and a broad-based decrease in manufacturing. That contrasted with a higher-than-forecast reading on the Fed Bank of New York’s gauge of regional manufacturing, which climbed to 19.01 this month, from 1.29 in April.

Initial claims for state unemployment benefits declined 24,000 to a seasonally adjusted 297,000 last week. It was the lowest reading since May 2007.

Consumer prices recorded their largest increase in 10 months in April. The Consumer Price Index increased 0.3% last month as food prices rose for a fourth consecutive month and the cost of gasoline surged. In the 12 months through April, consumer prices rose 2.0%. Stripping out food and energy prices, the so-called core CPI rose 0.2% after advancing by the same margin in March. In the 12 months through April, the core CPI increased 1.8%, the biggest gain since August last year.

Normally you might expect higher inflation numbers to result in lower bond prices, which means bond yields would move higher; not today. The yield on the 10-year Treasury note dipped below 2.5% intraday. Of course, Treasuries are considered a safe haven investment, and it seems a lot of people are looking for a calm port in a stormy world.

Wednesday, January 29, 2014 - Benny Jets

Benny Jets

by Sinclair Noe

DOW – 189 = 15,738
SPX – 18 = 1774
NAS – 46 = 4051
10 YR YLD - .07 = 2.67%
OIL – 01 = 97.40
GOLD + 12.00 = 1268.70
SILV + .15 = 19.81

You’ve heard the old post office creed; “neither snow nor rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed rounds.”

Generally true, however I bet some letter carriers are having a tough time delivering mail in Atlanta today. The Federal Reserve apparently has a creed. Who knew? Neither a disappointing December jobs report nor turmoil in emerging markets nor gloom of the US economy shall stay these central bankers from the incremental completion of their taper.

Don’t worry; nothing to look at here; keep moving, keep moving. No sonny, that’s not a train wreck on Wall Street, that’s just the debris and detritus stirred up by the whirlybird which will now carry Helicopter Ben into the sunset, or more accurately to the boardroom of some investment bank. Yes, this is the last FOMC meeting for Ben Bernanke. He promised he would set a course for exiting QE, and he has; the problem is that the set course is fraught with perils.

The Federal Reserve’s policy making Federal Open Market Committee wrapped up a two day meeting today by announcing they would cut back their bond buying program by $10 billion, to a mere $65 billion per month.  The FOMC added that it was “likely” to continue the pullback, suggesting a similar cut is probable at its next meeting, in March. The stock market fell for the fifth session out of the past six, wiping out yesterday’s gains, but stocks were already moving lower before the Fed announcement.

While noting recent weakness in the housing sector recovery the FOMC statement says the overall economic picture continues to improve. And then the statement included a little slap on the wrist for Congress: “Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.

The Fed reiterated their view that "risks to the outlook for the economy and the labor market as having become more balanced," language they added to the statement for the first time in December. They reconfirmed that they will likely keep interest rates in the near zero range even if the unemployment rate drops below the target of 6.5%. And just remember your mantra: tapering is not tightening, tapering is not tightening.

And if taper leads to a little turmoil in emerging markets, well what’s it to you? The Fed pullback is contributing to a global shift in investments. That is causing problems for countries like Turkey, which would the example du jour.  The central bank in Turkey tried to bolster that nation’s currency yesterday by sharply raising its benchmark interest rate. The Turkish central bank increased the rate for one-week loans to banks to 10% from the previous level of 4.5%. The idea was to lure investors with a better yield, instead it may be causing collateral damage to the rest of its economy.

And today, the Turks learned the meaning of the old axiom, “don’t fight the Fed”, as the Turkish lira slumped, along with other emerging market currencies. The Russian ruble took another hit, the Argentine peso continued to plunge, and the South African rand could not be shored up. The South Africans raised rates a more subtle half-percent from 5% to 5.5%.

We used to identify the fast growing emerging markets as BRICS – Brazil, Russia, India, China, and South Africa. Now the new catch phrase is the “fragile five” and it refers to the emerging economies of Turkey, Brazil, India, South Africa and Indonesia as economies that have become too dependent on skittish foreign investment to finance their growth ambitions. The term has caught on in large degree because it highlights the strains that occur when countries place too much emphasis on stoking fast rates of economic growth.

Actually, the emerging market turmoil may be working in the Fed’s favor. Investors concerned about emerging market risk are seeking out the safe haven of Treasury bonds, bidding up prices and pushing down yields even as the Fed pulls back from bond purchases. But there are limits to how low the Fed can push emerging market currencies. The declines could come back to bite the developed economies of the US, Europe and Japan. Developing countries have served as engines of global growth, but now they find their purchasing power diminished and that equates to buying fewer exports. The direct effects of the recent emerging market foreign exchange turbulence, if contained, are not likely to prove substantial, but that’s based on the idea that things don’t deteriorate from here.

It makes for challenging times for the central bankers of emerging economies. The flight of foreign capital, which is a primary reason for the currency declines, is a result of investors’ putting money back into developed countries as their economies improve. To counteract the outflow of capital, the policymakers lure investors with higher interest rates but higher rates put the brakes on economic growth. And currency investors know this and bet that the central banks won’t be able to keep rates high for long. Sure enough, in today’s case of the Turkish central bank, the currency sharks smelled blood and they killed off the policymakers last vestiges off credibility.

All the blame for the problems in Turkey can’t be laid at the feet of the Fed; the Turks had a big mess before the taper. There has been an extensive corruption probe against the government and Prime Minister Erdogan responded by purging the judiciary and the police force.

The world can be chaotic at times, but we usually muddle through, except when it gets too crazy. Whenever we talk about emerging market turmoil, we’re reminded of 1997, when the Fed raised rates just a little and a few months later, the hot money went flying out of the developing Asian markets, then Russia defaulted, Long Term Capital Management missed that bet, and wham, bam, it was a meltdown man.

Of course, back then we didn't have hundreds of trillions of dollars in derivatives to contain the risk. Nowadays we have more than a quadrillion in derivatives to protect us. What could go wrong?

And that brings us to our next question of the day: what the heck is a MyRA?

Did you catch that last night during the State of the Union speech? A quick and stumbling reference to My-aye-aye-aye-RA. Obama promised to use executive action to create a new middle class savings vehicle, although he didn’t explain what it was. So, the White House issued a briefing sheet to explain that the MyRA, or My Retirement Account, is a new simple, safe and affordable “starter” retirement savings account that will be available through employers and help millions of Americans save for retirement. This savings account would be offered through a familiar Roth IRA Account and, like savings bonds, would be backed by the US government.

The administration noted that many private-sector providers don’t allow “smaller balance savers” to open accounts; providers who do allow such accounts often charge fees that can eat up a proportionately high percentage of their balances. In his address, Obama described the myRA as “a new savings bond” that “guarantees a decent return with no risk of losing what you put in.”

Today, Mr. Obama signed a presidential memorandum to create the "myRA" program, which he told employees would go toward "making sure that after a lifetime of hard work you can retire with some dignity." The retirement accounts can be opened with as little as $25, and monthly contributions can be as little as $5, automatically deducted from paychecks. The program will operate like a Roth IRA, so contributions would be made with after-tax dollars. That means account-holders could withdraw the funds at any time without paying additional taxes.

The funds would be backed by US government debt, similar to a savings option available to federal employees, and earn the same variable interest rate return as the Thrift Savings Plan Government Securities Investment Fund accounts that federal employees enroll in. Investors could keep the accounts if they switch jobs or convert them into private accounts, and once the account reaches $15,000 funds must be withdrawn or it can be rolled over into a private sector Roth IRA. Treasury Secretary Jack Lew will be in charge of setting up the program and it should be available through some employers by the end of the year. Workers can invest if they make less than $191,000 a year. Businesses will not administer or run the accounts. They will simply offer them to their employees if they decide to participate.

There are still some details of the plan that are not quite clear. The Federal Thrift Savings Plan caps contributions to 10%, and there are rules on what investments are made. Already we are hearing the loons come out with conspiracy theories. This is not – repeat NOT – an effort to confiscate existing IRAs. It is a little like the old Savings bonds that you used to buy, which were actually a decent deal; not a big wealth builder but a decent savings vehicle.

There was plenty more to the State of the Union speech, but you probably slept through that part, so I’ll give you a quick recap: The state of the union is absolutely fantastic for the top 1%, and for about 25% it’s decent, and for the rest of the country things are pretty lousy. Fifty years after the declaration we can now announce that the War on Poverty has been won. The poor and the middle class have been defeated. 

Friday, January 24, 2014 - Bulls, Bears, and Bonuses

Bulls, Bears, and Bonuses

by Sinclair Noe

DOW – 318 = 15,879
SPX – 38 = 1790
NAS – 90 = 4128
10 YR YLD - .04 = 2.73%
OIL - .41 = 96.91
GOLD + 4.40 = 1270.00
SILV - .11 = 20.01

The Dow has fallen every day this week, leaving it down more than 3%. That decline is the Dow's worst weekly performance since mid-May 2012. Meanwhile, the S&P 500 is down 2.5% since last Friday. That's the index's worst weekly slide since early November 2012.

All of the sudden, everybody seemed concerned about political and economic problems in Turkey, Argentina, and of course, China. The Turkish lira hit a record low and the South African rand fell to five-year low against the dollar. The Argentine peso had its sharpest decline in 12 years, going back to the 2002 financial crisis in that country; and the government abandoned its long standing policy of intervening to support the peso currency. Such moves are crucial factors for big, institutional foreign investors because exchange rate losses can easily wipe out any gains in stocks and bonds of emerging countries.

Right now, the losses haven’t turned into a rout, but there is concern that the turn may push big institutional investors to cut losses and run as the effect of falling currencies becomes too painful to bear. Every emerging market crisis is first-and-foremost a currency crisis. For example, South African government debt was slightly positive in rand terms in 2013. But in dollars terms, it lost more than 18%. Fund tracker EPFR estimates emerging equity and bond funds have seen outflows of almost $5 billion so far this year, on top of $58 billion of losses seen in 2013. EM equity funds have had 13 consecutive weeks of outflows, the longest run in 11 years.

What we haven't seen in emerging markets is major currency devaluation, a run on government debt or ratings downgrades. Any combination of those would suggest a major move where developing countries could experience sudden stops in their access to global capital, or some event that throws economies into a balance of payments or financial crisis. What we have seen and might continue to see is emerging market currencies falling, possibly big drops, as the yield on the 10 year Treasury note moves higher; which is expected to happen as the Fed cuts back QE3.

For several years, the world’s emerging markets seemed to be the main beneficiaries of two global trends: very rapid growth in China and the Federal Reserve’s various accommodative monetary policies, which injected huge amounts of capital into global markets. Since the Fed officially announced in December that it would ease its bond-buying stimulus, investors in emerging markets have been cautious. There are fears that rising interest rates will choke off growth in countries dependent on foreign lenders.

And for many years emerging markets have been able to sell resources to China, as China emerged as the world’s biggest producer and biggest market for everything from steel to coal to cars, the demand from China for raw materials soared year after year. Investors have committed tens of billions of dollars to emerging market projects aimed at meeting China’s voracious demand, and now Chinese demand is softening. Chinese economic growth slowed to 7.7 percent last year and the latest surveys of manufacturers in China show that with the exception of a few exporters, expectations about future sales are falling. The result in recent days have been waves of cash flowing out of emerging markets and into industrialized countries, notably the United States; but the  money has been going into the safe haven of Treasuries, rather than into the stock market.

It was just a few days ago that most people were bullish. Even the Fed’s taper at the December meeting was hailed as proof that the economy was improving. Earnings season has been less than exciting but we haven’t had massive misses, except for maybe IBM, Best Buy, Coach, Intel, Citigroup, and a few others; but nothing out of the norm. For the most part, Wall Street continues to pump up expectations, and there are still a few high flyers like Netflix, even if they are selling at 326 times earnings with almost zero in actual free cash flow. The Fed FOMC meets next week to determine their next moves on monetary policy and they are expected to continue with more tapering. Equities on Wall Street seem to have been shaken by the same fears that have hit the global equity markets; or maybe that’s just an excuse for a long overdue pullback. Your guess is as good as anybody.

In a TV interview today, Attorney General Eric Holder said no American financial institution is too large to indict and no bank executive immune from criminal prosecution. Holder cited the case of JPMorgan, which in November agreed to a civil settlement under which it would pay $13 billion to end a series of government investigations into its sales of toxic mortgage backed securities. It was an interesting case for Holder to cite because you may recall JPMorgan was not indicted and no major JPMorgan bank executives have faced criminal prosecution.

In December, Holder said the Justice Department plans to bring civil mortgage fraud cases against several financial institutions early in 2014, using the JPMorgan case as a template. Civil not criminal. Today, Holder said: "There are no institutions that are too big to indict," and "There are no individuals who are in such high level positions that they cannot be indicted, criminally investigated." Holder’s timing is delicious.

Jamie Dimon, JPMorgan’s chief executive, just got a big raise. Dimon’s pay increased to $20 million for 2013, up from $11 million the year before. The bank’s board of directors approved the increase even though a steady stream of scandals and a raft of regulatory actions have in recent months cast doubt on Dimon’s leadership at the nation’s largest bank. The big raise for 2013 came in the face of opposition from a vocal minority of board members.

Over the course of the year, the bank agreed to a series of high-cost legal settlements, including the $13 billion claim. Dimon led JPMorgan while it committed what government investigators have identified as over 15 frauds, most of them massive. These frauds represent the greatest financial crime spree the government has ever identified. In January of last year, the Federal Reserve and the Office of the Comptroller of the Currency imposed sanctions on the bank for weak risk and financial controls, as well as deficient safeguards against money laundering and violations of the Bank Secrecy Act, over the 2012 derivatives loss; total legal expenses topped the $20 billion mark.

The bigger the frauds committed by JPMorgan under Dimon’s watch, and the larger the settlements, the greater the value that Dimon brings by way of getting the government to settle cheap, and not tear down the bank and put people in jail. JPMorgan’s board must be really satisfied with Dimon’s ability to negotiate a deal with regulators. The directors don’t bear the cost of Dimon’s bonuses. Dimon negotiations with the government ensure that the shareholders bear all the losses of the obscenity of giving Dimon a raise to reward the crime spree that occurred while he was both the CEO and chairman of the board of JPM.

The regulatory and prosecutorial response to JPM’s crime spree has failed to hold a single senior officer or director personally accountable either civilly or criminally. The officers who control the bank are delighted to use bank funds to negotiate deals in which there are large fines, but the government does not prosecute the officers or seek to claw bank their compensation and seek damages from them. The DOJ treats JPM as “too big to fail.” This means that the DOJ will never require JPM to pay the full cost of its frauds and disgorge the full extent of its fraud proceeds if doing so could even come close to creating a concern that JPM would lack adequate capital. This gives Dimon a crushing negotiating leverage.

Holder has zero prosecutions of the elite bankers whose frauds drove the worst financial crisis since the Great Depression. Holder has zero civil cases, and the banking regulators have zero enforcement actions, that bankrupted an elite bank officer or director whose frauds helped drive the crisis. JPMorgan, Washington Mutual, and Bear Stearn’s boards of directors made the officers who led the frauds wealthy for over a decade through their compensation and bonus deals.

So, I’m not sure what Attorney General Holder was really talking about. There are no criminal indictments; JPMorgan has violated multiple laws with impunity; Jamie Dimon gets a big bonus.

Meawhile, the Financial Stability Board, which coordinates regulation for the Group of 20 leading economies, is reported investigating manipulation in the foreign exchange markets, or Forex, and is working on a reform of interest rate benchmarks after the Libor interbank rate-fixing scandal. Britain's Financial Conduct Authority (FCA) and the US Department of Justice have been investigating allegations that traders at some of the world's biggest banks manipulated the largely unregulated $5 trillion-a-day foreign exchange market. In the foreign exchange probe, groups of senior traders are alleged to have shared market-sensitive information relevant for London fix, which is set at 4 p.m. London time, using actual trades.

Just a reminder that so far, we haven’t fixed anything, and everything, every market is rigged.